Strong businesses have a solid handle on their financial reality, and the cash flow statement is an excellent, if not the best, measure of a company’s ability to generate cash in excess of cash invested. Over a sufficiently long period of time, all businesses have to generate positive cash flow or they will go out of business.
1. Changes in receivables and payables.
Companies should set optimal accounts receivables and payables levels through corporate and financial strategy, then forecast those accounts according to their plan. The error is to simply grow A/R and A/P with sales.
2. Tax liabilities are another source of variability in projecting cash flows.
A business is not likely to be in touch with every tax change, and that is why the company hires tax professionals and advisers. Tapping into the expertise of the company’s accountants before the annual cycle begins is a good technique to avoid problems in the tax line.
3. The biggest cash flow statement error can start at the top: the income line.
The statement of cash flows is built upon the foundation of income delivered from the business’s operations, and errors in income projections can have a large impact on cash flows. One of the most common pitfalls in income statement projections is to incrementalize line items. Using the basic building blocks to drive forecasts does two things: it provides a solid structure to the operating performance of the business and it raises relevant questions all along the way.
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