02/ 17/ 2005
by Jeffrey Moses
Forecasting cash flow can be a more complex and potentially variable task than most small-business owners think. Accuracy in your cash-flow projections is important because it can help you know months in advance when cash reserves may become depleted. It's easier to prepare loan requests, balance inventory purchases and cut back on expenses such as marketing well in advance of actual cash shortages.
The reason cash-flow projection is both an art and a science is because a number of activities a business undertakes are often not included on simple profit-and-loss statements. These include:
- Purchases of equipment
- Added or increased employee salaries
- Addition of inventory by cash payment
- Future financial obligations such as inventory purchased on credit, advertising contracts, upcoming balloon payments of debt and others
- Investment income (loss)
- Varying credit rating, which can affect amount of credit available from vendors and lenders.
Also, increased credit sales to customers can result in higher accounts receivable in any given period. This is a positive variable, of course, but still can result in incomplete or inaccurate profit and loss statements.
Theoretically, cash-flow statements address these variables, giving a more accurate projection of cash flow a quarter or several quarters in the future. Even a simple cash-flow statement – often called a pro forma cash-flow statement – can serve as an early warning signal for upcoming cash shortages.
Pro forma cash-flow statements consist of:
- Cash at the beginning of a period, not including investments such as stocks and bonds.
- Accounts receivable and all other sources of income, including investment income, rents or loan payments.
- All anticipated cash outlays, including equipment purchases, salaries, utilities, mortgages/lease payments, debt payments, marketing costs, taxes and insurance.
- Projected net change of cash at end of period. This will be a positive or negative figure, and when added to or subtracted from the beginning cash is the basis for determining your ending cash position. Based on ending cash, financial adjustments can be made during the period, including: purchases of all types, operational costs such as marketing or addition of employees, as well as taking out of new loans to meet anticipated cash shortages.
While a traditional pro forma cash-flow statement does not include items such as varying credit ratings, which can affect the amount of credit available to you from vendors and lenders, you can use your ending cash position as a projection when you're being considered for loans. When you know with reasonable certainty that you will need to borrow a certain amount by a specific date, you can work with lenders well in advance to secure adequate funding. Preparing loan statements and approaching lenders before you actually need money will put you in the best possible light, and will give lenders a chance to examine your loan statement carefully.
