Posted by Karen Munoz, EA

Creating a Cash Flow Projection & Why You Should Create One

Creating a Cash Flow Projection & Why You Should Create One

Having a cash flow projection can be the difference between a thriving business and filling for a Chapter 11 for small business owners.

A study found that 30% of businesses fail because the owner is out of money and 60% of small business owners don't feel informed about accounting or finances.


Cash Flow Projection

Cash flow projection is a division of the money that should flow in and out of your business; it includes calculating your income and all your expenses, which will give your business a clear idea of how much you will be left within a company over a specific period.

However, understanding and forecasting your business's incoming and outgoing cash flow can help entrepreneurs make smarter decisions, plan, and avoid an unnecessary cash flow crisis.

Knowing whether the next month will be a financial holiday or a famine can help you make better decisions about how to spend, save, and invest in your business today.

If, for instance, your cash flow projection suggests that you will have higher than normal costs and lower than normal income, it might not be the best time to buy that new equipment. If, on the other hand, the cash flow projection suggests a surplus, it might be a good time to invest in the business.


Cash flow projections: the basics

To successfully create a cash flow forecast, there are two concepts we need to master: accounts receivable and accounts payable. "Receivable" refers to the money the business expects to receive, such as customer payments and deposits, but also includes government grants, repayments, and even bank loans and lines of credit.

On the other hand, Accounts Payable refers to the exact opposite - everything the business needs to spend money on. This includes payroll, taxes, vendor and vendor payments, rent, overhead, inventory, and owner's compensation.

A cash flow projection (also known as a cash flow forecast) is a breakdown of anticipated receivables and payables. Finally, it gives an overview of how much money the business should have on hand at the end of each month.

These projections generally take less than an hour to produce. Still, they can help business owners identify and prepare for a potential deficit and make smarter decisions while running their business.


Be realistic with your cash flow forecasts.

Cash flow projections are as strong as the numbers behind them, so it's important to be as realistic as possible when making your projections. For example, being overly generous in your sales estimates can compromise the accuracy of your projection. Also, if you offer customers a 30-day payment schedule and majority payment on the last possible day, make sure that this cycle is accurately reflected in your projection.

For equity accounts, try to anticipate annual and quarterly bills and allow for a higher tax rate if the business is likely to hit a new tax bracket. Anyone who pays their team every two weeks should also follow it for months, with three pay cycles, usually twice a year.

Those who want to be more careful in their projections can even include an "other expenses" category, which designates a certain percentage of income for unforeseen expenses. Leaving aside a little extra cash is especially useful for those making the first projections if they accidentally lose something.


Put it all together: How are the cash flow projections on paper?

Concretely, a cash flow projection chart includes 12 months distributed at the top of a chart and a column to the left with a list of debts and loans. This column usually begins with "operating cash" or unused income from the previous month. For example, if the cash flow projection for January suggests a surplus of $5,000, the operational liquidity for February is also $5,000.

In Operational Liquidity, list any expected sources of credit, such as sales, loans, or donations, leaving space at the bottom to add them all. Then list all possible debts, such as wages, overheads, taxes, and inventory, with another space to add the total below.

Once you have the numbers ready, simply subtract the total funds you are likely to spend from the money you will likely receive to get the cash flow projection for that month.

After calculating your monthly cash flow, take the final number and write it at the top of the next month's column under Operating Liquidity and repeat the process until you have a forecast for the next 12 months. After each month ends, be sure to update the projection accordingly and add another month to the projection.


What now: use cash flow forecasting to make data-driven decisions

Creating the diagram itself is an important exercise, but it is just as useful as the information you extract from it. Instead of hiding it for the rest of the month, check your cash flow projection when making important financial decisions about your business.

For example, if you are forecasting a deficit in the coming months, consider ways to cut costs, save surpluses or increase sales to help make up the difference. If you think payments are often late, consider introducing a late billing penalty.

You can also check your cash flow projection to determine the best time to invest in new equipment, hire new employees, review prices and payment terms, or when to offer promotions and discounts.


Improve the accuracy of cash flow projections over time.

Once you get into creating cash flow projections, it will be easier to improve your accuracy over time.

Comparing projections with actual results can help you improve the accuracy of your projections and identify long-term patterns and cycles. Seasonal changes in income, late payment patterns, and cost reduction opportunities will become more apparent with each new projection.

While all of these benefits don't come at once, entrepreneurs can use their cash flow projection to become better traders and decision-makers over the months.


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Karen Munoz, EA
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