Why a Cash Flow Projection is Important

Whether you have an established business or are a relatively new business owner, one key to making your business successful is understanding and knowing your cash flow. For small business owners, it can mean the difference between being successful or slowly failing. So, what is a cash flow projection, why is it important, and how do you create a cash flow projection for your business?

A cash flow projection is a breakdown of the money that is expected to flow into and out of your business. Though you cannot fully predict your cash flow, even a new company can have a pretty good idea of their expected income and expenses.

Having an accurate cash flow projection can help you know when you may have some extra cash to make a needed business purchase, versus when it is time to tighten the belt and put off any extra investments to a future date. It gives you an overall view of your business cycle. Think of it like a weather report. It is a forecast that you can use to plan your activities, whether to enjoy a sunny day or to prepare for a storm. It may not be 100% accurate but is very helpful in formulating the best possible plan.

Most financial reports are a lot simpler and less overwhelming when broken down into steps. To create a Cash Flow Projection, start by looking at the revenue side of your business. Record all expected income. When doing this, various things should be taken into consideration. First is your business invoicing cycle. Do you invoice monthly or quarterly? What are the terms? Asking these types of questions will allow you to predict when cash will be received and deposited. Some additional considerations include the seasonality of income and the impact of other things, such as credit card processing delays.

Hopefully, looking at your revenue is a positive experience, now you need to look at all cash expenses of your business. These are expenses that require cash to be available on specific due dates. Payroll and rent are the largest and most common examples of this type of expense. Payroll expenses should include related employer taxes. Depending on the type of business, payroll expenses can also have seasonality—for example, the need to increase staff for the holiday season. Taking these fluctuations into consideration is vital to accurate forecasting, especially if there are future payroll runs that will be higher than average.

Some expenses cycle through a business’ cash flow projection at various intervals. A good example is the multiple forms of insurance. Worker’s Compensation and health insurance amounts can vary with payroll and are usually billed monthly and, therefore, should be included in the forecast on the same schedule. General liability and auto insurance are charged on a six or nine-month schedule. Regardless of the billing cycle, the cash forecast must capture it correctly. Like payroll and rent, insurance cannot be paid late and ideally is paid in cash.

The forecast should also incorporate cash needs for the pay down of debt related to loans, credit cards, and lines of credit. Additional expenses can be identified from a review of the previous quarter or year’s financial statements.

The net of the total revenue and expenses will be the excess cash on hand. One of the primary benefits for a small business to do a Cash Flow Projection is to make sure there are no periods where the cash expense total is higher than the forecasted cash revenue plus the cash on hand.

It is helpful to have the big picture projection of your business’ cash flow, such as an annual overview. However, forecasting cash needs on a monthly or weekly basis will give you a better idea of your business trends, and allow you to make smarter business decisions. It is like our weather analogy. We planned a family vacation to Hawaii eight months in advance, anticipating beautiful weather. We had no way of knowing there would be a tropical storm our first few days there until days before its occurrence! In your business, you can make general plans based on a long-term forecast, but you need those short-term forecasts to make important decisions.