In the previous article, we discussed the projected income statement. There we discussed he concept of revenues and expenses and also net profit. We also discussed the fact that the projected income statement is used by a variety of users like the project initiators, bankers and financial analysts. In this article, we shall discuss the projected cash flow statements.
Projected Cash Flow Statement – Meaning and Uses
It is important to understand and analyse the projected cash flows of the firm. We shall begin our discussion by defining a cash flow statement. A cash flow statement is a statement that shows the actual receipt of cash (inflows) and the disbursement of cash (out flows) of a firm or project. Having said that, we can now go ahead to define a projected cash flow statement.
A projected cash flow statement is a statement which shows the forecasts of actual receipts of cash (inflows) and the disbursement of cash (outflows) of a firm or project. There are many users of information contained in projected cash flow statements. The first user of the projected cash flow statement is the project sponsor or initiator.
The project sponsor or initiator is interested in knowing well in advance the future cash flows of the firm. This is important because the future financing needs of the firm have to be known well in advance. The project initiator needs to distinguish between credit sales and cash sales.
If the project initiator does not distinguish between credit sales and cash sales, then his/her project may suffer cash flow problems. The initiator may not be able to estimate the amount of cash needs of the project as well as timing of the cash needs.
Similarly, providers of finance especially the lending banks are usually very interested in the projected cash flow statement. They need to determine the firm’s ability to service debt. The debt in question may be existing debts or future debts. Ability to service debts is a function of future cash flows.
Projected cash flow statements assist us to evaluate a firm’s future performance and of course financial condition that enables the project evaluator answer the following questions.
• What is the nature of the firm’s projected cash flow statement?
• Will the projected cash flow be able to service the project’s debts (loan, overdraft + interest)?
• When will the project need financing and to what extent?
• How should the loan or overdraft or finance be structured?
• How stable are the cash flows?
The Structure of the Projected Cash Flow Statement
The basic format of the projected cash flow statement is displayed in Table 33 is a projected cash flow statement of a company. But it covers a period of only 3 months. You can project a cash flow as long as you require but the basic principles should be followed. If you examine Table 33 properly, you will realise that the projected cash flow statement is divided into two main sections, namely:
2. The cash outflows (outgoings)
We will now go ahead to break down the projected cash flow statement.
Table 34: A Three Month Projected Flow Statement Niger Limited Cash Inflows January
Table 34: A Three Month Projected Flow Statement Niger Limited
| Cash Inflows | January | February | March |
| Capital introduced | 10,000,000 | – | |
| Loan introduced | 20,000,000 | – | – |
| Cash sales | 40,000,000 | 50,000,000 | 60,000,000 |
| Total Cash Inflows | 70,000,000 | 50,000,000 | 60,000,000 |
| Cash Outflows | |||
| Raw material | 30,000,000 | 30,000,000 | 35,000,000 |
| Salary and wages | 2,000,000 | 2,200,000 | 2,500,000 |
| Office admin expenses | 500,000 | 550,000 | 600,000 |
| Electricity and gas expenses | 500,000 | 550,000 | 600,000 |
| Loan repayment | 2,000,000 | 2,000,000 | 2,000,000 |
| Interest charges | 400,000 | 400,000 | 400,000 |
| Selling expenses | 1,000,000 | 1200,000 | 1,300,000 |
| Total Cash Outflows | 36,400,000 | 36,900,000 | 42,400,000 |
| Cash Surplus/(Deficit) | 33,600,000 | 13,100,000 | 17,600,000 |
| Opening Cash Balance | – | 33,600,000 | 46,700,000 |
| Closing Cash Balance | 33,600,000 | 46,700,000 | 64,300,000 |
Cash Inflows
We have seen that a projected cash flow statement is broken down into the inflows and the outflows (outgoings). Let us now proceed to examine some of the key items contained in the projected cash flow statement. The items will vary from capital to loan introduced and also cash sales. We shall treat them individually.
Every firm or project should have a capital. At the time a project conceived or is being expanded, the owners of the firm usually bring in what is known as capital.
In a limited liability company, the share holders usually contribute the capital of the firm. In cash flow construction, capital is usually entered as an inflow. The reason is clear. When you introduce capital, you bring in cash.
Another item appearing in a projected cash flow statement is loan. In some cases, a project is funded through loan from banks.
The loan will usually have the following features:
1. The loan amount will be specific
2. The loan has an interest rate attached to it.
3. The loan will be repaid in agreed instalments.
The sales figure is the most important in a projected cash flow statement. Projections for sales pose one of the most difficult challenges in cash flow projections. We must quickly distinguish between total sales, credit sales and cash sales. Total sales are the total value of goods or service sold to third parties. Credit sales refer to sales for which payment is not made immediately. The figure for credit sales is usually transferred to the debtors list. Cash sales are the difference between total sales revenue and credit sales.
