For a lot of new business owners, and those looking to buy a business, the uncertainty of what the future holds can be a source of great anxiety. But what if we told you that there was a tool you could use to help you predict future problems so that you can do something about it before it happens?
That's exactly what a cash flow projection is. With it, you can forecast possible cash shortfalls and surpluses in advance.
What Is A Cash Flow Projection?
By evaluating projected cash flow and estimating the company's anticipated cash receipts and disbursements over a specific time period, one can determine if there will be enough cash to cover those disbursements or if a shortfall is anticipated.
Before you start, you should establish the assumptions surrounding the way in which cash flows in and out of the business on a monthly basis, including how fast you receive payment from your customers and when your payments to vendors and suppliers are due. In business ownership, you should also establish a realistic expectation of the total percentage of receivables collected in the month following the sale and in the subsequent months.
It's important not to be overly optimistic when establishing these assumptions, otherwise, you may experience an unexpected shortfall if reality doesn't match your optimism. Over the course of time, you can compare your cash flow assumptions against what's happening and adjust them accordingly.
Drawing Up Your Cash Flow Projection
In a spreadsheet, create 12 columns, one for each month in the coming year. Then, add rows for each of the items in the following categories:
- Opening balance: this is the amount of cash you have available at the beginning of each month.
- Cash receipts: add a line for every source of cash entering the business. They can include cash sales, receivables collected, cash from loans or lines of credit, and other sources.
- Total cash available: the total of all cash receipts for the month plus the opening balance.
- Cash paid out: this category will include all expenses paid out during the month, with a line for each type of expenditure. They will include items like payroll, accounts payable to vendors, rent and other overhead expenses, loan and line of credit payments, owner’s compensation, estimated income tax payments, and other expenses.
- Total cash paid out: add up all of the expenses paid out over the course of the month.
- Excess (deficit) of cash: subtract the total cash paid out from the total cash available. If the amount is negative, it means you may be facing a deficit or cash shortfall. The figure in this category can then be carried forward to the opening balance for the following month.
You can then fill in your estimates for each of the following 12 months. Be sure to take into account months when insurance premiums are payable and those with three pay periods if you're on a biweekly structure. Keep track of your results against what you forecast in order to be sure you hadn't been overly optimistic or overly cautious.
By maintaining and evaluating your projected cost flow, you can make sure that the business will generate enough revenue every month to meet your obligations and, preferably, with a good margin of profit on top.
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