|So, you want to
by Bean Counter's Dave Marshall
|Introduction||Lesson 1||Lesson 2||Lesson 3||Lesson 4||Lesson 5||Lesson 6|
|Does my praying cartoon buddy
illustrate how you mange your cash ? Don't get me wrong, a little
praying can't hurt; but, you also need to do some planning
on your own ! Many of the small businesses that I have been
around don't make use of a simple tool the Cash Forecast
that can provide them with some restful instead of sleepless nights
worrying about bills. I really don't know why, because a Cash
Forecast (as you'll learn in this lesson) is not that difficult to
prepare once you know how.
Other names used to identify this tool are a Cash Budget or Cash Projection.
Cash is a business's most precious asset. Managing Cash Flow is one of the most important tasks every top manager and business owner must be able to understand. Believe it or not, many businesses have had to shut their doors not because they weren't making a profit, but because they weren't managing and controlling their cash.
If you recall, in our Introductory Lesson we learned how Profits and Cash Flow are both critical elements needed for a business to survive and be successful ! Good Cash Management is also just as important as making a profit. Great cash management is even better.
Good projections and accounting records are important tools for the success of a small business. While outside accountants are sometimes necessary to help, you can save some money by producing your own projections.
What is a Cash Forecast ?
In other words,a cash forecast is just an estimate of your business's cash inflows and outflows over a certain period of time. Cash coming in is called a cash receipt and cash going out is called a cash disbursement. If cash receipts are greater than cash disbursements during a period, the business has what is called a positive cash flow. On the other hand, if cash disbursements are greater than cash receipts during the period the business has what is called a negative cash flow.
We'll elaborate a little.
A Cash Forecast identifies when cash is expected to be received and where this cash will come from (source) and also when it must be spent to pay bills and debts and what the payments are made for.
Creating a Cash Forecast requires you to make reasonable estimates about what will happen in the future. In order to help predict the future, historical data when available is used and modified to reflect future expectations. For new start up businesses, an analysis of similar businesses and current market conditions provides help in preparing the needed estimates. Factors to consider when preparing the estimates include competition, local economic conditions, and the business's financial structure, capacity, and capabilities.
Cash Forecasting and Planning requires experience and judgment in order to determine such items as expected sales, purchases, and operating expenses.
A Cash Flow Forecast or Budget can be prepared for any period of time, a day, week, month, year, or even many years into the future. I recommend that you at least prepare a one year budget by month. It should be reviewed and revised periodically to reflect actual performance and any changes in plans.
By using this tool and analyzing your projections you can see the fluctuations in cash flow and take corrective actions to avoid potential shortfalls.
I'm amazed at how many small businesses don't take advantage of this simple tool that I consider one of the most valuable tools management has for monitoring, controlling, and changing the day-to-day operation of a business. Are you one of them ?
Where do you think most of the cash a business receives comes from ?
Now, this is no trick question. Of course it comes from the Sales of products and/or services that the business bills its customers.
When does the business receive this cash ?
It depends on your type of business and what credit terms that you need to offer to your customers. For example, if you give your customers 30 day terms, you have to wait 30 days in order to collect your money. On the other hand, if most of your sales are cash or "counter" sales, you receive your cash at the time of the sale.
On what do you think a business spends a good portion of its cash ?
When does the business have to pay for these type of expenditures ?
When a business pays its employees depends on the payroll policies that the business has set up. Nowadays, due to the use of computers and payroll software, it's a fairly common practice for businesses to pay their employees each week.
In the case of purchases, it depends on the credit terms that suppliers have granted to the business. One of the worst cases is COD which stands for Cash On Delivery. This means the business has to immediately pay for the purchases when they receive the goods. If the business has been granted more liberal terms such as 30 day terms, they can wait 30 days before they have to pay for the goods that they purchased.
When the payments for taxes and licenses are required is regulated and set by the states and federal government.
What's involved in preparing a Cash Forecast ?
Why do you need a Cash Forecast ?
How does a Cash Forecast benefit you ?
What Are Your Forecast Period Options?
Note the shorter the time frame, the better your estimates should be. In other words, it's easier to predict what will happen next month than it is to predict what will occur five years from now.
What information do you need ?
Using your actual historical Financial Statements, analyses, and other financial information:
You should normally analyze and use the information contained in these statements for more than one year in order to recognize your trends such as sales increases and seasonal peaks and valleys.
do these statements look like ? I hope and pray you already know
but let's see.
This is similar to using a household blender where you blend in different ingredients to prepare your favorite beverage of choice. In this case, we're blending our prior historical information with our future plans in order to arrive at our best guess of what will occur in the future.
What if you're a start up business and don't have any financial history ? In this case, your job is a little more difficult but still needs to be done. You need to research and obtain information about typical sales, salaries, and expenses from published sources of what actual typical sales and expenses are for your particular size and type of business.
What Type Of Questions Do You Need To Think About ?
Where do you start ?
Your Sales Estimate(s) is the most important estimate that you have to make. Why ? I just got thru telling ya, but I guess you're going to make me repeat myself, but it's definitely something that can stand repeating.
