Creating a cash flow forecast
7-step guide to setting up your cash flow statement using the indirect method
1. Brush up
In case you need a brush-up on the cash flow statement, check out our explanation of how cash flow statements work in our accounting academy.
In Francis, cash flows are estimated indirectly via the P&L and balance sheet. With the indirect method, cash flow is calculated by taking net income and adjusting for non-cash transactions as well as adding or subtracting differences on the balance sheet.
2. Calculated rows
As cash flows are estimated using the indirect method, all cash flow items are derived from items on the income statement and balance sheet. When modeling your cash flow statement in Francis, always use calculated rows. Calculated rows are characterized by the following properties.
Calculated rows are formula-consistent over time. I.e., always include the same formula.
Actuals are not imported from external data connections but are derived from other rows.
3. Cash flow categories
Organize your cash flow statement into three primary categories: operating activities, financing activities, and investment activities. While these are the standard sections, you have the flexibility to add more categories or subcategories as required by your financial model.
Operating Activities: This section focuses on the cash flows that arise from your company's core operations. Start with the net income for the period and make adjustments to reflect the cash components, e.g., add back depreciation.
Financing Activities: This section captures cash flows from external financing sources. It encompasses activities related to issuing debt or equity.
Investment Activities: Account for cash inflows and outflows linked to acquiring or disposing of long-term assets. It's crucial to remember that accumulated depreciation is not a cash item and should be excluded from this section.
4. P&L and balance sheet
Since the cash flow statement is derived from movements in the P&L and balance sheet, you'll need to ensure that these are set up correctly before modeling your cash flow statement. Start by structuring your P&L and balance sheet to your liking and then map your chart of accounts accordingly.
5. Cash and retained earnings
Cash and retained earnings link the financial statements together and should be forecasted in specific ways. Read more about cash and retained earnings here.
6. Forecast the P&L and balance sheet
As cash flow statements are derived indirectly in Francis, the prerequisite to forecasting cash flows is to first have forecasted all P&L and balance sheet items.
Forecasting balance sheet items can sometimes feel more tricky than forecasting P&L items. For a more comprehensive guide on forecasting balance sheet items, check out our guide on forecasting methods, more specifically fixed assumptions and prior month's balance.
7. Formulas for cash flow categories
The indirect method dictates that cash flow movements are a product of the P&L and changes on the balance sheet. Consequently, cash flow values are calculated by referencing the P&L and balance sheet items. When referencing balance sheet items remember to work with deltas, i.e. calculate the difference between this month's value less last month's value.
Assets Differences in assets should be subtracted. Increasing assets lead to decreasing cash flow.
Liabilities and equity Differences in liabilities and equity should be added. Increasing liabilities or equity lead to additional cash flow.
Almost all balance sheet items, except items like cash, retained earnings, and accumulated depreciation, should be included in a category to ensure that all balance sheet movements are accounted for.
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