3 - Forecasting cash flows: quantitative techniques and routes

Summary

Forecasting is important in all facets of business. A supermarket needs to forecast the demand for different types of cleaning agents, soft drinks and meat products. A car manufacturer has to forecast the demand for the different types of cars it produces. A farmer must forecast the demand for a variety of crops when deciding what to plant next spring. A government must forecast its tax revenue in order to design its budget each year. A business corporation needs to forecast the future requirement of different types of labour inputs, raw materials, machines and buildings as an integral part of its business processes. All business firms have to plan for the future. The success of a business firm is closely related to how well management is able to anticipate the future and develop suitable strategies. No business organization can function effectively without forecasts for the goods and services it provides and the inputs it purchases.

In project evaluation, the ‘cash flows’ of a proposed project refer to expected future cash flows of that project. The reference is not to past or historical data, but to future data expected from the proposed project. Perhaps the most critically important task in project appraisal is the forecasting of expected cash flows. The cash flows form the basis of project appraisal. If the cash flow estimates are not reliable, the detailed investment analyses can easily lead, regardless of the sophisticated project appraisal techniques used, to poor business decisions.