In the first two articles of this series, we discussed how to prepare a short-term cash flow projection and what to do if it indicates that you'll be facing cash problems in the near future. Now we're ready to tackle the long term.
Long-term cash flow projection
This is normally prepared as part of a business plan. Specific formats for business plans vary. This section might be called the "cash plan," "cash budget," or "pro forma cash flow." Many samples can be found online and in books about business planning. Essentially, it's a prediction of the cash demands that you expect to face over the course of the next three years. It's not tied to the clients and vendors currently on your books.
Preparing it requires you to make a series of very broad assumptions about future activities. You need to give careful consideration to such things as: changes in the overall size of the business, possible adjustments to staffing levels, potential changes to your mix of client categories or services offered, the timing of any major purchases, and other potential milestones such as relocation.
With each issue, you need to be as logical and objective as possible. Don't let yourself get carried away by unrealistic expectations. Your month-by-month sales projections should be based on past averages, adjusted to reflect current trends and planned changes. Monthly expense targets will be determined in a similar way.
Because this long-term projection is based on so many assumptions, it tends to become less accurate as it moves farther out into the future. For this reason, you should update it on a regular basis so that it keeps pace with your evolving business. Your goal in preparing this projection is to anticipate and estimate the resources and reserves that will be needed to support your continued success. For example, some businesses (such as annual report firms) go through seasonal cycles of profits and losses. If that's your situation, it may be necessary to borrow money to maintain operations during times of low sales or heavy expenses. The projection shows the amount of credit needed as well as the plan for repayment.
As you go through this planning process, keep the following tips in mind:
It may seem obvious but, for the long-term viability of your firm, your accounts payable must consistently be lower than your accounts receivable. If this is not the case, see if your prices can be raised and/or your costs lowered.
Whenever possible, avoid draining current cash balances to buy long-term assets such as equipment. It's much better to finance big purchases so that long-term assets are paired with long-term liabilities.
In periods where your cash balance is healthy, have arrangements in place to sweep any excess amounts into an interest-bearing account. Many banking systems will allow you to do this automatically.
Cash flow statement
In this final report, we turn from predicting the future to recapping the past. The cash flow statement can also be called a "statement of cash flows" or "sources and uses of cash." Samples can be found online and in most accounting textbooks. It's one of three standard financial statements that well-run businesses prepare at the end of each month, quarter, and year (the others are the balance sheet and the profit and loss statement).
This retrospective report shows the amount of cash that was generated and used by your company during a particular period in the past. From an accounting standpoint, it doesn't include any accrued amounts. This means that income and expenses are included only if cash was actually received or paid. It doesn't include any non-cash activity such as depreciation. The report is divided into these standard sections:
This shows cash flow that was related to the sale of goods and services. It includes the majority of daily activities involving customers, suppliers, and employees.
This shows cash flow that was related to discretionary business activities such as the purchase or sale of property and equipment.
This category includes external sources and uses of cash, such as loan activity or the payment of dividends to owners.
At the end of the cash flow statement, you'll see the net change that resulted from the listed activities, broken down by account (cash in the bank as well as any cash equivalents such as marketable securities).
Using these tools
As a smart businessperson, you'll want to master each of the management tools we've discussed in this three-part article. They'll help you to spot trends and anticipate future needs. Planning and managing cash effectively is vital for the overall health of your creative firm.
Did you find this column helpful? Click here to rate it!