Sales and cash collection forecast

- To create a good cash budget, you need a good cash collection forecast. We can use a company's historical cash collection patterns and current information about expected sales to create a cash collection forecast. Creating accurate sales forecasts is a topic all on its own. In this introduction, let's consider two important factors that should be remembered when creating a sales forecast. First, the historical trend and second, the impact of current plans. Let's work with a simple numerical example. Spencer Company had sales last year of $1,000. For the past five years, Spencer has done business out of 10 store locations. The average overall sales growth rate has been about 8% per year. This year, in addition to continuing to operate these same 10 store locations, Spencer has decided to open one new store. To keep things simple, let's say that Spencer plans to open this store on January 1st and that the store will be fully functional and ready for business on that first day of the new year. Okay. So what is your forecast of Spencer's sales for the coming year? Now, if you just put Spencer's historical numbers into a spreadsheet and do a quick growth rate extension, you will get forecasted sales for the next year of $1,080, continuing the 8% annual growth rate seen over the past five years. But this myopically-focused historical extrapolation, completely ignores the existing expansion plan. That new store will add more sales beyond the increase in same-store sales. If we use last year's value of $100 in sales per store, that's $1,000 in sales divided by 10 stores, then the addition of the new store will bump the forecast up from 1,080, from same-store sales, to 1,180. That's 1,080 same-store sales plus $100 from the new store. In addition, a simple historical extrapolation ignores any changes in the competitive environment, in the broader economy or in customer tastes. The historical trend is the starting point for a forecast of future sales. Those historical data should be augmented with as much detail about possible expansion plans or contraction plans. Now, let's move from a sales forecast to a cash collection forecast. Here are sales and sales forecasts for December, January and February for Jude Company. Note, we are imagining ourselves as beginning at January 1st. The December sales, they've already happened. And the January and February sales numbers represent forecasts. All of Jude Company's customers are credit customers. Historically, 20% of those customers have made cash payments in the month of sale. And 80% have paid cash in the month following the sale. So, here's the question. What is the forecasted amount of cash to be collected in January and February? Well, let's do the computations for January. First, it's expected that 20% of the January credit sales will be collected in January itself. That's $50,000 times 20% or $10,000. In addition, it's expected that 80% of the prior-month sales, that's in December, will be collected in January. That's $200,000 times 80%, which equals $160,000. Total forecasted cash collections in January are $170,000. That's $10,000 plus $160,000. We can do the same calculations for February. Here are the forecasted cash collections for January and for February. Remember, we're doing these calculations at the beginning of January. And even this simple example shows that sales forecasting and cash collection forecasting are not the same thing. Once the sales forecast has been generated, then the pattern and timing of cash collections must be considered. In this case, the one-month delay in most cash collections after the sale, means that January is a huge cash collection month even though sales are quite low in January. The reason for the huge cash collection in January is because of the delayed cash collections for sales made in December. An important tool in cash management is the forecasting of cash collections. This starts with forecasting sales, which involves incorporating both historical trends and current plans. To the sales forecast, we then add consideration of the timing of the cash collections of those sales.