Cash Flow Projection | 6 mins read

Complete Guide to Cash Flow Projections for Businesses

complete guide to cash flow projections for businesses
Chloe Henderson

By Chloe Henderson

Very few businesses consistently sustain high levels of customer demand, sales, and revenue throughout the fiscal year. Most companies see noticeable changes in profits during different time frames, known as slow and peak seasons. Without financial preparation, unsuspecting businesses can fall into a deficit from decreased cash flow during these periods.

A cash flow projection alerts companies of future profits by considering income and expenses. This enables management to create a plan of action to conserve cash for slow seasons and launch expansion ventures during profitable months.

It is vital for all businesses, regardless of their industry, to understand how to calculate cash flow projections and how it can impact performance.

What is a Cash Flow Projection?

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A cash flow projection is the estimated amount of money expected to go in and out of a business within a specific time period. In other words, it is the breakdown of capital that flows through a company, including income, taxes, and expenses. This value gives management an idea of how much capital, or profit, the company will be left with after a specific timeframe.

The two departments involved in cash flow projections are accounts payable (AP) and accounts receivable (AR). AP handles all outgoing billing, such as payroll, supplier payments, rent, inventory costs, and all other expenses. On the other hand, AR collects funds from outside sources, including grants, rebates, loans, and client payments.

While this concept may seem similar to cash flow forecasts, a projection uses hypothetical scenarios to calculate a value. For example, a business can assume they will increase their product prices, hire more employees, or reduce operational costs.

These schemes help determine how cash flow will look in the future after certain changes are made. It also defines a company's best- and worst-case scenarios so that they can prepare for decreases and drives in revenue.

How to Conduct a Cash Flow Projection

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While all companies should take the time to project cash flow estimations, small businesses especially can benefit from understanding their financial standings and recognizing lucrative and draining operations. Management can conduct a cash flow projection by following four steps-

1. Project Sales

First, accountants need to estimate their sales within a given time frame, such as monthly, quarterly, or annually. Businesses can get a good estimate by referencing the previous year's sales reports.
Management should also consider the company's monthly income statements, which contain information on credit, cash, and sales. Startups and other businesses that haven't built up enough sales history will need to research their market to estimate typical sales forecasts.

However, managers will also want to consider any changes the company is experiencing that may impact these metrics. Incoming competitors may decrease average sales while reduced stock expenses could boost profit margins.

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2. Determine Incoming Payments Based on Terms

Businesses that only handle cash and instant payments can move on to step three. However, calculating term-based payments is a key step for companies that extend credit lines or invoices and process multiple forms of transactions.

Since these payments are not immediately received upon the sale, management needs to determine when they will receive the funds. This can be calculated using the days sales outstanding (DSO) formula-

DSO = (Monthly AR / Total Sales Value) x Days in the Month

This formula calculates the number of days it will take to receive a customer's payment. For example, a retailer made $7,500 in credit sale in the month of July and had $5,000 in AR-

($5,000 / $7,500) x 31 = 20.7

The retailer has a DSO of 20.7, meaning it takes approximately 21 days to convert sales into cash.

3. Estimate the Fixed and Variable Expenses

Next, management needs to calculate the monthly fixed and variable expenses. Fixed expenses are costs that don't fluctuate based on usage, such as rent, labor wages, insurance, and storage.

On the other hand, variable expenses change depending on sales. Common business variable expenses include shipping, inventory, and commission costs.

Just like the sales, costs will need to be calculated and totaled for the given time period. For this step, it is helpful to collaborate with the AP department, who have access to detailed sales and expense reports.
Businesses that have not yet established AR can manually calculate expenses by categorizing costs in a spreadsheet.

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4. Calculate the Total

Finally, it is time to total all of the previous values to determine the business's projected cash flow. Beginning with the previous month's cash balance, managers need to add the current month's projected income based on the DSO. Then the estimated expenses are subtracted to determine the current month's projected cash flow-

Current Month's Projected Cash Flow = (Last Month's Balance + Current Month's Projected Income) Estimated Expenses

For example, a bookstore is projected to generate $3,500 in sales this month, but has an average of $800 in monthly expenses. With $2,000 still leftover from the previous month, their current month's projected cashflow is $4,700-

($2,000 + $3,500) - $800 = $4,700

Once the projected monthly cash flow is calculated, management can multiply or divide the value to determine weekly, quarterly, or annual cash flow. However, it is best not to project cash flow too far in advance, as any changes can significantly impact the calculation. Therefore, companies should routinely formulate their cashflow and re-calculate whenever a new variable is introduced.

4 Sources of Cash Received

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While estimating cash received may seem straightforward, AR handles several different sources of income. The most significant cash sources in business include-

  • Product and Service Sales
Retailers' primary source of income is product and service sales. However, there are different types of sales, depending on the form of payment. While cash is immediately available to the company, other forms, such as credit, may take additional time to process or receive.

