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If you’re not sure how financially healthy your business is, creating a cash flow projection can give you important insight into where you stand. Having a strong cash flow is a crucially important part of running a successful business. For most businesses, cash flow problems are a temporary deadlock (i.e., waiting on incoming cash) but can cause massive problems if not quickly corrected. To prepare for these issues or avoid them altogether, it’s important to be in the habit of cash flow forecasting.
Cash flow problems can exist in a business experiencing growth and can critically injure or destroy your business growth opportunities. Each spending decision you make in business can have a material impact on your cash flow situation. For this reason, it’s important to have a long-term perspective and understanding of the full impact the financial decisions you make today will have on your business. If you’re currently running into cash flow problems or have a financial decision to make on the horizon, let’s talk about how cash flow projection can help you.
What is a Cash Flow Projection?
Before we dive too deep into this, let’s discuss cash flow as a whole. Cash flow is the amount of cash on hand in a given time period. For example, let’s assume your revenue (cash in) this month is $10,000 and your expenses (cash out) are $8,000. While you’re profitable by $2,000, that profit margin assumes customers have all paid you on time and that all expenses became due after you have enough cash in hand to pay them. Let’s assume in this scenario that your biggest client has an outstanding $3,000 they still owe you. At the end of the month, your expenses of $8,000 leave you negative by $1,000 until they pay. This process is called a cash flow analysis.
As you can see, you can be profitable and still cash-flow negative. Even high-volume businesses can run into cash flow problems. This is why timing is everything with cash flow management. A deficit may cause you to miss a bill or pay it late, which can exasperate problems down the line if your spending that month is not reined in.
A cash flow projection is a technique that helps you see your future cash flow today by seeing how a decision (like financing a new piece of equipment, hiring a new employee, or raising your prices) will impact your business. It estimates the amount of cash that will come in and out of your business during a given timeframe given this new variable to see if there are any snags, (places where the cash out is greater than cash in). It takes into consideration the change(s) you plan to make in your business and estimates the impact.
Cash flow projection vs. management
As we’ve explored, cash flow projection is about predicting your future cash flow. It’s a decision-making tool to help project and ultimately protect your cash flow when making impactful business decisions.
Cash flow management, on the other hand, is the active practice of watching cash in and out on a day-to-day basis. It’s the process of monitoring and analyzing the data (income and expense receipts) in real-time to optimize spending. Cash flow management is a major element of every financial plan or budget.
Cash flow projection vs. cash flow forecast
Forecasts and projections sound a lot alike, and that’s because they are. They’re both about estimating future income vs. expenses to optimize. But there is a key difference. A cash flow projection differs from a cash flow forecast because it takes into consideration variable information (the impact of a hypothetical decision). Their main goal is to evaluate the impact of something new.
Cash flow forecasts, on the other hand, look to the future as if all stayed the same as it is today. Their main goal is to predict the most likely scenario and prevent predictable situations of negative cash flow.
When paired together, decisions become clearer. Build a cash flow forecast first to see your current position and run a cash flow projection to see how that will change as you add new variables.
Why are Cash Flow Projections Important?
Cash flow projections are important because they help you to see the impact a decision will have on your business before you make it. Over 80% of small businesses fail because of problems with cash flow. Having your cash flow down to a science is one of the best things you can do for your business. It’s one of the most important ways to secure your business’s future, regardless of your business structure.
3 Benefits of Cash Flow Projections
There are a few key benefits of creating cash flow projections worth noting. While your business may find additional value, these three benefits are universal.
1. Prevent financial problems
One of the major benefits of cash flow projections we’ve discussed already is that it can help you prevent financial problems before they arise. You’ll have an honest and unbiased look at the choices you’re faced with so you can make the best decision from a cash flow perspective.
2. Understanding your cash flow
By putting cash flow projections together regularly to guide decision-making, you’ll become a master of your own cash flow. You can start by creating a cash flow analysis to determine the health of your incoming and outgoing funds at the moment. Having a deep understanding of where you are and where you hope to be will be an invaluable resource as you look to grow and scale your business.
3. Confidence booster
If you’ve found a business expense won’t hinder your future cash flow projections, you can move forward with that decision with far more confidence than if it were a “guess and see what happens” kind of situation. This will instill confidence in your business practices as well as the direction your business is heading in.
How to Create a Cash Flow Projection
So, we’ve discussed all the reasons you should use cash flow projections to make more informed decisions from the cash flow perspective. But how would you actually put one together and manage your finances?
Step 1: Estimate your sales
The first step is to calculate, over the span of the period being analyzed, what your estimated sales will be. Unless you have a very regular schedule of income, it’s possible this amount will vary from month to month, so factor in likely fluctuations.
Step 2: Factor in your revenue schedule
The second (and most crucial) piece to the income puzzle is your revenue schedule. Over the time period analyzed, when will you receive the cash from your sales? Map it out to the best of your ability on a calendar.
Step 3: Calculate your business expenses
Next, add up your expenses over the time period you’re analyzing. Similar to how we did with the income estimates, map your expenses out on a calendar. On a day by day basis, where are you cash-thinnest or strongest? Are you consistently positive or are there some places you’d be cash flow negative? Make note of these extremities.
Step 4: Project your cash flow projection for your term
Finally, add in the new expense or revenue (like in a price increase example). When will you receive the new income or make a payment on the new expense? For example, note a payment every other Friday in the case of a new employee. You’ll be able to see how and if your situation will change with the changes you’re proposing to make.
Cash flow projections are an extremely useful tool for building and growing your business. Cash flow mistakes are the leading cause of business failure, so mastering yours through cash flow projections and cash flow forecasts may be the single most important thing you do as a small business owner