Financials and Cash Flow

Creating a cash flow projection

In less than an hour a month, you can identify potential cash shortfalls — and surpluses — in your business's future.

Published: August 29, 2011
Updated: February 29, 2016

Even businesses with healthy growth and strong sales run the risk of owing more than they can pay in a given month. Fortunately, spending just 35 to 45 minutes each month on a cash flow projection can help you identify potential cash shortfalls in the months ahead.

Create a cash flow projection

Before you create a cash flow projection for your business, it's important to identify your key assumptions about how cash flows in and out of your business each month.

Key assumptions should relate to two primary areas:

  1. Receivables: These assumptions should outline how quickly you receive payment from your customers. For example, if most of your customers pay you within 30 days, a key assumption could be: 90% of sales will be collected the month after the sale.

  2. Payables: These assumptions should outline when your payments are due. For example, if your vendors require payment within two weeks of delivery, a key assumption could be: Payables are due within 14 days of purchase.

Tip: Don't let optimism factor into your key assumptions. Only the most likely numbers should appear on your spreadsheet.       

For many projections, business owners will use the high end of their sales estimates in an attempt to put their best foot forward for potential investors, explains Jerry L. Mills, founder and CEO of B2B CFO. However, in this case, aiming high can actually create a financial shortfall, he says.

"This is the time for the business owner to be very realistic," he says. "This is where the rubber hits the road."

With these realistic assumptions in hand, you can begin drafting your cash flow projection. To get started, create 12 columns across the top of a spreadsheet, representing the next 12 months. Then, on the left-hand side, list the following cash flow categories:

  • Operating cash, beginning— The amount of money you'll have at the beginning of each month.

  • Sources of cash— All money coming in each month (receivable collections or direct sales, loans, etc.).

  • Total sources of cash— Add the amounts in the Operating cash, beginning row to the amounts in the Sources of cash for each month.

  • Uses of cash— List every likely expense your business may incur, such as payroll, accounts payable to vendors, rent and loan payments.

  • Total uses of cash— Tally all your expenses so you can see exactly what will be going out the door each month.

  • Excess (deficit) of cash— This is the number that counts. If you see positive numbers across the board — congratulations, you may have some extra dollars to invest back into your business. If you see a negative number for one of the months — don't panic — you have time and options to prepare your business.

Here is an example of a cash flow projection that has been abbreviated to four months for the sake of clarity:

XYZ Company, LLC

Internal Cash Flow Projections

August to November 2019




 

August

September

October

November

Operating Cash, Beginning

$3,000

$1,000

$800

$800

Sources of Cash

       

Receivable collections 

$65,000

$60,000

$70,000

$65,000

Customer Deposits 

$10,000

$12,000

$10,000

$10,000

Loans from the bank -Revolving Line

$18,000

$20,000

$15,000

$16,000

Other

$3,000

N/A

$5,000

N/A

Total sources of cash, beginning

$99,000

$93,000

$100,800

$91,800

Uses of Cash

       

Payroll, including payroll taxes 

$20,000

$22,200

$20,000

$20,000

Accounts Payable - Vendors

$18,000

$15,000

$17,000

$18,000

Other overhead, including rent

$16,000

$16,000

$16,000

$16,000

Owners compensation

$16,000

$16,000

$16,000

$16,000

Line of credit payments

$15,000

$15,000

$23,000

$15,000

Long-Term principal payments

$3,000

$3,000

$3,000

$3,000

Purchases of Fixed Assets

$5,000

    N/A

    N/A

$10,000

Estimated income tax - current year

    N/A

    N/A

    N/A

$10,000

Other

$5,000

$5,000

$5,000

$5,000

Total Uses of Cash 

$98,000

$92,200

$100,000

$113,000

Excess (Deficit) of Cash

$1,000

$800

$800

*($21,200)

*The company is projecting negative cash in November. What can you do today to prevent the negative cash flow?

Key Assumptions:

  1. 75% of sales will be collected the month after the sale.

  2. 25% of sales will be collected the 2nd month after the sale.

  3. Payables are due in 25 days.

  4. 60% of eligible receivables can be used for the revolving line of credit.

Strategies to improve accuracy

As the months pass and you compare your monthly cash flow statements to your projections for each month, the numbers should match up. "You can get away with a 5% variance one way or the other, but if it starts being more than 5%, usually you're in trouble," Mills says. "Five percent grows exponentially. Let's say that sales were overstated by 5%, cash collections was overstated by 5% and expenses were understated by 5%, what we have then is a 10% spread."

If you see large differences from month to month, you should revisit your key assumptions to check for flaws in your logic. Even if your actual numbers come in higher than your projections, you should take a close look at your assumptions, because higher returns in the short term could lead to shortfalls later on.

To make sure your projection stays accurate throughout the year, be sure to consider these variable expenses:

  • Months with three payrolls

  • Months when insurance premiums are due

  • Increased estimated taxes due to increased sales

Tip: A good rule of thumb is to designate an amount equal to 10% of revenues for "other expenses" under Uses of cash — so you'll have some cushion when unforeseen costs arise.

Continue to refine your projection

To keep your projections on track, create a rolling 12-month plan that you update at the end of each month. If you add a new month to the end every time a month is completed, you'll always have a long-term grasp of your business's financial health.

However, don't try to project more than 12 months into the future. "If you shoot too far into the future: One, you spend a lot of time. Two, there are too many variables that can happen. Prime rate could shoot up, for example. Sales could go down dramatically, as an example," Mills says. "What happens is we get into too many guessing games, too far in the future. What I like is having a rolling 11 months or 12 months, meaning if this is now August, I'm now looking at August a year from now."

Tip: If possible, delegate projection updates to a bookkeeper or accountant to take control of your business's finances. Beyond saving you time, this allows you to take a higher-level view of the projection and will help you identify errors more easily.

Once you've gotten into the habit of using a cash flow projection, it should give you added control over your cash flow and a clearer picture of your company's financial health.

 

The information in this article was based on an interview with Jerry L. Mills, founder and CEO of B2B CFO.

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