August 15, 2024
A cash flow projection is much more than a way to predict how much cash will move in and out of your business over a set period.
It’s the lifeblood that helps your business become less reactive and more proactive, enabling you to anticipate challenges and make sure bills are paid on time and cash surpluses are wisely invested.
Think of a cash flow projection as a financial navigator for your business, one that gives you advanced warning of any potential storms or opportunities on the horizon.
In this guide, we outline the six steps required to perform a cash flow forecast and explain techniques like scenario planning and sensitivity analysis.
We also weigh up the pros and cons of using spreadsheets versus cash flow forecasting software, so you can decide which one makes most sense for you.
Before we explain how to perform a cash flow projection, let’s first cover the basics.
Cash flow is the amount of cash that flows in and out of your business during a specific period. Also known as a cash flow forecast, cash flow projection involves estimating what your cash flow will look like for a future period – whether a month, quarter or year from now.
As we’ll explain in this guide, this estimate of future cash flow is based on a range of data and factors, including predicted sales and expenses as well as the timing of payments to your business. These predictions are typically informed not only by your business’ past financial data, but also non-financial data.
This can include factors like expected market or economic conditions, or internal initiatives slated for the future period, like for instance entering a new market or launching a new product.
Once you’ve created your base level cash flow forecast, you can get even more insight into future cash flow using sensitivity analysis or scenario planning – techniques that we’ll fully explain later in this guide.
Performing an accurate cash flow projection means tapping into a variety of financial and non-financial data.
For instance, estimating future sales will involve assessing past revenue figures as well as seeing how many opportunities you currently have in the pipeline and at what stage they're at in the sales cycle. You’ll also need to factor in how long it typically takes for different sales opportunities to close.
To estimate future sales or expenses, you’ll need to look at historical data to identify patterns and trends over past months, quarters or years. You’ll also need to factor in external dynamics like seasonal fluctuations, changing economic or market conditions, as well as the fluctuating price of goods and materials.
Considering all these factors means sourcing data that may sit in spreadsheets, accounting software or CRM systems, or with different business stakeholders. It’s important to have easy access to this data to perform an accurate cash flow projection.
Now that you understand the purpose and general scope of a cash flow projection, let’s get into the practical considerations and actions required for an accurate calculation. We’ve broken this down into five key steps:
To start your cash flow forecast, you need to know your opening cash balance, which is the amount of cash you have at the beginning of the period you’re forecasting.
If this is your first cash flow projection, use your current reconciled cash balance. If you’ve done this before, use the closing balance from the previous period as your opening balance for the new projection.
An accurate cash flow projection requires predicting your future sales for the period based on figures in past income statements, as well as the trends you identify across these.
When reviewing past figures, make sure to consider contextual factors that may have influenced sales. This can include seasonal fluctuations, supply chain disruptions, wider economic factors or the effect of internal changes like, for instance, the launch of a new product.
Also consider such factors when predicting your sales, too. For example, if your historical data shows that sales typically increase by 20 during the holiday season, you should factor that into your projection for those months.
Another example is if you’re planning a significant marketing campaign, you might anticipate a boost in sales.
The timing of your cash inflows is as important as the amount. If your business primarily deals in cash sales, this step is straightforward – payments are received at the time of sale. However, if you extend credit to customers, you need to account for the delay in receiving payments.
To do this, calculate your average Days Sales Outstanding (DSO), which represents the average time it takes for your customers to pay their invoices. For instance, if you have 30-day payment terms but typically receive payments after 45 days, this delay should be factored into your cash flow projection.
To calculate DSO, use the below formula:
DSO = (accounts receivable \ total credit sales) X number of days
While sales revenue often constitutes the bulk of your cash inflows, your business may have other sources of cash inflows like rental income, interest earnings, investment returns, royalties and any one-time gains.
To incorporate these revenue sources into your cash flow projection, first list each type of additional income and estimate the amounts for the period based on contracts, agreements or historical data.
Combine this with your projected sales revenue to determine the total incoming cash for the period.
Next, estimate your expenses for the period, dividing them into fixed and variable costs. Fixed costs, such as rent, salaries and insurance remain constant regardless of your sales and are therefore relatively easy to predict.
Variable costs, on the other hand, fluctuate with your business activity. These might include costs for raw materials, shipping, utilities and commissions.
For example, if you’re planning a significant marketing push, your advertising expenses will likely increase. Similarly, if you’re scaling up production to meet higher demand, your material and labour costs will rise.
It’s important to also account for any irregular expenses, such as annual subscriptions, tax payments or one-off equipment purchases.
This first involves determining your net cash flow for the period by subtracting the costs from the revenue you expect. With this calculation, you can see whether you expect a surplus or a shortfall of cash.
For example, if your total inflows are $9,000 and your total outflows are $3,590, your net cash flow for the month would be a surplus of $5,410
Next, you’ll need to add your net cash flow to your opening cash balance to determine your closing cash balance for the period. This closing balance will become your opening balance for the next month or period.
