Profitable companies run out of cash when the money arrives later than the bills, and idle companies pile up cash that earns nothing. The finance manager’s defence against both is to look ahead: to estimate month by month when money will come in and go out, and to see the surplus or shortfall before it happens, while there is still time to borrow, delay a payment or invest.
This topic covers why businesses hold cash at all (the three motives), the objectives of good cash management, the difference between a cash flow forecast and a cash budget, what a forecast is used for, and how to prepare one from sales, production and payment timings, with a full worked example and what to do with the answer. The next topic covers short-term investment and treasury management.
Cash flow forecasts appear throughout the course: they determine the funding need in the working capital strategy and the amount to invest in the cash models. Read early settlement discounts and trade payables first.
In 30 seconds
Businesses hold cash for three motives: the transactions motive (day-to-day payments), the precautionary motive (unplanned spending) and the speculative motive (taking up investment opportunities). Cash management balances minimising idle cash (profitability) against meeting obligations when due (liquidity), through forecasting, investing surpluses and deciding the optimal cash level.
A cash flow forecast estimates receipts and payments for a future period before any action to adjust them; a cash budget is the plan after such action. A forecast predicts liquidity, shows problems early, informs decisions and identifies funding needs. It is built from receipts and payments with their timing, excluding non-cash items such as depreciation.
Why a business holds cash
- Transactions motive: cash to pay expenses and settle debts as they fall due.
- Precautionary motive: cash held as a guard against unplanned or uncertain spending.
- Speculative motive: cash kept available to take advantage of investment or buying opportunities in the market.
Every organisation should balance minimising idle cash (which earns nothing, so profitability suffers) against being able to meet short-term obligations (liquidity). Cash management therefore has three aspects: forecasting cash needs and operating cash flows, finding investment opportunities for surplus cash, and deciding the optimal cash level, which the Baumol and Miller-Orr models address in the topic after next.
Cash flow forecasts and cash budgets
A cash flow forecast is an estimate of the receipts and payments for a future period under existing conditions, before taking account of actions to adjust the cash flow, raise new capital or invest surplus funds. A cash budget is a commitment to a plan for receipts and payments for a future period after taking the action needed to bring the forecast in line with the business plan.
Forecasts differ from budgets in that they are not part of a formal budget plan, are often prepared in less detail and are prepared throughout the year.
What a forecast is for
- Predict liquidity needs from inflows and outflows.
- Manage cash flow: spot problems and take corrective action early.
- Inform decisions such as investments or financing.
- Identify funding needs to cover shortfalls.
- Monitor and control cash so that the business stays solvent.
How to prepare one
- Identify every type of cash inflow (customer receipts, loans, disposals) and every outflow (suppliers, wages, overheads, assets, tax, loan repayments, dividends) and the month in which each is paid, allowing for credit periods.
- Exclude non-cash items, such as depreciation and provisions.
- Calculate the net cash flow each month and add it to the opening balance to find the closing balance.
- Compare each closing balance with the cash the business needs, and plan to finance any deficit and invest any surplus.
A worked forecast: Eko Traders
Sales forecasts are: December 1,000 units, January 1,100, February 1,200, March 1,300 and April 1,350. The price is ₦600 a unit, rising by 5% to ₦630 from March; sales are on one month’s credit. Goods are produced one month before sale. Each unit needs 3 units of material at ₦90, bought on one month’s credit with no material inventory, and variable overheads and wages of ₦80 a unit are paid in the month of production.
The cash balance on 1 January is ₦25,000, a loan of ₦200,000 arrives on 1 March and a machine costing ₦350,000 is bought for cash in March.
| ₦ | January | February | March |
|---|---|---|---|
| Receipts from customers (previous month’s sales) | 600,000 | 660,000 | 720,000 |
| Loan | 200,000 | ||
| Total receipts | 600,000 | 660,000 | 920,000 |
| Materials (previous month’s production) | 297,000 | 324,000 | 351,000 |
| Wages and overheads (this month’s production) | 96,000 | 104,000 | 108,000 |
| Machine | 350,000 | ||
| Total payments | 393,000 | 428,000 | 809,000 |
| Net cash flow | 207,000 | 232,000 | 111,000 |
| Opening balance | 25,000 | 232,000 | 464,000 |
| Closing balance | 232,000 | 464,000 | 575,000 |
Workings: production in a month equals next month’s sales, so January produces 1,200 units (February sales), costing 1,200 × 3 × ₦90 = ₦324,000 of material, paid in February, and 1,200 × ₦80 = ₦96,000 of wages and overheads, paid in January. The March price rise does not help March cash, because March sales (1,300 × ₦630 = ₦819,000) are received in April.
