Auditing Cash Flow Forecasting – Risk, Assertions, And Procedures

Overview:

We do not usually audit Cash Flow Forecasting during the normal course of an audit. It is only under certain circumstances that Cash Flow Forecasting will be included as part of the audit procedures, such as:

  • There is insufficient information to support the going concern assumption of the entity: We will audit the Cash Flow Forecasting of the entity
  • The entity has a huge amount due from its related company and its related company’s net current assets are lower than the amount it owes: We will audit the Cash Flow Forecasting of the related company

A Cash Flow Forecast is usually prepared for a period of at least 12 months.

Risks:

Before the auditors decide what procedures to perform, the risks associated with auditing Cash Flow Forecasting have to first be identified:

  • Risk of Material Misstatement: The Risk of Material Misstatement when auditing Cash Flow Forecasting is generally high. Why we said that is because the preparation of a forecast involves a lot of assumptions and judgment. We do not know what will happen in the future, hence Cash Flow Forecasting is usually management’s best estimates of its future cash flows prepared based on historical data and a set of assumptions. The Risk of Material Misstatements is high as there is a possibility that the entity uses the wrong set of data and/or sets irrealistic assumptions that do not align with the general market or business trend.
  • Control Risk: The Control Risk related to Cash Flow Forecasting is relatively low as there is not much control that can be imposed for this highly manual and non-routine process. The main control that an entity should have for the Cash Flow Forecasting process is the segregation of duties between preparer and approver to ensure all work is reviewed to minimize error.
  • Detection Risk: Detection Risk is the risk that an auditor is not able to detect the material misstatements made by the entity in Cash Flow Forecasting.
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Assertions:

For an auditor to be reasonably assured that the Cash Flow Forecasting prepared by the entity is accurate, tests will be performed to cover the audit assertions. The assertions applicable to Cash Flow Forecasting are as follows:

  • Completeness: All relevant cash flows that the entity may have during an accounting period are included in the Cash Flow Forecast. Any expected special cash flows based on new contracts that have been agreed but yet to be finalized should also be included.
  • Rights and obligations: All cash inflows that the entity included on the Cash Flow Forecast should be at least reasonably supported by evidence such as sale and purchase contracts, customer contracts, an application made to apply for a government incentive, etc. If a growth rate is used to predict revenue (a cash inflow element), the growth rate must align with the current market trend or past business performance.
  • Valuation: Cash Flow Forecasting is correctly computed. The net present value and discount rates used are reasonable and any transactions in foreign currency should be fairly estimated based on reasonable forecasted exchange rates.
  • Existence: The cash flows included in the Cash Flow Forecasting prepared by the entity are based on existing cash flows of the entity and reasonably supported by relevant evidence.

Procedures:

Audit Procedures for testing Cash Flow Forecasting will rely more heavily on Substantive Tests. However, some Test of Controls can also be performed to improve the reliability of the entity’s Cash Flow Forecasting.

Test of Controls:

One of the important controls relevant to Cash Flow Forecasting is the segregation of duties.

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Segregation of Duties: Segregation of Duties is a control that requires the person who prepares the Cash Flow Forecast to be different from the person who reviews and approves it.

This can help to make sure that the work of the preparer is examined and approved which effectively reduces the risk of any material error.

Substantive Audit Procedures for Cash Flow Forecasting:

Substantive Audit Procedures for Cash Flow Forecasting will be more extensive as there is usually a lack of control due to its non-routine nature. The Substantive Audit Procedures are made up of the following components:

1) Substantive Analytical Procedures:

Substantive Analytical Procedures is very useful in helping the auditors to identify if all major cash outflows and inflows have been included in the Cash Flow Forecast prepared by the entity.

Auditors perform these procedures by benchmarking the Cash Flow Forecast against a set expectation such as historical performance, latest business developments, and any other information relevant to the entity. This will allow the auditor to detect potential areas with a higher risk of material misstatements.

For example, the rate used by the entity to predict its revenue growth can be benchmarked against historical data and the general trend of growth across the entity’s industry.

This may assist the auditor in identifying potential misstatement when the growth rate used in Cash Flow Forecasting is unusually high and is not per the auditor’s expectation. This ultimately allows the auditor to design appropriate audit procedures to address such risk.

2) Test of Details for Cash Flow Forecasting:

Multiple audit procedures can be performed to test details for Cash Flow Forecasting. Examples and description of the test of details are given in the table below:

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Audit AssertionExample of Audit Procedure
Completeness  Performing a comparison of the Cash Flow Forecast to the preceding period and the actual statement of cash flow to ensure that all expected cash flows are included in the forecast.
Rights and ObligationsReviewing any sales documentation relating to a planned sale or customer contracts to confirm that the cash inflow is achievable.   Reviewing any application submitted by the entity to the authority to apply for a grant or incentive to confirm the amount of the cash inflow.
ValuationReviewing the market statistics and the entity’s past business performance to ensure the assumption regarding its growth rate is appropriate.
ExistenceAgreeing the opening cash balance to the previous year audited financial statements and general ledger or bank reconciliation, to ensure accuracy of the extracted figures.