Why You Should Create a Cash Flow Projection

Cash flow is a critical metric every small business needs to pay attention to. It reveals your company’s financial health in the immediate present by comparing money flowing in and expenses flowing out. While knowing your revenue is obviously important, cash flow shows you how much actual money is moving into and out of your bank accounts.

With some math and some informed conjecture, you can chart the expected cash flow of your business for the future.

Why Is Cash Flow Projection Important?

What if you have to make payroll before receiving funds from a big invoice? This situation is a cash flow emergency—and a dangerous one at that—but you might not foresee it by just looking at income statements and expense reports. A cash flow statement can help you understand the present situation.

Cash flow projections, then, predict your cash flow in the future. A cash flow forecast can help you circumvent dreaded cash crunches, which is when your business needs to spend money but there isn’t enough cash on hand to cover the expense. Cash crunches are damaging to any business, and they can be ruinous for young or very small businesses.

Fortunately, with some preparations, you can project your future cash flow and determine how to focus on creating cash flow.

Cash Flow Forecast vs. Projection

The terms cash flow forecast and cash flow projection are used interchangeably by most small business owners and banks, but some consider them to be slightly different documents. In this latter definition, a cash flow forecast predicts your cash flow based on the most likely prospects of your company’s future, while a projection predicts cash flow based on alternative, hypothetical future situations, like an economic recession or a boom in customers due to a great marketing campaign.

No matter what you call your cash flow documents, you should prepare several based on different potential futures. It is a good idea to prepare one cash flow projection based on your present business, as well as a best-case cash flow projection and a worst-case cash flow projection.

How Do You Calculate Cash Flow Projections?

You must pay attention to  2 main elements when creating a cash flow forecast: accounts receivable and accounts payable.

Accounts receivables includes money that is expected to flow into your business, such as sales and payments from client invoices. Grants, rebates, loans, and funding are all considered receivables, too.

Accounts payable is the other side of the equation. Payables include anything your business spends money on: your salary, payroll, inventory, overhead, rent, taxes, and all expenses.

A cash flow statement compares accounts receivables to accounts payable. A cash flow projection predicts your cash flow over time.

To create a cash flow projection, it can be wise to start with the past. Look at 12 months ago and record how much cash was in your bank account—this amount is your starting balance in this example. Break down the past 12 months in terms of receivables and payables. Try to categorize your income and expenses as much as possible to get a better sense of where your money is coming from and what you are spending it on.

For the first month, subtract the total amount of payables from your total receivables. This calculation gives you your cash flow for the month. If it is negative, subtract it from your starting balance. If it is positive, add it to your starting balance. This new balance is the starting balance for the following month.

Repeat these calculations for the entire 12-month span and you’ll have a cash flow chart for your business.

The Small Business Administration has several great templates you can use to make this easier, including a cash flow projection template.

To predict into the future, you can sometimes reuse a lot of the data from the previous 12 months if your business stays stable in that regard. If you know of the specific revenues, funding, and costs that your business will incur in the future, you can use that data, although you should include some contingency spending.

If you are less sure about the future, start with what you know, like rent payments and clients who pay you a specified amount on a repeating basis. Then make educated guesses about what your cash inflows and outflows will be over the next few months. Here is where it makes sense to create several different cash flow projections for your status quo, best-case, and worst-case scenarios.

The time extent of your predictions is up to you, but you should think about your available data. If your company is well-established, you can create projections for many years into the future. If your company is very young, though, it might be more accurate to think in terms of a few months to a year out.

What Is a Cash Flow Projection Example?

Say your company starts the year with $80,000 in its bank account. This amount is your company’s starting balance for the year. During the month of January, you think you’ll make $5,000 in cash sales and collect outstanding invoices totaling another $2,000. You will also receive a business loan of $10,000 from a lender. These are all accounts receivable, and your accounts receivable total is $17,000. Between all your expenses for rent, inventory, and your salary, your accounts payable for January is expected to be $15,000. Your cash flow projection for January is $2,000 and you expect to end the month with $82,000 in your bank account.  

Is Positive Cash Flow More Important Than Profit?

Positive cash flow and profit are different but interwoven elements of a company’s success. Positive cash flow can be more important in the moment because it helps you avoid cash crunches. Over time, though, you want to earn a profit if you want to expand.

You should think about and create forecasts for both profit and cash flow.