Welcome to the topic: “How to forecast cash flow projections for a startup business“.
Cash flow refers to the amount of money that is flowing in and out of a company or a business. The money that is coming into the company is known as inflows and the cost of different expenses paid by the company is known as outward flow. Understanding the basics of cash flow is essential to properly learning how to forecast cash flow projections for your business.
These cash flows both inward and outward are determined by different operations of company including investing and financing. These cash flows can be analyzed by inspecting the cash flow statements for a period which can be weekly or monthly.
There is another side to this as well; the cash flow statements do not show the complete picture of the money moving in and out of the company. There are certain payments, which are paid at a later time and these are recorded into the cash flow statement at the time these are paid.
Cash flow forecast
There are multiple things happening all at once in a company and it is important to monitor the inward and outward flows. A cash flow forecast helps to monitor different fluctuation in the money that is flowing in and out of the company.
A cash flow projection helps to access the current situation, while predicting the future position of the company. This helps businesses to plan ahead of time for various problems that might occur in the future.
Types of cash flow forecasting
There are two types of cash flow forecast for a company. These two types include:
1. Direct method
Direct method refers to a short term cash flow forecast. This uses the daily bill payments, which are combined with the future predictions. These can be daily operational forecast of the cash that is flowing in and out of the company. The direct method is accurate in its projection, but the projection is short term as compared to the indirect method
2. Indirect method
The indirect method of cash flow projection is a long term forecast of the cash that flowing into the company. This method is less accurate than direct method, but it provides projection for a long period as compared to the direct method of forecast.
Importance of forecasting cash flow projections
Cash flow projection is an important factor for businesses, and this is especially true for startups. This projection helps them understand where their company stands and what can expect from the future. In the initial days of a startup, there are a lot of costs that have to be managed.
Thus, it is important for business owners to know if they have the adequate amount of funds available to manage these costs. Many startup rely on loans and other mean to make these ends meet, this information for whether a company should go for these loans is based on their cash flow forecast.
For these projection, a startup can use the direct method to make short term forecast of these important factors. Using the direct method, they will be able to make a more accurate forecast as compared to indirect method. These forecasts can be up to three years and can help determine essential factor such as if the company will be able to manage various initial costs of managing business.
Advantages of cash flow projections
After understanding the importance of forecasting cash flow projections, it is imperative that we move to certain benefits of constantly updating and preparing cash flow projections. Among these advantages are:
1. Cash availability
Cash flow projections help a company to realize if they have the adequate amount of money available various expenses. It also helps to determine if there will be a need for more money in the future, thus the startup is able to prepare in advance for these situations.
2. Serves as credibility for various agencies
Different financial players and agencies such as banks and investors can be provided with cash flow projections as a source to determine the credibility of the business. This helps to secure loans faster with a cash flow projection available.
3. Find areas that are lacking
Preparing and maintaining cash flow projections will help to determine areas that are causing cash flows and need improvement and management. These areas can be given more attention and can be improved to prevent future cash flows from these areas
4. Identification of opportunities
By making cash flow projections, a startup will be able to determine time where there is money available in surplus. This period can be used to further invest in different technologies and advancement to improve the startup. Thus, making cash flow projections helps to play ahead for the company.
Disadvantages of forecasting cash flow projections
After understanding the advantages of cash flow projections, it also important to look at the other side of the picture as well. Though, there are many advantages of cash flow projection there are certain disadvantages as well. Prominent among the disadvantages are:
1. Unpredictability not reflected
There is unpredictability in business as many factors can impact the amount of cash that flowing in and out of the company at any given instance. This unpredictability is not reflected in the cash flow projection. Thus, an important part of the situation is overlooked.
2. Creates false sense of security
Another disadvantage of cash flow projection is that it creates a false sense of security in the mind of the people. Since the cash flow can be halted or any other issue can arise this false sense of security makes sure that these aspects of the business are overlooked and there is no planning for the worst case scenarios beforehand.
3. It is estimate
The cash flow projection only shows a rough estimate of the money that can be expected to flow into the company. Since, the figures that are shown by the cash flow report are not concrete the reality can be often different to the statistics that are being shown. These can be only useful for a small part of a year.
It is a good practice to be prepared for an unexpected scenario, which can lead to outward or inward flow of money. The lack of preparedness can adversely impact the business.
4. It can create bad decisions
Decisions are made based on the cash flow projection of the company. A company might be keen to invest in a certain technology or product when they are expecting a certain amount of cash flow into the company.
If unexpectedly the cash flows outwards, the leadership would have made a bad decision of investing at that time with little to no cash flow coming in. This will impact the revenue and the profit margins of the company. Thus, it will cause a negative impact on the company as a whole.
How to forecast cash flow projections in 2023
Cash flow projections are important in various decision making, so we must move on to way to forecast this cash flow with the available data. There are certain steps that can be followed to forecast cash flow projection by a startup.
The first step in forecasting the cash flow projection is to determine the amount of cash that has been received by the company. There a multiple sources of inward flow of cash into a company.
Sales
This includes the sale of product and services by the business. The amount of money that is received or will be received is considered in this part. This also includes any potential sale of assets by the company. Things such as equipment are considered to be part of assets of a company.
Investment and loans
Investment and loans are considered to be money coming into the company. These are cash flows into the company and are mentioned as the cash that has been received by the company.
After determining the inward flow of money, the second step includes mentioning the outward flow of cash from the company. Usually, the outward flow of cash represents the money that is paid by the company to bear various expenses. Common sources of outward flow of cash include:
Loan payments
The payments that are made for the loans that were received have to be mentioned as the outward flow of cash from the company. These payments are to be mentioned in the outward flow of cash from the company.
Bill payments
Bill payments refer to the operational cost of the company. These are different payments that are made by the company for various services such as the internet or electricity. These payments are also mentioned in the outward flow of cash.
Operating expenses
These refer to the cost faced by company for running day to day operation of the company. These are outward flow of cash from the company, which include different factors such as the salaries of employees; bonuses that were paid to the employees and any purchase of equipment are also included in these expenses.
After mentioning both inward and outward flow of cash, the final step for calculation is subtracting the cash that the company is projected to spend by the amount the company is projected to receive.
If you need help learning how to forecast cash flow projections in 2023, contact us at Speed Financial Group. Our dedicated team of tax professionals is here to educate you on the various strategies to forecast your cash flow projections in 2023 and increase your bottom line.
Schedule a consultation today!
Also read “How to Create a Simple Business Budget in 2023“