As far as we are concerned, the cash sale is the most important component of sales and it is the one that appears in the projected cash flow statement. Credit sales are only reflected in the cash flow when they are converted to cash. For example, if in January 2007, a company sells four cars at a credit of N10,000,000. In the cash flow for January 2007, there will be no entry for cash sales. But if in February 2007, the company receives a cash payment of N5,000,000, then that figure will appear in the inflows column for February 2007.
The basic rule is that only actual cash received is usually entered in the inflow column. In actual practice, projecting for cash sales will involve exhaustive consideration of the following:
• General economic outlook in the country
• The industry outlook. What is the demand situation like? What is the supply situation?
• What is the structure of competition and how fierce is it?
• What will be the effect of competition on prices in the firm’s area of operation?
Cash Outflows
Cash outflows or outgoings will include all expenses that use cash. They will include items like:
Sensitivity Analysis
Usually, when constructing a projected cash flow statement, the first set of projections is what we call normal estimates of cash flows. Normal estimates of cash flows especially cash revenues are based on all things being equal; but all things cannot be equal. A lot of things may happen.
In a market, supply can come from unexpected source and cause prices to fall. Prices of raw materials may rise suddenly and all these tend to reduce our earlier revenue projections and jack up expenses.
Sensitivity analysis provides the tool for subjecting a project’s cash flow s to adverse market situations. Sensitivity analysis seeks to adjust revenues for risk and also costs. In conducting sensitivity analysis, we say that we are adjusting a project’s cash flows for risk. If we conduct sensitivity analysis on a cash flow, we may do that by making one, two or three of the following assumptions:
• Due to intense competition the project will not be able to make the earlier normal sales volume. Cash revenues will drop.
• Due to excess supply, prices in the market will fall, that will reduce cash revenues.
• The prices of raw materials and other items will rise. A close examination will reveal that the impact of any of the above will have the effect of reducing the cash revenues of a project.
We now state that if a normal projected cash flow statement is reconstructed to accommodate the fact that the market could be worse, we say that the reconstructed cash flow is now called a risk “adjusted cash flow statement.” The risk- adjusted cash flow is a pessimistic cash flow and should be admired by analysts.
Table 34 is a risk-adjusted income statement reconstructed from Table 33.The critical assumption is that Table 34 assumes that only 75% of cash sales of Niger limited will be realised.
Sensitivity analysis is a tool for subjecting cash flows to risk analysis. The key objective of the sensitivity analysis is to forecast a worst-case scenario for a project.
Other ways of conducting a sensitivity analysis is to assume that expenses attached to a project will increase.
Table 35: A Three-Month Risk-Adjusted Projected Cash Flow Statement Niger Limited
| Cash inflows | January | February | March |
| Capital introduced | 10,000,000 | – | – |
| Loan introduced | 20,000,000 | – | – |
| Cash sales | 30,000,000 | 37,500,000 | 45,000,000 |
| Total Cash Inflows | 60,000,000 | 37,500,000 | 45,000,000 |
| Cash Outflows | |||
| Raw material | 30,000,000 | 30,000,000 | 35,000,000 |
| Salary and wages | 2,000,000 | 2,200,000 | 2,500,000 |
| Office admin expenses | 500,000 | 550,000 | 600,000 |
| Electricity and gas expenses | 500,000 | 550,000 | 600,000 |
| Loan repayment | 2,000,000 | 2,000,000 | 2,000,000 |
| Interest charges | 400,000 | 400,000 | 400,000 |
| Selling expenses | 1,000,000 | 1,200,000 | 1,300,000 |
| Total Cash Outflows | 36,400,000 | 36,900,000 | 42,400,000 |
| Cash Surplus/fDeficit) | 23,600,000 | 600,000 | 2,600,000 |
| Opening Cash Balance | – | 23,600,000 | 24,200,000 |
| Closing Cash Balance | 23,600,000 | 24,200,000 | 26,800,000 _____ |
CONCLUSION
We have discussed projected cash flow statements. We discussed the nature of cash flow statements and their users. We also examined the structure of cash flow statements. We used an example to show what a projected cash flow statement looks like. We also constructed a risk adjusted cash flow statement.
In this article we treated projected cash flow statements which we said constitutes a very vital document used in the evaluation of projects. The cash flow gives us a picture of cash inflows and outflows together with timing.
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