Cash flow is the lifeblood of your business, It’s simple as that. If your business does not generate cash and manages its circulation throughout the business properly, it will all go up in smoke. Now this “breathing” of cash is called the cash flow. This is the circulation of cash coming in and going out of your business.
Contrary to popular perception, making enough cash is not why businesses fail. Rather, it is more due to the inadequate prediction and mismanagement of cash flow.
Now, why do business owners tend to overlook their cash flow prediction and management? There are two main reasons:
- Small business owners tend to be unrealistic in predicting their cash flow where they tend to overestimate income and underestimate expenses.
- Failure to anticipate a cash shortage and running out of funds, thereby forcing to suspend or cease operations despite having active customers.
It follows along the line that Profit is not equal to Cash. Just because you have profits, it does not mean the money you gain is equivalent to that.
This will bring problems such as lack of funds during a period. With that in mind, the importance of being able to predict the cash flow becomes more significant. Being able to estimate and prepare cash flow projections can help boost your business’s success.
With a robust cash flow forecast, you can then make informed business decisions, plan for change, and know how to implement measures to enable business growth.
Inversely, not predicting a business’s cash flow, would make it nearly impossible to estimate how much cash your business will have at a given time. It becomes even more complicated if you factor in wages, taxes (e.g., payroll taxes, VAT, corporation tax payments), payments for loans, other financial obligations, and overheads.
If you want to predict your business’ cash flow, you need to create a cash flow projection.
A cash flow projection gives an estimate of the money you expect to come in and go out of the business, including all income and expenses. Using the data on the anticipated payments and receivables serves as a projection of a business’s future financial position.
A cash flow projection can give the following advantages:
- The business can predict cash shortages and surpluses
- The business can gain an overview and compare business expenses and income for a specified period.
- The business will estimate the effects of a change like moving locations or hiring an employee.
- The business can prove to their lenders that they can repay on time.
- The business can determine if they need to adjust like cutting expenses.
To get started making a Cash Flow Projection, the business owner must get reports detailing their business’s income and expenses. These can be obtained from their accountant, books, or accounting software.
Depending on the time frame, additional information may have to be gathered.
Concerning the process of making a Cash Flow Projection, the general steps are outlined below:
- Compute for Cash at the beginning of Period
- Start by gathering determining the cash for the beginning of the period.
- Cash at the beginning of Period = Previous Period’s Income – Previous Period’s Expenses
- Compute for Estimated Income
- Estimate the incoming cash for the next period.
- Incoming cash may include revenue, sales on credit, loans, etc.
- Compute for Estimated Expenses
- Estimate all the expenses for the next period.
- Expenses may include raw materials, rent, utilities, insurance, and other bills
- Compute for Net Cash Flow
- Subtract all estimated expenses from income.
- Net Cash Flow = Estimated Income & Funding (inflows) – Estimated Expenses and Financial Obligations (outflows)
- Compute for Closing Balance
- Your closing balance will carry over to act as your starting balance for the next period.
- Closing Balance = Opening balance + Net Cash Flow
- To create the next period’s projected cash flow, repeat the steps from above.
Once you have made the above calculations, you can start creating your Cash Flow Projection. Utilize a spreadsheet to prepare (Template here) and organize the data.
The projection should contain the following data:
- Opening balance
- Incoming Cash – From revenue, sale of investments or funding
- Cash Outflows – Operational expenses, Capital expenditure, Loan repayments
- Totals for cash in and cash out
- Uses for the Cash
- Total cash flow for the period
- Closing Balance
Once you have laid out the above sections on your cash flow projection report, start adding the projected cash flow calculations – The template provided already have the format.
A good rule of thumb is to not project too far into the future. Too many variables can come into play with your business (e.g., recession) and affect the prediction.
A standard period for cash flow projections is 12 months. But Cash flow projections are not absolute and subject to adjustments. To keep things accurate, a business owner must revisit its projection from time to time to see their current standing.
It is best to review your cash flow monthly and makings adjustments to future months up to one year ahead – effectively 12 months rolling cash flow forecast.
Get in touch if you require assistance in preparing a cash flow forecast for your business.
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