Companies typically make financial forecasts to help guide them in future business activities. Long-term cash flows are usually from periods lasting more than 12 months, sometimes as long as three to five years. While cash-flow forecasting helps create budgets and provide guidance to managers, disadvantages also exist for this process.
Forecasting often involves working with limited information. Accountants and business finance analysts typically gather all known information prior to creating forecasts. Unknown or unavailable information will require analysts to fill this in with their best estimate. These estimates can prove to be wrong in some cases. Making the best estimate, however, is a common forecasting process and one major disadvantage for measuring future cash flows.
Cash-flow forecasting is by no means 100 percent accurate. Companies may create a decision tree to determine the probability of certain events occurring. Each section reports the percentage of each cash flow amount -- high, average or low -- a company will expect from certain activities. The percentages, however, can be incorrect and display inaccurate results. For example, companies may expect to receive $5,000 from selling widgets in the northeast. Cash receipts only result in $4,000 from sales due to current conditions.
Companies may experience unforeseen factors that affect long-term cash flow forecasts. A significant increase in competition or excessive government regulation can quickly change expected cash flows. Changes in technology also can be an unforeseen factor. Companies that expect a certain level of cash flows in the next three years will certainly have to adjust expectations for these unforeseen factors.
Owners and managers can make improper decisions based on long-term cash-flow estimates. For example, making large investments in production equipment today represents a significant cash outflow. Companies expect to earn cash flow from increased production output in the future, resulting in higher future cash flows. Changes to expected cash flows or poorly prepared cash-flow estimates can lead to inappropriate decisions by a company’s management.
- "Analysis for Financial Management"; Robert C. Higgins; 2009