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Cashflow Forecasting

Many business, during the course of a year, will fluctuate between positive and negative bank balances. The chart below depicts a business that has a positive bank balance in January, April, May, June, October, November and December. It also has a negative bank balance in February, March, July, August and September.

So how can a business have a negative bank balance? What does this mean?

The answer is that a business can have a negative bank balance if it has an Overdraft. An Overdraft is a facility whereby a bank allows a business to continue to draw funds even when it has exhausted all the funds in its account. In such a situation, where the business's bank account goes below zero, the business is in fact using the bank's money to pay its bills.

Usually a bank imposes an Overdraft Limit, that is a limit to how much the business goes below zero in its bank account. If the overdraft limit is set to $10,000, then the business must not go beyond a negative $10,000 bank balance.

A bank is in business to make a profit, and so businesses that want to set up an overdraft are usually charged a fee by the bank for this privilege.

Chart of Bank Balance

The main purpose of cashflow forecasting is to predict what will happen to the bank balance. It is important for a business to know when it is likely to run out of funds in its bank account, and by how much.

If the business knows (by creating a cashflow forecast) when it will run out of funds, arrangements for an overdraft facility can be made in a timely fashion.

Generally, a bank will not create an overdraft facility unless it feels that the business has the capacity to repay the borrowed money.

Therefore the cashflow forecast has two main benefits:

  1. It predicts when the business will need an overdraft
  2. It helps to assure the bank manager that the business will recover to a positive bank balance.

In the illustration above, the business slips into a negative bank balance at the end of June, but recovers and moves back to a positive bank balance in October.

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