For example, if your opening balance was $2,000 and you project a net cash inflow of $5,410 for the month, your closing balance would be $7,410.
While a single projection can give you valuable foresight, you can gain a wider idea of how your cash flow may perform by testing different potential scenarios.
One technique to do this is scenario planning, which helps you visualise the paths your business could take by creating multiple cash flow forecasts based on different assumptions about the future.
Unlike sensitivity analysis, which focuses on the effect of changing a single variable, scenario planning considers multiple variables and their interactions to project complex situations.
To conduct scenario planning, start by identifying the key factors that could influence your business, such as market trends, economic conditions, regulatory changes or technological advancements. Then, develop a series of scenarios which could include:
Let’s get more clarity on what these different scenarios can tell you with some practical cash flow projection examples.
In the base-case scenario, you project stable revenue at $10 million. The cost of goods sold (COGS) remains consistent at 60 percent of revenue, resulting in costs of $6 million. Operating expenses are maintained at $2 million. The result is a net cash flow of $2 million.
A best-case scenario could be that you anticipate a 20 percent rise in revenue to $12 million. With COGS improving to 58 percent of revenue, costs total $6.96 million. Operating expenses went up by 10 percent to $2.2 million. This results in a net cash flow of $2.84 million.
Finally, a worst-case scenario may involve a 15 percent revenue drop to $8.5 million. COGS stays at 60 percent of revenue, costing $5.1 million. Operating expenses remain at $2 million. This results in a net cash flow of $1.4 million.
Check out our blog for more information on scenario planning.
When it comes to performing projections, most people typically fall into two camps; those who use spreadsheets and those who use advanced cash flow projection software.
Let’s look at the advantages and disadvantages these tools offer to help you decide which is right for your business.
Spreadsheets have been a go-to tool for cash flow projecting for decades, and they have some clear advantages. But like anything, they come with downsides too. Here’s a quick rundown:
Benefits:
Drawbacks:
There is a variety of cash flow projection software on the market designed to help you save time, reduce manual data entry and gain more granular insights.
For instance, our cloud-based financial management platform Fathom can help you visualise your cash flow forecasts and test different scenarios. Let’s look at the advantages of Fathom over spreadsheets.
Look at the video below if you want a helpful overview of Fathom’s cash flow forecasting capabilities:
Given their limited cash reserves and uncertain revenue streams, maximising cash flow is especially critical for startups and small businesses – and the insights they can gain from cash flow projections are invaluable to this end.
But compared to larger businesses, those on the smaller end of the scale typically need to overcome certain hurdles when performing a cash flow forecast. Let’s look at these challenges and how they can be solved, as well as a few tips that can help enhance cash flow.
A key challenge for startups and small businesses is they may lack the historical financial data needed to project future revenues and expenses. A solution to this is to use industry benchmarks like this Australian example provided by the AUSTRALIAN TAXATION OFFICE (ATO).
These benchmarks can help you establish baseline projections based on the performance of similar businesses. Market research can also help identify key trends, customer behaviors and competitive dynamics that may impact cash flow.
Another common challenge for start-ups and small businesses is the unpredictability of income streams. This is where scenario planning and sensitivity analysis is particularly useful.
As we explained before, scenario planning enables you to test best-case, worst-case and most likely scenarios, and then develop contingency plans for each. Testing a worst-case scenario, where you underestimate potential revenue and overestimate expenses, is especially important if your business has uncertain and fluctuating revenue streams.
The first few years of a startup or small business are often the most challenging in terms of cash flow management. Here are some helpful tips for boosting cash flow during this uncertain time:
Cash flow projections are not just a financial exercise; they are a vital strategic tool that can guide your business through uncertainty and towards growth.
By projecting your cash flow, you gain valuable insights into your business’ financial future, allowing you to make informed decisions and seize opportunities as they arise.
Incorporating cash flow projections into your financial planning process not only helps you stay ahead of financial pitfalls but also enables you to make strategic investments and manage resources more effectively.
Whether you choose to use spreadsheets or invest in dedicated cash flow forecasting software, the key is to regularly review and refine your projections to keep them aligned with the evolving needs of your business.
Try Fathom free for 14 days to see why it’s the cash flow forecasting software of choice for over 80,000 businesses globally to forecast, analyse, report and consolidate.
With Fathom, it is easy to visualise your future cash flow with one powerfully simple business management solution. Fathom also provides KPI dashboards to track profit, growth and progress towards financial goals, and advanced reporting capabilities.
It integrates directly with leading accounting platforms like Xero, QuickBooks and MYOB, making it easier to get started, stay connected, and get more out of your data. View all our integrations.
You can learn more about Fathom’s cash flow projection capabilities with our webinars for businesses and accountants. You can also access more helpful content and customer case studies on our blog.
Kit is the Content Marketing Manager for The Access Group APAC and Fathom. He is a former journalist with extensive experience in content writing and copywriting across various industries, including higher education, not-for-profit, and finance sectors.
