A pro forma cash flow predicts a business’s future cash flow, helping management identify potential cash flow shortages and operational problems. It lists sources of income and expenses, including fixed and variable costs, and is based on existing evidence. The accuracy depends on the time scale involved.
A pro forma cash flow is a statement that predicts the rate at which money will flow in and out of a business in the future. This can give company management an idea of whether they are likely to have to make temporary arrangements, such as loans, to cover cash flow shortages. It can also expose some fundamental problems with company operations that need to be permanently fixed.
Pro forma is a Latin phrase that translates as “as a matter of form” and is used in various contexts in the world of finance. For example, it may refer to a set of accounts that include additional details beyond those required by corporate accounting laws. In this case, it refers to the fact that the financial statements are prepared ahead of the time they cover and are therefore a forecast rather than a record, even if it is a forecast based on existing evidence.
When looking at the future of a business, it’s all too simple to consider how much the company will spend and how much it expects to earn. The timing of payments can be just as important. A pro forma cash flow helps identify problems that could occur when a profitable business falls short because payments and receipts are on a different schedule.
A pro forma cash flow begins with the existing cash balance for the company. Then list your sources of income and anticipated payment dates. For example, if a company supplies goods on credit, it may know in early February that it will receive a certain amount during the month that covers sales beginning in January.
The statement then discusses upcoming expenses. Part of this will be a fixed and regular sum, such as personnel costs. Other expenses will be known, but will only be paid at certain times, such as taxes. There will also be variable costs, such as buying stock or materials. When payment dates are variable, it is generally safer to work on the basis that the company will pay suppliers as soon as possible but will not receive payment from customers until the latest possible date.
The accuracy of a pro forma statement of cash flows depends on the time scale involved. A forecast covering the next 30 days could be taken as extremely reliable as the payments to be made and received during that time can already be known. This means that the forecast will be extremely accurate unless there are unforeseen problems, such as a customer going out of business before paying their bills. A forecast for the next 12 months may be less reliable as it will include estimates of future sales. This doesn’t make forecasting worthless: even if overall sales are unpredictable, a business owner can still get a pretty good idea of seasonal variations.
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