The forecast shows a growing surplus. The company should invest it, or use it instead of the loan, which costs interest while the balance stays above what the business needs. If a forecast showed a deficit, the manager would consider delaying payments (while keeping suppliers’ goodwill), speeding up receipts, arranging an overdraft, deferring the machine, or raising finance.
The ideas in more depth
Why profit is not cash
The forecast is built from the timing of payments, not from the profit and loss account. A sale in March produces profit in March and cash in April; a machine bought in March is a cash payment in March but a depreciation charge spread over years. A business can show a good profit while the forecast shows a shortfall, and the forecast is the better guide to survival.
Why forecasts need to be prepared often
Forecasts rest on assumptions about sales, collection and payment, and these change. A forecast is updated as actual figures arrive and is reviewed for the accuracy of each assumption, so that the company learns which of them are unreliable. A forecast used with a range of outcomes (best, worst, expected) shows how large a reserve is needed.
Sources and references
- No accounting standard governs cash flow forecasting. The statement of cash flows is prepared under International Accounting Standard (IAS) 7 Statement of Cash Flows, which reports the past; the forecast looks forward.
These points are stated as at 5 November 2026.
Worked examples
Example 1: receipts. January sales are 1,100 units at ₦600 on one month’s credit. Required: the cash received in January and February.
- January.
Receipts relate to December sales: 1,000 × ₦600 = ₦600,000. - February.
1,100 × ₦600 = ₦660,000.
Example 2: payments. February sales are 1,200 units; each unit needs 3 units of material at ₦90, paid a month after production. Required: the January production and the February payment.
- Material.
1,200 × 3 × ₦90 = ₦324,000, paid in February.
Example 3: the balance. Opening ₦232,000, receipts ₦660,000, payments ₦428,000. Required: the closing balance.
- Net.
₦660,000 − ₦428,000 = ₦232,000. - Closing.
₦232,000 + ₦232,000 = ₦464,000.
How to answer in the exam
- Lay out receipts, payments, net flow, opening and closing balances by month and show the workings for each line.
- Place every item in the month it is paid, using the credit periods given.
- Leave out non-cash items.
- Comment on the result: the surplus or deficit, the timing of the peak need and the actions available.
Common mistakes in the exam
- Including depreciation as a payment.
- Recording sales in the month of sale when the customers pay later.
- Forgetting that production precedes sales.
- Applying a price rise to receipts of the month before the rise.
- Omitting loan receipts, repayments or asset purchases.
- Not carrying the closing balance forward.
Quick revision
- Motives: transactions, precautionary, speculative.
- Forecast before action; cash budget after action.
- Closing = opening + receipts − payments; exclude non-cash items.
- Surplus: invest; deficit: finance or delay.
Practice questions
These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.
Recall check: multiple choice
Question 1. The transactions motive for holding cash is to:
- Speculate
- Guard against emergencies
- Pay for day-to-day expenses and debts
- Avoid tax
Show the answer
C. Cash is needed to settle obligations as they fall due.
Question 2. The precautionary motive is to:
- Take investment opportunities
- Guard against unplanned expenditure
- Reduce tax
- Pay dividends
Show the answer
B. It covers uncertainty.
Question 3. The speculative motive is to:
- Take advantage of market investment opportunities
- Pay wages
- Pay tax
- Hide profit
Show the answer
A. Cash is available when a bargain appears.
Question 4. A cash flow forecast estimates receipts and payments:
