It’s easy to assume that if your business is healthy today, it’ll be healthy tomorrow. But while optimism is important, so are hard facts. Monitoring your cash flow and knowing how to run periodic cash flow projections can help prevent future money troubles. If 29% of small businesses fail because of cash flow problems, learning to predict cash flow performance could be valuable.
If you’re new to cash flow projections, here’s what you need to know.
What is a cash flow projection?
Cash flow projections predict the amount of money entering and leaving your small business. As the name suggests, this method uses cash flow to anticipate future business performance. And cash flow is the net amount of cash and “cash equivalents” that transfers in and out of your business.
This transfer occurs through accounts payable and accounts receivable. Accounts payable is money out, while accounts receivable is money in.
Why is cash flow projection important?
Many business owners mistakenly gauge their business’s health by looking at their business value in assets, intellectual property, and so on. But while these are important for attracting investors or selling your business, they won’t help you predict future business performance. They’re also not factored into cash flow calculations.
Running regular cash flow projections is important because it can help you steer your business toward the future. Rather than making critical plans based on present circumstances, you’ll use historical data to move forward, which can be more accurate.
Cash flow projection vs. cash flow forecast
Essentially, cash flow projections and cash flow forecasts are the same thing. Both are methods for projecting the business’s financial future. Small business owners can use the terms interchangeably.
How to perform a cash flow projection
Small business owners should take the time to understand their cash flow. Not just to build a solid cash flow projection, but so they can recognize areas of opportunity and potential shortfalls. Follow these steps to perform a month-by-month, year-long cash flow projection. Or use them as a jumping-off point for further talks with your bookkeeper, regarding cash flow projections.
1. Estimate your sales
The first step to creating an accurate cash flow projection is to estimate your sales. Start by looking at last year’s numbers. These can help you predict the amount of cash that may come into your business each month next year. You’ll find your business’s credit and cash sales on your monthly income statements. But while the past is the best indicator of the future, you’ll also want to consider some changes.
For instance, if a competitor is moving into your territory, you may want to decrease your sales forecasts. But if you’re adding a new product or service to your offerings, you might expect a slight bump in cash inflow, at least in the short-term.
If you own a new business and don’t yet have a sales history, you will have to use industry research to create a reasonable sales forecast. Be sure to estimate sales for each month, not just the year.
2. Calculate when you will be paid based on the terms you offer
If you operate a business that does mostly cash sales or takes instant payment from customers, you may skip this step.
This step is for business owners who extend credit lines to their customers, send invoices, or take multiple customer payments for a single sale. The idea is to estimate when you will actually receive cash from your sales. To do that, you’ll want to calculate your days sales outstanding (DSO).
The DSO formula first divides your monthly accounts receivable by your total sales. Then it multiplies that number by the number of days in the month. The DSO formula follows:
(Monthly accounts receivable ÷ total sales) x days in the month = DSO
The DSO will tell you the average number of days it takes to receive payment from customers. So if you offer something like 30-day payment terms to your clients, the DSO will tell you how long it actually takes, on average, to receive payment. Then you can incorporate that number into your estimates.
3. Estimate your fixed and variable expenses
Next, you’ll need to estimate both your fixed and variable expenses monthly. Your fixed expenses (rent, employee salaries, insurance, etc.) don’t change.
Variable expenses tend to fluctuate with your sales. For example, your shipping costs vary because they depend on how many products you sell and ship. Your packaging, raw materials, commissions, and labor costs may also go up and down with 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 someone like an accountant in charge of your 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 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 tally them up. Your variable costs will likely be a little trickier since you’ll have to break down many pieces. These pieces include things like material costs, labor costs, product costs, etc. If you’ve calculated your breakeven point, you can pull most of this information 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. Here’s how to run your current month’s projected cash flow.
Begin with the cash balance from last month’s operations, then add this month’s projected receipts, accounting for your DSO. Next, subtract your projected expenses. The formula follows:
(Last month’s cash balance + current month’s projected receipts) – projected expenses = current month’s projected cash flow
Once that’s done, you can calculate your projected cash flow for next month or the next 12 months. To do this, carry the balance from this month’s projected cash flow to the next month, and repeat the steps above. Do this for the next 12 months.
If you find yourself feeling overwhelmed, it may help to use a cash flow template. Some experts also recommend that business owners create a best-case and worst-case scenario to get the most realistic cash flow projection. Your actual cash flow will likely be somewhere in the middle.
Cash flow projection template
Ready to start a cash flow projection for your business? You can use the QuickBooks cash flow forecast template to project your business’s cash flow.
The steps in our guide and the prompts within the template build a 90-day cash flow projection for your business.
4 benefits to cash flow projections
Once you know how to create a cash flow projection, you’ll find plenty of benefits to measure future performance this way.
1. Understand your money and where it goes
For many small business owners, cash on hand doesn’t last long. Bills and unexpected emergencies can drain your business’s cash balance and derail your business growth. That’s why it’s critical to know when to pivot and when to stay the course.
A cash flow analysis can help you determine any consistent causes of negative cash flow. And, hopefully, show you when, historically, you have enough cash in your bank account to invest or spend. From there, a cash flow projection can help you understand and predict future cash inflow and cash outflow.
2. Make more confident business decisions
Cash flow projections don’t just increase your understanding. They also help you act with confidence. Knowing how your business will perform in the coming months, based on actual cash flow data, can enable you to make informed decisions. You can say with confidence if now is a good time to invest in a new opportunity or put money aside.
For instance, you may find that, right now, you’re in a period of negative cash flow. But if the coming month looks positive, there’s less need to postpone investments.
3. Convince others to trust your plans
Budgets help you stay on course, but cash flow projections show you and others where your business is going. Outsiders—even insiders sometimes—need to know your business’s financial health is sound. Cash flow statements and cash flow forecasts can work together to help them understand your business’s current and future performance.
If all looks well, a solid cash flow projection may help you gain future investors or win a new business contract. It could also make your company more attractive to buyers.
4. Prevent problems before they arise
While cash flow projections can’t always predict events, they can help you prepare for the worst. For instance, let’s say you know when your business is most cash flow positive. That’s a great time to put aside some extra savings in an emergency fund. Then, if there’s a hiccup, you have a cushion to prevent negative cash flow.
Another example is unpaid invoices. A cash flow projection might tell you there’s a time when those outstanding payments tend to stack up. If you know that problem is likely to occur, you may prevent it with additional communications or early payment incentives.
Use cash flow projections to predict success
Cash flow projections are fairly straightforward but incredibly useful. It can be a bit sobering to see your actual cash flow, but this information can only help you make better decisions and grow your business responsibly.
Make cash flow forecasting a part of your business routine, and forecast at least once a year to stay on top of any changes. You can be more in tune with your business and confident in where you’re going.
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