The Entrepreneur’s Guide to Cash Flow Projections

Have you ever seen a time travel movie? I am a child of the 80’s so my favorite time travel movie was Back to the Future, staring Michael J. Fox (1 million points to 1st person to comment with the name of high school). Honestly, Back to the Future Part II was my favorite movie in the trilogy. I always wanted to be the one that knew exactly what was going to happen in the future. The thing is that no one knows with 100% certainty what is going to happen tomorrow, much less 3 months, or a year from now.

If a flux capacitor doesn’t exist, then how do entrepreneur have any realistic hope of projecting their business and their cashflow needs 3 months from now. This is a difficult skill, and some of the best entrepreneurs that I know assess their cash flow needs every single month. These entrepreneurs realize that cash flow is the lifeblood of their company and it is critical that they get it right. A missed forecast, can be extremely detrimental to your business. Let’s take a look at the framework that they use to look into the future.

Step 1: Know where you are.

It does not matter what type of business you have (service or product based) you cannot hope to have an accurate forecast until you know what your cost of operations are. There are some costs that increase or decrease as you have work (variable costs) and there are some that you will always have matter the number of estate plans, lawns mowed, shirts sold, or houses built (fixed costs).

The variable costs are somewhat easy to track (you have to simply understand exactly what goes into each project and the cost of the inputs), the fixed cost can be somewhat more difficult to break down on a per job basis. I have found it best to come up with some type of measurement (hours worked, jobs completed, truckloads delivered, etc.) that you can use as a unit to allocate your fixed costs. For example, if you know that your fixed costs are $10,000 a week and you have 6,000 of man hours of grass mowing time each week (150 people x 40 hours a person) then your fixed cost is $1.67 per man hour ($10,000 / 6,000). Of course, this gets trickier once you start to add inventory management.

Knowing where you are, does not only mean knowing the cost of you doing business. You need to understand the capacity that your business has. Every business has a bottleneck, that place where resources constrain the flow of jobs. The trick is to understand where your bottleneck is, what causes it, and to know how to move it to the place where it impacts you the least.

The point is that by knowing where you are, you are free to project where you will be in the future, and you have a baseline on which to base your assumptions.

Step 2: Know the pipeline.

Of course, knowing what you have to spend each month is important, but a business that has no sales is doomed to close. So, you need to sell your product and services. As an entrepreneur in charge of a fast-growing company, you need to be able to have an honest talk with your sales team and understand their actual pull through of deals. Salespeople by their very nature are optimistic that all the clients are going to say yes to their latest proposal. After all isn’t that what you are paying them for? But when they promise quarter after quarter that their whale of a client is going to come through, and quarter after quarter, a one-time delay keeps popping up – you have to start to wonder. Having this discipline is very hard, but the sales team needs to understand that their input had real impacts on the future of the company. For example, if they have a project that is going to require additional manhours, you may either go out and hire a bunch of people or authorize overtime; both of which will directly impact your bottom line and the sustainability of the company. On the other hand, if they say that they don’t have any major new deals that will be signed this quarter, and you plan for that – then 3 weeks into the quarter, a deal from nowhere (that they have been working on for 6 months) is signed. This is great, but now you have to work with your operations team to make sure that you can manage existing (and new) client expectations. It may take some time, but having a system in place that tracks your sales team’s projections and close rates will provide you a critical insight into your future.

Step 3: Know your working and operational capital cycles.

Nothing impacts your cash flow more than your working capital cycle. When do you agree to pay your suppliers and vendors? Do you receive any discounts from prompt or early payment? Do you have the cash (or a line of credit) available to take advantage of these discounts? When you agree to receive payment from your customers? Do you customers pay on time? What happens when they do slow-pay you? All of these questions are critical to knowing your working capital cycle.

There is another cycle you need to pay attention to, what I call your operational cycle. The working capital cycle captures your inputs (Cost of Goods Sold) and your financing (Accounts Payable and Accounts Receivable) components, but it does not capture your rent, utilities, loan payments, taxes, etc. All of these are very real expenses and cash outflows. You would be creating a false projection if you did not include these in your projections.

Step 4: Share, Track, and Celebrate your results.

There is nothing more frustrating than putting all this work into developing and sharing a projection and then filing it away – never to be looked for another month (or quarter). Tracking your results not only forces you to assess your ability to pull client projects through but also your ability to project expenses accurately. Do not be discouraged if you do not get this correct the first few times. For entrepreneurs that have not completed this exercise, it can be frustrating, but I highly encourage you to stick with it. As you do, your ability to see into the future will get better, which will allow you to manage your business more confidently.

Being an entrepreneur is one of the most difficult and demanding things you can do. The good news is that entrepreneurship today is a team sport. Hit the connect button on LinkedIn or Facebook NOW and together we will work towards hitting your 10-year target. Along the way we will increase your profit, strengthen your leadership skills and define your strategic vision. This will lead to confidence in your path, freedom to dream up bigger targets and a strategic banking relationship. When we connect, tell me the steps you use to create your projections.

Greg Martin is an entrepreneur’s insider to the banking industry and passionately believes that every person was uniquely designed for a higher purpose and calling. Greg guides entrepreneurs in defining and achieving their purpose and calling. His deepest passion is living life with his wife and their wonderful son.