A cash flow projection shows the expected amounts of money that will come into your business and what will go out as expenses. It is a different concept from business profit. A company can realize a profit but still have a cash flow problem.
To project the inflow and outflow of money in your company, you have to base on the previous financial performance of your company. You also need to compare it to the current financial position and then project the future.
A good cash flow projection enables you to estimate the accurate money inflow and outflow in business. You’re able to foresee a decrease or increase in expenses and cash inflow. You can decide in which month to buy or replace the company van based on the projected expenditure and cash inflow. In other words, it helps you a lot in managing a company without running out of cash.
Besides, it helps you to answer some of the most common financial questions in your business. Questions like; Does your business make a profit for all the twelve months? Do you know the most recurrent expenditures in your business?
And lastly, do you know the monthly revenue capacity of your business?
Do you know how to make a cash flow projection?
For one to create a money flow estimation, you need to understand and consider all the seven steps as discussed below:
1. Bring forward your total ending balance
In the first place, you have to bring all your ending cash total forward. The ending cash may be an ending profit or loss of the previous month. In the case of profit, you add it to the revenue of the current month. And in case of a loss, you deduct it from the revenue of the current.
2. Estimate sales
Besides, you have to project your sales per month. You need to estimate sales that you expect to receive payment in the upcoming month. For example, if you have $95,000 in invoices due for payment in the following month, and you expect 60% of the payment for those invoices, you need to put $57,000 in income for sales paid.
3. Estimate other revenue
In addition, if your only revenue source is sales, you can skip this step. However, if you have other sources of revenue, such as payment received from hiring the company van, you can place it below the sales revenue. For example, if you currently rent the company van that brings in $5,000, you’ll add that amount under van income, making your total incoming cash for the following month $62,000.
4. Estimate regular costs
Further, you are required to estimate your regular expenses for the month. You need to ensure that all your daily expenditures are inclusive. For example, your monthly expenditures should consist of rent of $3,000, utilities that average $2,000 a month, a part-time employee, whose salary is $500 monthly, and insurance of $90 a month.
5. Estimate seasonal costs
Furthermore, you have to include a one-time expense upcoming in a separate line. You have to ensure not to include that expense monthly. For example, if you have a subscription to a professional accounting firm that you pay $5,000 annually, you will only include that expense in the auditing month.
6. Subtract costs from income
On the other hand, when you have estimated all the cash in and cash out, you can subtract your total expenses from your total income to see your cash flow for the month. This amount is significant since it displays whether you had more incoming cash than expenses.
7. Add the beginning balance to the estimated cash flow
And lastly, once you have your total cash flow for the month, you need to add your beginning balance to your current cash flow to get your ending cash balance for the month. It is the balance that you need to use as your beginning cash balance in the next month.
The four benefits of creating a cash flow projection
It helps you to plan better for the future of your company and make more informed decisions. Here are the four reasons why making a money flow projection is beneficial to your business.
1. Improves decision-making
Since it makes you aware of your cash inflow and outflow, you can make the right decisions. You can tell the revenue for the following month and base on that to plan your expenditure. It enables you to avoid making business decisions that do not match your income.
2. Helps control spending
Besides, it assists you in managing your spending. You’re able to know your current and following month’s income and plan your budget accordingly. It helps to determine which months to buy an item in your company and when not to buy.
3. Points out potential problem areas
Additionally, you can point out possible areas of trouble in your company. For example, if you have $100,000 in invoices due for payment in the following month and you’re expecting 40% of that money, your income becomes $40,000. And that advice to find out other sources of income should you have an expenditure of $150,000 that month.
4. Predicts cash shortages
And lastly, it is significant in foreseeing cash scarcities in your business. For example, if you have $100,000 in invoices due for payment in the following month, and you expect to get only 30% of that money, your income is $30,000 in that month. So, should other sources of revenue only account for $50,000, then it is easy to predict cash shortages in your business.
In summary, cash flow projection as part of an accounting system plays a significant role in your business, as discussed above. Therefore, it is recommendable that you should all adopt it in the management of your company.