A cash flow projection is a tool that helps you estimate how much money your business will receive and spend in a given period. It can help you plan ahead, avoid cash shortages, and make informed decisions. But how do you create a realistic cash flow projection for your business? Here are some steps to follow.
The first step is to gather all the data you need to create your cash flow projection. This includes your historical cash flow statements, your current bank balance, your sales forecasts, your expense budgets, and any other relevant information. You can use accounting software, spreadsheets, or templates to organize your data and make calculations easier.
What is the cash vs credit mix? Understanding your aged debt % and cash sales historical results will aid the process. Assessing your customers contribution to credit sales and the their payment frequency (i.e customers who pay weekly/fortnightly/monthly) will aid in making a more accurate projection of your credit collections. With respect to outflows, what are your payment obligations based on contracts & the law (taxes, loans, suppliers). This is usually the simplified approach. It gets more interesting when you assess your statement of cash flow; assessing your working capital and cash conversion cycle.These metrics highlight how your leveraging your cash. Are we having favorable cash position at the expense of our suppliers?
When preparing a Cash Projection, I have found it very important to seek data outside the Accounting system. Sales Leaders and Operations Leaders are vital sources of information and should be included in the conversations.
The next step is to estimate how much cash your business will receive in the projection period. This includes your sales revenue, interest income, grants, loans, or any other sources of income. You should base your estimates on your sales forecasts, your payment terms, your customer behavior, and your industry trends. You should also account for any seasonal variations, discounts, refunds, or bad debts that may affect your cash inflows.
As with any projection and especially cash flows, you need to have data that has input from the business leaders within the firm. Sales, COGS, OPEX and CAPEX assumptions should have consensus from the management team and can easily be understood by the entire organization as well as external parties.
To estimate Cash Inflow, having good Sales Forecasting tempered with reality is critical. How likely are the sales to occur? It is guesswork, but a Sales leader should be able to differentiate between almost certain sales and sales that are likely and those with a 50/50 shot of occurring. This will allow sufficient detail in crafting the CFP. Then, it is important to revisit the completed forecasts at least quarterly to determine if estimates need to be adjusted up or down based on actuals.
The third step is to estimate how much cash your business will spend in the projection period. This includes your operating expenses, such as rent, utilities, wages, taxes, supplies, and marketing. It also includes your capital expenses, such as equipment, inventory, or debt repayments. You should base your estimates on your expense budgets, your payment schedules, your vendor contracts, and your business goals. You should also account for any contingencies, such as emergencies, repairs, or unexpected costs that may arise.
Another way to categorize spend is whether it is routine or non-routine. Routine expenses are those you see every month. Rent, office supplies, loan payments, etc. You may see non-routine spending only once or twice a year. Maybe it's a piece of equipment that suddenly became necessary. Or perhaps headcount needs to increase faster than planned, so there is additional spending on recruiting and training. Discussions need to occur between Finance and the Operations and Leadership groups to plan for the non-routine spending to the extent possible, as well as analyze the routine spending to see if it is still in line with previous projections and is still necessary.
The fourth step is to calculate your net cash flow for each month or week in the projection period. This is the difference between your cash inflows and your cash outflows. If your net cash flow is positive, it means you have more cash coming in than going out. If your net cash flow is negative, it means you have more cash going out than coming in. You should also calculate your cumulative cash flow, which is the sum of your net cash flows over time.
The fifth step is to analyze your cash flow projection and see what it tells you about your business performance and financial health. You should compare your actual results with your projected results and identify any gaps, trends, or issues. You should also evaluate your cash flow ratios, such as your current ratio, your quick ratio, or your cash flow margin. These ratios measure your ability to meet your short-term obligations, cover your expenses, and generate profits from your operations.
The final step is to adjust your plan based on your cash flow projection and analysis. You should use your cash flow projection as a guide to make better decisions and improve your cash flow management. You may need to increase your sales, reduce your costs, negotiate better terms, or seek additional funding. You may also need to revise your sales forecasts, expense budgets, or business goals. You should update your cash flow projection regularly and monitor your progress.