Having sufficient cash flow is essential to the survival of your business. Therefore, you also need to predict how much is coming in, from where and when.
If your accounts are accurate and up-to-date, you can examine your current cash receipts and payments to estimate the amount of money coming in and going out of the business. Next you can estimate future sales of services and products from past records.
From these figures, after making allowances for future marketing plans or predicted cost increases, you should be able to come up with an estimate of cash flow for the period ahead.
If your cash flow is planned, temporary cash shortages can be remedied in advance by seeking a bank overdraft. Banks are more likely to agree to an overdraft if you can show a cash flow forecast that demonstrates when and how the overdraft will be repaid.
Remember, when you are negotiating payment schedules with customers, to always keep one eye on the cash flow consequences.
Forecasting Your Cash Flow
Net cash flow is the difference between the inflows and outflows within a given period. A projected cumulative positive net cash flow over several periods highlights the capacity of a business to generate surplus cash.
On the other hand, a cumulative negative cash flow indicates the amount of additional cash required to sustain the business.
Cash flow planning entails forecasting and tabulating all significant cash inflows relating to sales, new loans, interest received, etc. and then analysing in detail the timing of expected payments relating to suppliers, wages, other expenses, capital expenditure, loan repayments, dividends, tax, interest payments, etc.
The difference between the cash inflows and outflows within a given period indicates the net cash flow. When this net cash flow is added to or subtracted from opening bank balances, any likely short-term bank funding requirements can be determined.
There are two methods of determining the net cash flow from operating activities, indirect and direct. The direct method is the preferred method and presents cash flows from activities through a summary of cash outflows and inflows. This may be the more intuitive method for individuals that have no accounting training.
However, most businesses prefer the indirect method because it shows a reconciliation from reported net income to cash provided by operations.
The following should provide some guidance as to how the reconciliation using the indirect method takes place. It begins with net income and adjusts net income for changes in account balances that affect available cash.
The table below illustrates how you will arrive at your net cash flow position.
| Depreciation Expense | Decrease in Deferred Taxes | |||||
| Increase in Deferred Taxes | Increase in Accounts Receivable | |||||
| Decrease in Accounts Receivable | Increase in Stock | |||||
| Net Income | + | Decrease in Stock | _ | Increase in Prepaid Expenses | = | Net Cash Flow from Operating Activities |
| Decrease in Prepaid Expenses | Decrease in Payables | |||||
| Increase in Payables | Gain on Disposal | |||||
| Loss on Disposal |
When preparing your cash flow projections, be aware of the following:
Overstating sales forecast
Underestimating costs and delays likely to be encountered
Ignoring historic trends or performances
Making optimistic assumptions about the availability of bank loans, credit, equity, etc.
Realistic views should always be taken about future aspects of your cash. Usually the best forecasts depict the worst case scenario and use this to plan for shortages and surpluses.
Determining cash inflow
The first major source of cash is money received from operating the business, ie. selling of products and services. Cash is usually received on a regular and recurring basis. It can be forecasted and planned for.
You receive this money when customers pay you, either at the time of the sale or and from the collection of sales on account to which you have extended credit. Offering credit to your customers increases sales, but it also increases risk (ie. non collection). So, there is always a trade-off. As your business grows, your ability to accept risk may also increase.
How and when your customers pay for your product or service will affect your “cash flow”. The sooner a customer pays you, the easier it is for you to manage the cash flow of the business. Remember, a good business always monitors its level of receipts from debtors.
Investment Income
Cash received from investments should be included in your cash flow projections. This may include the sale of an investment such as shares, the receipt of dividend or interest income.
You can calculate the income you expect to receive from them and include these amounts in your cash flow. Take into account the anticipated interest rate, the dividend yields of investments in previous years and the timing of payments.
Current rates can be found in the financial section of your daily newspaper. You will also find predictions of changes that are likely to happen, but be wary, as these may be somewhat speculative.
Other Investment Income
Other investing activities include cash received from the sale of fixed assets (such as equipment). Be aware that you will rarely receive the same amount of cash when you sell an asset as its written down value in the balance sheet.
You may also want to use some assets, due for replacement, as trade-ins and, therefore, you will receive no cash. However, a trade-in will also reduce your cash outgoing. If you plan to sell investments, enter the money you expect to receive in your cash flow projections.
Once you have established your likely cash inflows, you must then consider your cash outgoings.
What are your cash outflows?
Your major cash outflow is usually payments to creditors. These will be determined by the payment terms set by your suppliers, the timing of their invoices and any settlement schedule previously agreed to with your creditors.
Other factors, which affect the timing and amount of cash flow, are the purchase of non-current assets (eg. equipment, vehicles). You can estimate this item from your capital budget for the year and any investments you make during the year.
In your cash flow statement, deduct the trade-in value of any old assets that are being replaced from the purchase price of the new asset. Remember, installation costs are extra and that you may make some purchases by instalments (ie. hire purchase).
Payments To Employees
In most businesses staff wages and benefits will be another major outflow, but one which is fairly predictable. You will need to deduct income tax and remit that to the ATO as well as pay a percentage of each employee’s income into a superannuation fund. If your business is highly seasonal, allow for the likely amount and timing of any overtime or casual employment. You should also allow for any expected pay rises or salary progression, and any extra labour you may need when you plan to increase production.
Sundry Payments
These may be difficult to plan in advance. They include donations and the results of legal action. Factor in a nominal amount in your cash flow for sundry payments.
Interest Payments
You should try to forecast your level of borrowing, including payments on a bank overdraft. On this basis, make an estimate of the interest due, remembering that interest rates may vary both up and down during the year. Include estimates of the timing of interest payments and any anticipated loan capital repayments.
Dividends and Drawings
The money you draw to live on as the owner of the business must be included as a cash outflow. The timing and amount of dividends, and drawings you make, should be determined by your forecasted profit.
Working out your cash flow budget
Once you have gathered the cash inflow and outflow information, you should complete the cash flow budget for the year. Analyse the results of your budget, highlighting in particular:
seasonal variations in cash flow
cash flow peaks and troughs
cash shortages or surpluses.
It is important that you identify and address the above cash issues. For example:
you need to adequately prepare for seasonal sales and “harbour” cash during the off season
during cash peaks or surpluses consider using the funds for other purposes (eg, bank deposits, shares)
during cash shortages or troughs, discuss with the bank the need for cash or have money set aside.
A cash flow budget in many respects is only as good as what you do with the information it presents. You need to analyse the results and take appropriate action (as required). The type of action is discussed above.
