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How to create a cash flow projection (and why you should)

Apr 1, 2019 | 4 minutes read | Running a business

For small business owners, managing cash flow can be the difference between a thriving, successful company and filing for chapter 11.

In fact, one study showed that 30% of businesses fail because the owner runs out of money and 60% of small business owners don’t feel knowledgeable about accounting or finance.

Understanding and predicting the flow of money in and out of your business, however, can help entrepreneurs make smarter decisions, plan ahead, and ultimately avoid an unnecessary cash flow crisis.

After all, knowing whether the next month will see a financial feast or famine can help you make better decisions about spending, saving, and investing in your business today.

If, for example, your cash flow projection suggests you’re going to have higher-than-normal costs and lower-than-normal earnings, it might not be the best time to buy that new piece of equipment. If, on the other hand, your cash flow projection suggests a surplus, it might be the right time to invest in the business.

Cash flow projections: The basics

In order to properly create a cash flow forecast there are two concepts one has to master: accounts receivable and accounts payable. “Receivable” refers to the money the business is expecting to collect, such as customer payments and deposits, but it also includes government grants, rebates, and even bank loans and lines of credit.

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Accounts ayable, on the other hand, refer to the exact opposite—that is, anything the business will need to spend money on. That includes payroll, taxes, payments to suppliers and vendors, rent, overhead, inventory, as well as the owner’s compensation.

A cash flow projection (also referred to as a cash flow forecast) is essentially a breakdown of expected receivables versus payables. It ultimately provides an overview of how much cash the business is expected to have on hand at the end of each month.

These projections typically take less than an hour to produce but can go a long way in helping entrepreneurs identify and prepare for a potential shortfall, and make smarter choices when running their business.

Be realistic with your cash flow forecast

Cash flow projections are only as strong as the numbers behind them, so it’s important to be as realistic as possible when putting yours together. For example, being overly generous in your sales estimates can compromise the accuracy of the projection. Furthermore, if you provide customers with a 30-day payment schedule and a majority pay on the last possible day, make sure that cycle is accurately reflected in your projection.

On the payables side of the equation, try to anticipate annual and quarterly bills and plan for an increased tax rate if the business is likely to reach a new tax level. Those who pay their staff on a bi-weekly basis also need to keep an eye out for months with three payroll cycles, which typically occurs twice each year.

Those who want to be extra cautious with their projections can even include an “other expenses” category that designates a certain percentage of revenues for unanticipated costs. Putting aside some extra cash as a buffer is especially useful for those building their first projections, just in case they accidentally leave something out.

Put it all together: How a cash flow projections looks on paper

In practical terms, a cash flow projection chart includes 12 months laid out across the top of a graph, and a column on the left-hand side with a list of both payables and receivables. This column typically begins with “operating cash,” or unused earnings from the previous month. For example, if your cash flow projection for January suggests a surplus of $5,000, your operating cash for February is also $5,000.

An example cash flow projection chart from the U.S. Small Business Administration.

Below operating cash list all expected accounts receivable sources—such as sales, loans, or grants—leaving a space at the bottom to add them all up. Next, list all potential payable items—such as payroll, overhead, taxes, and inventory—with another space to add their total below.

Once you have your numbers prepared, simply subtract the total funds that are likely to be spent from the cash that is likely to be received to arrive at the month’s cash flow projection.

Once you’ve calculated your monthly cash flow, take the final number and list it at the top of the next month’s column under operating cash, and repeat the process until you’ve got a forecast for the next 12 months. After the end of each month, be sure to update the projection accordingly, and add another month to the projection.

If you prefer to use a ready-made chart to help you create your projection, you can pull your financial data from the Reports section of Wave and feed it into this cash flow forecast template.

What now: Use your cash flow forecast to make data-driven decisions

Building the chart itself is an important exercise, but it’s only as useful as the insights you take away from it. Instead of hiding it away for the remainder of the month, consult your cash flow projection when making important financial decisions about your business.

If, for example, you anticipate a deficit in the months ahead, consider ways to cut your costs, increase sales, or save surpluses to help make up the difference. If you notice that payments often come in late, consider introducing a late penalty for bills past due.

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You can also consult your cash flow projection to determine the best time to invest in new equipment, hire new staff, revise your pricing and payment terms, or when to offer promotions and discounts.

Improving the accuracy of cash flow projections over time

Once you’re in the habit of creating cash flow projections, it becomes easier to improve their accuracy over time.

Comparing projections to actual results can help you improve the accuracy of their projections, and help identify longer-term patterns and cycles. Seasonal changes in revenue, patterns that contribute to late payments, and opportunities to cut costs will all become more apparent with each new projection.

While all these benefits won’t come all at once, entrepreneurs can use their cash flow projection to become better operators and better decision makers with each passing month.

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