Financial Statements or Cash Flow Forecast

Which one should you be paying the most attention to?

Some of the most frequent questions that I get asked in my consulting practice are around financial statements and cash flow forecasts. For example:

1.     If I have a cash flow forecast, why do I need formal financial statements?

2.     Which is the more important of the two?

3.     Why doesn’t my cash flow forecast match my budget?

4.     Is my cash flow statement the same as my cash flow forecast?

Often business owners and managers will look at the cash flow forecast and see that they have sufficient cash coming in for ongoing operations and conclude that the company is doing well. The problem is that the cash flow forecast does not address the profitability of your company. It is a model of the future and is as good as the inputs and modelling software used. Many assumptions are made in preparing a cash flow forecast and there are several software programs that the cash flow can be modelled in, including Excel, Dryrun and others.

To get a better understanding of this issue, we will take each of these questions in order.

1.     The cash flow forecast vs financial statements is the most common question I get. This is because, for most small to medium-sized business owners, the most important data is where am I going, not where have I been. The cash flow forecast is forward-looking, what you are expecting in your business, whereas the financial statements tell you where you’ve been.

2.     Cash flow forecasts and financial statements are both valuable in their own way but it's important to understand the difference between them. Financial statements are made up of the Income Statement, Balance Sheet, Statement of Cash Flows and Statement of Owner’s Equity. The Income Statement reports on your company’s profitability over a period, usually a month or a year. The Balance Sheet is a snapshot of your assets, liabilities and shareholders equity. It shows the company’s resources as well as its capital (debts and owners’ equity). The Statement of Cash Flows shows how the company’s money was used, whether for operations, investing or financing.

The Cash flow forecasts are internal management documents that are an estimate of future cash coming into and out of your company. If you are applying for a loan or bringing in an investor, they will most likely ask for both sets of reports.

3.     Cash flow forecasts are not the same as the budget, but both are forecasts of future events. Cashflow forecasts are dynamic but narrow in focus and look only at when your company receives and spends cash. They are usually updated on a weekly or monthly basis. A budget on the other hand is static, it is usually prepared before the start of the fiscal year and should not change over the year. The budget is based on aspects of the company's operations and can be broken down by department or division. Often, the budget includes KPIs that affect bonuses and other incentives for employees.

4.     Cash flow forecasts and Cash Flow Statements are also known as Sources and Uses of Cash and are often confused with each other. As previously stated, a cash flow forecast is a forecast of future events while the Statement of Cash Flows is a formal financial statement that gives a view of how money was used in the past fiscal year.

To answer the question in the subheading, you need to pay attention to both the cash flow forecast and the financial statements. They provide different but vital information to your company.

References:

Corporate Finance Institute, Sources and Uses of Cash Schedule, February 20, 2022; https://corporatefinanceinstitute.com/

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