  • Loans and Business Investments
Businesses can also receive accessible funds by acquiring a loan from a bank or investments from a client. However, it is important to record these values separately, as loans will eventually need to be paid back, converting the loan into an expense.

  • Asset Sales
Anything a business owns that holds significant value is considered an asset. Typical assets include cars, machines, equipment, and property.

Assets are also considered sources of income as they can be sold and converted into cash. For example, if a company sells a vehicle, the profit made from the sale would be incorporated in that month's cash flow statement.

  • Additional Income and Sales Tax
For companies that hold funds in a savings account, additional income can be generated from their bank's interest rates. Many businesses also collect sales taxes from their customers.

However, it is important to note that tax funds are temporary and will eventually be paid forward to the government. Therefore, organizations should not rely heavily on this source of income.

4 Sources of Cash Spent

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Just like income, there are several expenses that businesses need to consider when estimating cash flow. The most common costs include-

  • Bills and Cash Spending
Cash spending refers to any purchase made using petty cash, including lunches and immediate bills. These expenses are paid immediately upon the sale, unlike monthly bills.
Typically, companies receive invoices for their monthly expenses, such as rent, utilities, and storage, which are paid within the month. This gives AP time to record invoices and collect funds, as these costs are among the most significant.

  • Loan Payments
Businesses that have received a loan must eventually repay the institution. Recurring payments can be scheduled to minimize fees, based on the loan amount and interest rate.

  • Investments
Purchasing assets sometimes require major investments, including buildings, equipment, vehicles, and inventory. Assets provide the opportunity for resale in the future for a return of investment (ROI).

  • Non-Operating Expenses and Sales Tax
Non-operating costs are expenses that do not directly affect operations and sales, such as interest payments. Companies are also responsible for different taxes, including sales, state, and national.

Benefits of Cash Flow Projections

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Beyond expense and income awareness, cash flow projection offers businesses many benefits that can promote operational efficiency and long-term financial stability.

  • Early Awareness of Potential Cash Flow Decreases
By regularly calculating projections based on adjustments and updated metrics, management is able to anticipate decreased cash flow. This gives companies the opportunity to drive sales and minimize expenses to avoid cash restrictions.

For example, if a business has extra funds, they may make early payments towards loans. However, if projections show that cash flow will soon decline, the company would want to save any extra capital.

  • Transparency Among Stakeholders
Banks, inventors, and other stakeholders will want to know a business's cash flow before investing or accepting loan applications to ensure they will get their money back. By providing cash flow statements and projections, companies can be completely transparent with stakeholders to build respect and credibility.

  • Optimize Operations
Understanding how cash flow will fluctuate allows management teams to appropriately staff and make investments, without jeopardizing the business. Without a cash flow prediction, companies can restrict cash flow further with poor financial decisions.

  • Define Cash Leaks
Small leaks often go unnoticed but can add up to a considerable expense over time. Routine cash flow projections can identify lags between sales and payments, slow inventory turnover, and billing inefficiencies.

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  • Identify Income Needs
Cash flow projections alert businesses if they do not have enough capital to sustain operations and fund investments. This allows management to source additional income from loans, lenders, or investors.

  • Avoid Penalties
Some companies generate enough income from sales to cover regular expenses but lack the cash to pay sales tax. Unfortunately, the Internal Revenue Service

(IRS) is not very forgiving. Companies can consider their cash flow projections to ensure they have enough capital to cover necessary taxes and avoid penalties.

  • Match Cash In and Out-Flows
Every business has busy seasons where revenue reaches its peak and slow seasons where cash flow is limited. However, by projecting these fluctuations, companies can stockpile funds during peak seasons to ensure they can cover expenses through the slow periods.

  • Designate Ownership
Accurate cash flow projections can optimize financial planning, allowing directors to appropriately distribute equity to enhance profitability.

  • Capitalize on Opportunities
Projections inform companies when they can begin making investments, such as buying property, updating equipment, and onboarding employees. With a projection date, management can research deals and prepare finances to capitalize on increased cash flow.

How Forecasting Software Can Help

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Alongside calculating cash flow projections, companies can utilize forecasting software to gain a better overview of fluctuating trends. Forecasting solutions use historical financial data to detect emerging trends in demand, sales, and revenue.

Businesses with established software, such as inventory and point-of-sale (POS) solutions, can integrate their forecasting systems to analyze real-time metrics as well, providing the most accurate projections.
By anticipating future trends, businesses can prepare operations to reduce expenses. Management can limit staffing, inventory orders, and other purchases to minimize costs and stretch available funds.

Without proper forecasting, companies can lose capital on excessive labor costs during slow seasons, which can negatively impact cash flow and profitability. Businesses also need to be able to anticipate increases in demand, as they may lose potential sales if they experience stockouts. Forecasting enables warehouse managers to order inventory in advance to maximize sales and avoid understocking.

An accurate cash flow projection has the ability to alert organizations of impending fund activity, enabling them to create a plan of action to secure capital. Otherwise, businesses would need to rely on guesswork for financial planning.