What is Cash Flow Projection and Why Is It Important to Your Business?

February 1, 2016 / Reading: 4 minutes

Cash flow projection is very important in any business, especially small businesses. If you ever want to succeed in your business you need positive cash flow, and the only way you can achieve this is by having regular financial forecast. Financial projections is a method of analysing your business in order to detect any possible ‘leakages’. It determines the weak areas in your business as well as possible solutions to them.

Cash flow on the other hand explains the inflow of cash into a business. It helps an entrepreneur to have knowledge of how to spend money, what to spend money on and how much money comes into the business.

Related: Download Your Free Cash Flow Projection Template

Cash flow is a challenging concept that can be tricky to many business owners. An entrepreneur whose income statement looks profitable may still find himself in a financial problem. To fully understand what cash flow is, you need to view cash flow as the total amount of money a business generates minus the amount that goes out.

How important is cash flow forecast to your business?

Cash flow is very important in a business as it is necessary for the continuity of a business operation or survival since cash is the life blood of any conceivable or existing business. Therefore, you need a regular financial forecast to detect any future crises. In fact, cash flow projections are important in the following ways:

  • They identify potential shortfalls in cash balances.
  • They enable you to identify when problems are likely to occur
  • To ensure you have enough cash to pay suppliers and employees.

Here is a good example to consider

imagine that you run a business and a client bought a $20,000 goods in February but didn’t pay till April and you need to pay your electric bills, salaries and expenses, all amounting to nothing less than $8,000. $12,000 may appear on your income statement but it sure won’t pay you or even settle your bills. In this case you are profitable in your income statement but your cash flow is negative. The only paper that pays you is the dollar not your income statement.

How to properly manage cash flow

Having understood the concept of cash flow clearly, you should know that properly managing cash flow is a determining factor in whether a business is to flourish or fail.

  • Ensure that your debtors pay you as quickly as possible, or better still pay you in advance. Try motivating your clients by offering them incentives for upfront or early payment. In this way, your customers will be motivated to continually pay upfront or on time in order to get incentives from you.
  • If you are a good negotiator, you want to use your skills to your advantage. Negotiate with vendors to see if you can receive loan or other form of assistance from them.
  • Never spend money on things that of little value, or at worse of no value to your business. Ensure that all your expenses are for the betterment of your business. Practice the habit of always buying in credit and getting paid in time. Again, that’s where your negotiating power comes in. This guarantees influx of cash into your business.

In order to run a successful business, you need to have weekly and monthly financial forecast. This will assist you in managing your finances.

Related: How to Use Your Cash Flow Statements to Gain Crucial Info about your Business

Financial forecasts are future prediction of your business finances which provides details of actual results. However, this is not easy, especially if you are just starting but they are very important for your business.

What you need to put into consideration in your financial forecast

  • Sales: Estimate your average sales per month and set it as a benchmark for your business sales. At the end of the week or month, review the difference between your actual sales and the one you set as a benchmark. In this way, you will identify whether you are in profit or in loss.
  • Expenses: Regularly estimate your expenses. This may include rent, insurance, vehicles, advertising, employee wages and others.
  • Cost of goods sold: Forecast how much it takes you to produce the goods (in the case of physical goods) or how much it takes you to provide your service.