For businesses of all sizes, managing an organization’s cash flow is an essential ingredient for success. For a business to successfully manage its cash flow, it must first understand its current cash flow standing and consequently project how cash flow will look in the future.
In this blog post, we’ll be discussing everything from what is cash flow, what is a cash flow projection, why projections are important, and how you can calculate these projections for your business.
Sign up for a Free Trial today
• Why Cash Flow Projections Can Make or Break a Business
• Benefits of forecasting your business cash flow
• Common cash flow forecasting challenges
• How to calculate your financial projection
• Cash flow projection in business plans
• Cash flow projection for a start-up
• 5 Tips for making an accurate cash flow projection
But before we get into the specifics, let's discuss what cash flow is and why cash flow projections are important.
Cash flow in basic terms is the difference between the amount of cash a business has and receives versus how much it spends. Now a business may easily figure out the current period’s cash flow by comparing how much cash it spent versus how much cash it received; however, that is just a snapshot in time of the current cash flow. In many cases it is not enough to keep the business in a comfortable cash flow position.
When a business understands the importance of cash flow management, it starts to think about how its cash flow will change throughout the next month, quarter, and year. To accomplish this, businesses must first understand future cash flows and to do this they must create cash flow projections.
If a business does not create these projections, it may have liquidity issues in the future where an unexpected or unaccounted-for expense creates a sustained net negative cash flow balance. If this occurs, a business may not be able to stay in business.
Now that we’ve covered why it’s essential to project your future cash flow, let’s talk about the benefits you can achieve from using cash flow projections.
The first and most obvious benefit is that your cash flow projections will help you more accurately forecast the expected inflows and outflows of your business. This will help you understand where your business stands in terms of liquidity.
After understanding your general cash position , you can dive deeper into potential cash shortages or cash surpluses . This can help you address potential bottlenecks and take advance of opportunities.
By reaping the benefits of forecasting you will contribute to the overall health of the organization. You can use this information to create longer-term plans that benefit for the organization and its employees.
Now that we’ve discussed the benefits let's discuss some of the challenges with forecasting.
One of the most common forecasting challenges is that companies may be too optimistic with their projections. Secondly, businesses may not account for specific scenarios that may come up or are unable to predict these gaps preemptively. Lastly, there is the two-pronged issue of data entry error (which automation can help with) and a failure to reassess the forecast periodically.
Now that’ve covered most of the basics let’s get into how your future cash flow can be calculated.
Below you can see a basic formula for calculating future cash flow projections:
Cash Flow Forecast = Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash
Now, let’s break this down even further and get into what each of these sections represent and how you can calculate these numbers for your business.
The first thing you must account for is beginning cash or in other words the cash you have in the bank before your projection.
After this, you calculate the inflow of cash. Cash can come in multiple forms and different payment types can have different caveats to them. For example, an organization that has a subscription fee can most likely account for that cash being received with more certainty whereas if you are a vendor who sells products a delay or a naturally longer period to pay may affect your cash flow. With that being said, cash inflows can include:
After you’ve calculated inflows, you must calculate outflows. This aspect of your forecasting may also vary at different times. You may start renting a new building mid-year, taxes may go up, and miscellaneous expenses can come up without notice. Some of the common cash outflows are:
After you have these three components: 1. Beginning cash, 2. Cash flowing in 3. Cash flowing out, you use the formula and land at your forecast for that specific period. After you do this for a particular month you repeat the process using the previous cash flow as your beginning cash balance.
And that’s it! You have an ongoing projection for your business. Make sure to adjust your forecasting as you progress throughout the months so that you can account for any changes in your business .
This brings us to how you use cash flow projections in business planning.
Cash flow projections, as we mentioned before, can help a business understand potential future cash shortages, future cash inflows, and potential cash avenues for a business. Using this forecasting method businesses can create a more agile financial environment where continuous forecasting and reassessment can help businesses stay profitable and be financially sound in the long run.
Forecasting especially benefits small to medium-sized businesses for a variety of reasons. Let’s discuss one of the biggest benefits of cash flow projections for start-ups. According to a CB Insights report, “running out of cash” is mentioned as one of the core reasons a start-up fails. Therefore, using cash flow projections is an essential practice for start-ups to stay financially healthy and avoid failure due to a lack of cash.
Using projections, a start-up can gain insights into its current and future financial position and can adjust its plans accordingly. These projections can help a startup find gaps and opportunities, which can be leveraged to maximize cash flows. If a start-up is executing well, it would stay solvent and could use their positive cash flow projection to attract new talent and investment.
Let’s now get into our final section and leave you with some tips on how to make an accurate cash flow projection, no matter the size of your business.
And that’s everything! We hope our article has given you a better understanding of how your business can use cash flow projections effectively to better understand and improve your organization’s financial situation.
Frequently Asked Questions
Here are some of the frequently asked questions we thought readers may have on our topic:
When a business understands the importance of cash flow management, they start to think about how its cash flow will change throughout the next month, quarter, and year. To accomplish this, businesses must be able to understand future cash flows and to do this they must create cash flow projections. A cash flow projection projects the ins and outs of cash for a set amount of time in the future.
In simple words, cash flow projections must include the cash you had on hand before the projection (beginning cash), the cash you expect to get in any given month(s) (inflows), and the cash you expect to spend (outflows). After you do this for one month you may repeat the process for the future months and get a projection for the year.
Cash Flow Forecast = Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash
An example of a cash flow projection can be that an organization had 5000 beginning cash and expected inflows of 10000 and outflows of 10000. This means that the cash flow projection for that specific month would be 5000.
Here is a basic example of a cash flow projection: