Incremental cash flow: Is this project right for me?
You can create positive incremental cash flow by investing in the right new projects.
New projects may hold the promise of growth and increased profitability. But there are costs to taking on new clients or expanding products and services. That's why it's important to determine incremental cash flow: the additional operating cash flow an organization receives from taking on a new project.
Consider the costs and risks
Estimate new costs such as materials or additional staffing, then calculate how long it will take for the new customer to make a payment. This will help you determine when the venture will likely produce a positive incremental cash flow. Also, account for potential risk. "If you're working with an existing customer, do you have the capacity to produce the goods they want?" says Royal Johnson, a partner in the Chicago office of B2B CFO, a nationwide firm providing CFO services to mid-market-sized businesses.
Be realistic about expectations, and prepare for worst-case scenarios. If a new project doesn't pan out, can your business afford to absorb the costs and still meet its current obligations? Reviewing your current cash flow can answer that question before new projects are undertaken.
Consider an investment's long-term benefit
Adding a new client or expanding your business in a new direction may be worth a temporary reduction of your business's short-term cash flow if the long-term benefit is big enough, says Johnson.
Reduce the risk of taking on potential new clients through research. Ask other industry contacts about their experience with the client. Consider raising prices to ensure better margins on riskier ventures.
Monitor your cash flow and update your business plan
New business will likely increase expenses, which can strain budgets. So carefully and frequently monitor cash flow to ensure it stays in the black, or remains positive. If you have a solid grip on the weekly ebb and flow of income and expenses, you'll have a better idea how much of that positive incremental cash flow can go to new investments.
Johnson believes additional business requires updating your business plan with the details. "You put down all of your assumptions about what the new client or project will require," he says.
Acquiring new customers or expanding your product or service offering will most likely present additional expenses. But by calculating the payoff and carefully estimating costs in your business plan, you can help ensure the incremental cash flow is positive.
Learn more about managing cash flow.