- After adjusting them
- Only for the past
- In the profit and loss account
- Before any action to adjust cash flow
Show the answer
D. A cash budget comes after action.
Question 5. A cash budget is:
- A forecast of profit
- A commitment to a plan for receipts and payments after taking action
- A list of assets
- A tax return
Show the answer
B. It is part of the formal budget plan.
Question 6. A forecast helps management to:
- Identify future surpluses and shortages
- Avoid selling
- Increase tax
- Reduce costs only
Show the answer
A. And take action early.
Question 7. A cash forecast should exclude:
- Loans
- Customer receipts
- Depreciation, a non-cash item
- Wages
Show the answer
C. Only cash movements belong in it.
Question 8. If a deficit is forecast, a manager may:
- Do nothing
- Order more inventory
- Pay all suppliers early
- Arrange an overdraft or speed up receipts
Show the answer
D. Or delay payments or defer capital spending.
Question 9. If sales are on one month’s credit, cash is received:
- In the month of sale
- Two months earlier
- In the month after the sale
- Never
Show the answer
C. So the price rise reaches cash a month later.
Question 10. The main aim of cash management is to balance:
- Minimising idle cash and meeting obligations when due
- Sales and profit
- Tax and dividends
- Debt and equity
Show the answer
A. Profitability against liquidity.
Section B style: written questions
Question 11 (10 marks). (a) State the THREE motives for holding cash. (3 marks) (b) Distinguish between a cash flow forecast and a cash budget. (4 marks) (c) State THREE uses of a cash flow forecast. (3 marks)
Question 12 (15 marks). A company has ₦50,000 on 1 January. Receipts are ₦300,000 in January and ₦340,000 in February; payments are ₦280,000 in January and ₦330,000 in February, plus a loan repayment of ₦60,000 in February. (a) Prepare a forecast with opening and closing balances. (9 marks) (b) State the net cash flow for each month. (2 marks) (c) Comment on the position and TWO actions. (4 marks)
A further written question
Question 13 (20 marks). A company sold 700 units in December and forecasts 800, 900 and 1,000 in January, February and March at ₦500, on one month’s credit. Materials and wages cost ₦210 a unit, paid in the month of sale; fixed costs of ₦40,000 a month are paid in the month. Equipment of ₦150,000 is bought in March. The January opening balance is ₦20,000.
(a) Calculate receipts for each month. (4 marks) (b) Calculate payments for each month. (6 marks) (c) Prepare the forecast showing closing balances. (6 marks) (d) State TWO uses of the result. (4 marks)
Model answers
Show the model answer to Question 11
(a) Transactions; precautionary; speculative (1 each).
(b) A forecast estimates cash flows before any action to adjust them, is less detailed and is prepared throughout the year (2). A budget is a commitment to a plan after the action needed to align cash with the business plan (2).
(c) Predict liquidity; identify problems and funding needs; inform investment and financing decisions; monitor solvency (1 each, any three).
Show the model answer to Question 12
(a)
- January.
opening ₦50,000 + 300,000 − 280,000 = closing ₦70,000 (4). - February.
opening ₦70,000 + 340,000 − 330,000 − 60,000 = closing ₦20,000 (5).
(b) January +₦20,000; February −₦50,000 (2).
(c) The balance falls to ₦20,000 because of the loan repayment, so liquidity is thin (2). Actions: arrange an overdraft facility, and speed up collections or defer other spending (2).
Show the model answer to Question 13
(a)
- January 700 × ₦500 = ₦350,000
- February 800 × ₦500 = ₦400,000
- March 900 × ₦500 = ₦450,000 (4).
(b)
- January 800 × ₦210 + 40,000 = ₦208,000
- February 900 × ₦210 + 40,000 = ₦229,000
- March 1,000 × ₦210 + 40,000 + 150,000 = ₦400,000 (6).
(c)
- Closing balances.
January 20,000 + 350,000 − 208,000 = ₦162,000 - February 162,000 + 400,000 − 229,000 = ₦333,000
- March 333,000 + 450,000 − 400,000 = ₦383,000 (6).
(d) (2 marks each) Invest the surplus or reduce borrowing; plan the equipment purchase from internal cash; show lenders the liquidity position.
Spotted a mistake? Tell us and we will check it.
