Cash flow

Performing cash flow forecasting in 4 steps [EBook]

It’s clear that to pave the way for financial success in your small business, you need to stay on top of your cash flow. You’ll know where your business could be heading, you’ll make better business decisions, and you’ll potentially avoid collapse. Now, it’s time to do a cash flow projection. Follow these four steps to project your cash flow for the next year.

1. Estimate your sales

To predict the amount of cash that will come into your business next year on a month-by-month basis, you’ll first need to take a look at your actual results for the past few years. The past is the best indicator of the future, so you should use historical numbers as a starting point. But to ensure accuracy, you’ll need to take some changes into consideration.

For instance, if a competitor is moving into your territory, and you fear they may take some of your market share, you might want to decrease your forecasts. On the other hand, if you added a new product or plan to run a major marketing campaign, you’ll want to account for it by increasing your sales estimates.

If you own a new business and don’t yet have a sales history, you will have to use your industry research and make an educated guess. The key is to make a reasonable estimate based on your research and logic, and not be overly optimistic.

Don’t just make a yearly estimate. Estimate sales for each month of the next year.

2. Calculate when you will be paid based on the terms you offer

If you operate a retail store or a website that takes instant payment from customers, you are probably paid at the point of sale and can skip this step. However, if you extend credit to your customers, you will have to wait to see the cash from those sales.

In these instances, it’s important for you to estimate when you will actually receive cash from your sales to more accurately predict your cash flow.

For example, if you sell to other businesses and offer 30-day terms, you should use your current days sales outstanding (DSO) figure — the average number of days it takes to receive payment from customers — to predict when you’ll be paid. Incorporate that lag time into your estimates.

To calculate your DSO, use the following formula:

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3. Estimate your fixed and variable expenses

Next, you’ll need to estimate both your fixed and variable expenses on a month-to-month basis. Your fixed expenses are those that don’t change — such as rent, employee salaries, insurance, and marketing expenses.

Variable expenses tend to fluctuate with your sales.

For example, your shipping costs are variable because they will change depending on how many products you sell and ship. Your packaging, raw materials, commission, and labour costs may also go up and down depending on your sales volume.

Just as you did for sales, you will need to estimate your fixed and variable expenses for each month of the next year. If you have an accounts payable department or someone in charge of accounts payable, they’re a great resource here. They can help you go through your sales records and estimate what your next year could look like.

If you don’t have an accountant or someone who can help you with this process, you can tackle it yourself. Start a spreadsheet with columns for fixed costs and variable costs, and start tallying them up. Your variable costs will likely be a little trickier, so take your time and breakdown the parts costs, labor costs, etc. for your products. If you’ve calculated your breakeven point, you can pull most of this info from there as well.

4. Put it all together

Now that you’ve calculated all the numbers you need, it’s time to put them together to get an idea of how much cash your business will take in next year.

Begin with the cash balance from last month’s operations, and then add this month’s projected receipts to it after accounting for your DSO. Next subtract your projected expenses, and you have this month’s projected cash flow. Carry over that balance to the next month, and repeat the steps above. Do this for the next 12 months. The formula for this goes as follows:

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While the calculation is an easy one, there are a lot of moving parts to it, so it helps to use a cash flow template. And to rein in that unbounded entrepreneurial optimism, some experts recommend that you create a best- case and worst-case scenario to get the most realistic projection of cash flow. Your actual cash flow will likely be somewhere in the middle.

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