## **Learning Outcomes**

After studying this article, you will be able to construct and interpret a cash flow forecast, explain key liquidity control techniques, and describe how to manage relationships with banks to support effective working capital management. You will also learn how cash flow information underpins short-term borrowing and investment decisions and the main features and risks of banking arrangements relevant for exam questions.

## **ACCA Financial Management (FM) Syllabus**

For ACCA Financial Management (FM), you are required to understand the importance of cash forecasting and how liquidity is controlled within an organisation, as well as the role of banks in finance and risk management. Specifically, revision should focus on:

- The role and preparation of short-term cash flow forecasts to determine future cash flows and balances
- The use and limitations of cash budgets
- Strategies to manage cash surplus and deficit situations
- The main liquidity control techniques, including use of bank accounts and short-term finance or investments
- Effective management of banking relationships, including selection, negotiation, and monitoring of bank services
- Understanding risks associated with bank arrangements and methods to reduce these risks

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. What is the primary purpose of a cash flow forecast within working capital management?
2. Name two liquidity control techniques that a company might use to avoid a cash shortfall.
3. Why is effective bank relationship management important to an organisation’s liquidity?
4. True or false? Relying on a single banking provider for all cash management needs poses no risk to the business.

## **Introduction**

Cash forecasting and the control of liquidity are essential to the day-to-day survival of any business. Even profitable companies can fail if they run out of cash, making careful management of immediate and future cash requirements central to the financial manager’s responsibilities. Accurate forecasting enables timely actions to avoid cash shortfalls or to invest surplus funds appropriately. At the same time, organisations need to manage their relationships with banks, as these institutions provide critical facilities, services, and advice supporting liquidity and risk management.

> **Key Term: cash forecasting**
> The process of estimating the cash inflows and outflows of an organisation over a specific period, typically to identify periods of cash surplus or deficit and support financial planning.
>
> **Key Term: liquidity control**
> The range of techniques and internal policies used to ensure an organisation maintains enough cash or access to cash to meet its payment obligations as they fall due.
>
> **Key Term: bank relationship management**
> The systematic process of establishing, monitoring, and negotiating the terms and quality of services provided by a bank to ensure they support an organisation’s financial needs.

## CASH FORECASTING AND LIQUIDITY CONTROL

### The role of cash forecasting

A cash forecast predicts expected receipts and payments over a given period—typically days, weeks, or months. Its primary function is to inform management of expected cash shortages and excesses, enabling appropriate action to prevent insolvency or to earn a return on excess funds.

Short-term cash forecasts are critical for:

- Prioritising payments and collections
- Planning short-term borrowing or investments
- Satisfying external stakeholders, including banks and investors

Accurate forecasting reduces the risk of running out of cash and increases the chances of obtaining favourable terms when arranging finance.

### Preparing a cash flow forecast

A forecast starts with anticipated receipts (such as customer payments, loan proceeds, or asset sales) and payments (like payroll, supplier invoices, tax, and loan repayments), mapped onto a timeline reflecting when each will actually be received or paid. The result is a projected net cash flow for each period and a running closing cash balance, allowing management to spot negative balances in advance.

#### Common features of a good cash forecast

- Inclusion of only cash-based items (e.g., not depreciation)
- Realistic timing for each item, reflecting credit terms and known delays
- Regular review and update as actual results and expectations change

### **Worked Example 1.1**

A business expects the following cash flows in April:

- Receipts: \$100,000 from customers (received 30 days after sale), \$20,000 from a loan repayment
- Payments: \$60,000 to suppliers (paid after 45 days), \$10,000 wages, \$5,000 utilities

Prepare the cash forecast for April, assuming sales and purchases have been even in previous months.

> **Answer:**
>
> - Receipts in April: include only receipts actually due—customer payments from March sales, plus the loan repayment.
> - Payments: wages and utilities for April, supplier payments related to purchases made in mid-February to mid-March (due after 45 days).
> - The predicted April closing cash balance allows management to anticipate any cash deficit and take action (arrange overdraft, delay a payment, etc.).

