The Top 4 Cash Flow Forecasting MistakesHere's how to avoid them.

Strong businesses have a solid handle on their financial reality, and the cash flow statement is an excellent, if not the best, measure of a company's ability to generate cash in excess of cash invested. Over a sufficiently long period of time, all businesses have to generate positive cash flow or they will go out of business.

Forecasting the statement of cash flowsis a valuable exercise for a business for several reasons. The most obvious is, without a forecast, the executive team has no way to measure success or failure against its targets. Additionally, going through each item will raise important questions for the financial oversight of the company, and it can be used to hone in on poor strategic or financial decisions and help shape strong management.

Now, how to avoid some of the errors that plague cash flow forecasters.

1. Changes in receivables and payables.

As notedhere, companies should set optimal accounts receivables and payables levels through corporate and financial strategy, then forecast those accounts according to their plan. The error is to simply grow A/R and A/P with sales. That is what most outside analysts do; however, they do not have control over the policies. The business or CFO does. Set a Days Sales Outstanding level, then stick to it. This goes for accounts payable as well.

2. Tax liabilities are another source of variability in projecting cash flows.

A business is not likely to be in touch with every tax change, and that is why the company hires tax professionals and advisers. Tapping into the expertise of the company's accountants before the annual cycle begins is a good technique to avoid problems in the tax line.

3. Reporting cash flows from financing and investing activities.

This requires a relatively high-level understanding of GAAP and/orIASstandards and principles. And even when the team has the expertise, predicting these cash flows can be difficult. The best way to deal with this area of the financial statements is to set policies and then make and follow a strategic plan in the areas of the acquisition and disposal of long-term assets and other investments not included in cash equivalents and in activities that result in changes to equity and borrowings. To read more, see this excellentpiecefrom accounting firm Grant Thornton.

4. The biggest cash flow statement error can start at the top: the income line.

The statement of cash flows is built upon the foundation of income delivered from the business's operations, and errors in income projections can have a large impact on cash flows. One of the most common pitfalls in income statement projections is to incrementalize line items. "We grew 10% last year; we should grow 12% this year," is not a powerful way to forecast a business. Top financial teams actually build from projected contributors such as pricing, volume and product mix (and that can be across divisions and geographies). Using the basic building blocks to drive forecasts does two things: it provides a solid structure to the operating performance of the business and it raises relevant questions all along the way.