### Limitations of cash forecasts

Cash forecasts cannot prevent cash problems unless acted upon. They also:

- Rely on the accuracy of inputs—unrealistic sales or cost assumptions will reduce reliability
- May not capture unexpected receipts or payments
- Become less reliable the further into the future they project

### Liquidity control techniques

Once a cash forecast identifies periods of shortfall or surplus, the financial manager must decide how to source or deploy cash. Common liquidity control methods include:

- **Overdrafts:** Arrangements with banks to temporarily borrow up to an agreed limit. Flexible but often more expensive than agreed loans.
- **Short-term loans:** Used to cover specific predicted shortfalls. Usually fixed maturity and less flexible.
- **Investment of surplus cash:** Short-term money market investments (e.g., treasury bills, certificates of deposit) allow idle cash to earn a return, while remaining accessible.
- **Centralised treasury management:** Companies with multiple sites can hold minimal cash at individual branches, remitting surplus to headquarters for central management (cash pooling).

> **Key Term: centralised treasury management**
> The approach of managing an organisation’s liquidity, investments, and borrowings from a single head office location or treasury unit to achieve a group-wide optimal cash position.

### Policies for managing fluctuating cash balances

Effective policies may include:

- Setting minimum operating balances for all accounts
- Automatic sweeps of surplus funds into short-term investment accounts
- Pre-arranged lines of credit with banks to cover sudden needs

### **Worked Example 1.2**

Company Z forecasts its account will fall into overdraft by \$75,000 halfway through next month, but will have a \$100,000 surplus by the end of the month. What action should the treasurer take?

> **Answer:**
> Arrange an overdraft facility or short-term loan to cover the temporary deficit, and plan to invest the surplus when it arrives, ensuring neither excess borrowing nor surplus cash sits idle for long.

### Bank relationship management

Managing the relationship with the bank is not just about good communication—it is about ensuring services remain suitable, terms are competitive, and risks (such as withdrawal of facilities) are kept low. Key steps in bank relationship management include:

- Maintaining clear contact points and regular reviews of account activity
- Negotiating and reviewing charges and interest rates
- Obtaining competing quotes for major services (e.g., loans, foreign exchange)
- Avoiding excessive reliance on a single bank provider (“single bank risk”)

> **Key Term: single bank risk**
> The risk that arises when a company relies too heavily on one banking provider for its day-to-day or funding needs, increasing vulnerability to withdrawal of facilities.
>
> **Key Term: bank covenant**
> A contractual obligation imposed by the bank as a condition of lending—such as maintaining certain financial ratios—to control the lender’s risk.

### **Worked Example 1.3**

A financial manager finds that her company pays a higher interest rate on its overdraft than industry peers. What bank relationship management actions should she take?

> **Answer:**
> She should review current fee and interest terms, obtain quotes from alternative banks, and approach her existing bank to negotiate improvements. If terms cannot be improved, consider switching part of business to another provider.

### Managing risk in banking arrangements

Risks in bank arrangements can include:

- Withdrawal or reduction in facilities (especially if a covenant is breached)
- Bank failure or reputational issues
- Poor service—delays, errors, or inadequate advice

Management can reduce risk by:

- Monitoring compliance with covenants
- Maintaining relationships with more than one bank if appropriate
- Following up on service level failures and documenting negotiations

### **Exam Warning**

> Relying entirely on a single bank for all funding and payments needs may leave the business vulnerable if circumstances change. The FM exam may require you to discuss the pros and cons of single versus multiple bank relationships.

### **Revision Tip**

> Prepare to illustrate your answers with examples of how cash flow forecasting and good bank management can avoid business failure—even in otherwise profitable organisations.

## **Summary**

Cash forecasting and liquidity control are essential to the ongoing survival of any organisation. Cash forecasts help anticipate shortages or surpluses, guiding the use of overdrafts, loans, or short-term investments. Careful management of the bank relationship ensures the necessary facilities and support are in place, reduces risk, and may lower costs. Together, these elements underpin effective working capital management and are frequently tested in the ACCA FM exam.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- The role and preparation of cash flow forecasts in liquidity management
- Limitations and best practice in cash forecasting
- Liquidity control techniques: overdrafts, loans, and short-term investments
- Principles of centralised treasury management
- How to manage banking relationships to support business needs
- Risks in banking arrangements and how to mitigate them

## **Key Terms and Concepts**

- cash forecasting
- liquidity control
- bank relationship management
- centralised treasury management
- single bank risk
- bank covenant

Cash forecasting and liquidity control - Bank relationship management