Most of the other estimated amounts for expenses and other payments depend on the amount of sales that you estimate. If an increase in sales of, for example 10 percent is anticipated various other expenditures must also be adjusted. One that should come to light immediately is Purchases. Quite simply, in order to sell more, you have to buy more. You might, but not necessarily, also need to hire some additional sales people to handle the increased amount of sales. Another expenditure that might need to be increased is advertising.
Hopefully, you now see how the level of sales also affects the amount of other related expenditures. Therefore, in order to prepare realistic forecasts, you need to understand the relationships of your costs and expenses to your sales forecast.
You should now know that your sales forecast is the first estimate that is prepared and it sets the expected level of business that you plan to conduct during your forecast period. In addition, the amounts estimated for many other types of expenditures and payments depend on the amounts that you estimate for sales.
If you do a poor job of estimating your sales, you're well on your way to preparing a useless Cash Forecast.
How Do you Go About Developing Your Sales Estimate / Budget ?
As we mentioned earlier, the foundation upon which you will build your cash forecast is your sales forecast. So you need to round up your historical information such as your Prior Years Income Statements and Sales Analysis Reports.
Tasks You Need To Perform
Click below to take a look at a sample of a simple sales analysis
for our fictitious business Ma and Pa's Antiques.
You can also get fancy and use software and spreadsheets to aid you in developing sales estimates that include trend and probability analysis.
Analyze Sales Credit Terms and Collection Patterns
Estimating your Cash Receipts for your Cash Forecast involves using the Estimated Sales Amounts determined in your Sales Budget to determine when the Cash will probably be received (collected) from these sales.
If your business only has cash sales, the sales estimated in your Sales Forecast / Budget also represent when the estimated payments for these "cash" sales are received.
If your business sells a significant portion of its products or services on credit, you should do a historical analysis of your accounts receivable credit terms and collections. In other words, you need to perform an analysis to determine how long it is after you bill your customer for the goods and/or services sold until you actually receive the payment.
Applying your sales and accounts receivable collection patterns based on your historical analysis from the past to your sales forecast is the best way to predict your cash receipts from the collection of your estimated sales.
Blank Sample Sales Collection Analysis Worksheet
Let's use an illustration to help us understand exactly what this analysis is telling us.
Suppose your business had 10,000 sales in a month. After reviewing your detail records, $2,000 of these were "cash" sales (paid for at the time of sale) and $8,000 were made on credit (allowed your customers to pay you later). In addition our analysis found that of the $8,000 of credit sales that $6,000 of these credit sales were collected in the following month, $1,000 two months after the sale, and $1,000 was collected three months after the sale.
For this particular sales period, we now know that 20% ( $2,000 / $10,000) of our sales were "cash" sales and collected in the month of sale, 60% ( $6,000 / $10,000 ) were collected in the following month ( one month after the sale), 10 % ( $1,000 / $10,000) were collected two months after the sales, and 10% ( $1,000 / $10,000) were collected three months after the sale.
When you apply this method to 12 months of actual sales activity, you will have an excellent indicator of the time that it takes for your business to convert its sales into cash (collect its money).
If the results are roughly the same for each of the 12 periods that you analyzed and calculated, you can use an average percentage calculated for the entire years worth of sales. If your collection patterns vary with the time of year, you may want to use monthly data rather than averages.
below for a sample of a completed worksheet.
What major factor do you think might affect the time that it takes to collect your sales ? This is not a difficult question. The credit terms that you grant your customers affect when your sales will be converted into cash (collected). Common sense tells you that the longer the period of time that you allow your customers to pay you, the longer it will take to get your cash. On the flip side of the coin, if all your sales were "cash" sales you would have your cash at the time of the sale.
In conjunction with your analysis of the your future collections, you should use an Accounts Receivable Aging Report to schedule your prior year amounts that will be collected in your future periods.
An accounts receivable aging schedule is a report that lists all of the amounts that your customers owe to you and groups the unpaid invoices that make up the total into categories to indicate if any are late.
Blank Sample Accounts Receivable Aging Report
below for a sample of a completed Accounts Receivable Aging
Prepare Estimated Accounts Receivable and Sales Collection Schedule
After completing your Sales Credit Terms and Collection Patterns Analysis and reviewing your Accounts Receivable Aging Report you should now have the information needed to prepare your Estimated Accounts Receivable and Sales Collection By Period Schedule.
All your doing here is using your Estimated Sales along with your collection analysis to estimate in what periods you'll actually receive the cash from these sales.
do you think an Estimated Accounts Receivable and Sales Collection
Schedule might look like ? Find out by clicking below.
Other Sources Of
Analyze Purchases Credit Terms and Payment Patterns
If your business buys a significant portion of its products or services on credit, you should do a historical analysis of your accounts payable credit terms and payments.
Estimating your Cash Payments for Purchases and Inventory for your Cash Forecast involves using the Estimated Purchases based on the sales in your sales forecast and your analysis of payment patterns to determine when the Cash will probably be paid out for these purchases. In other words, you need to perform an analysis to determine how long it is after you buy the goods and/or services until you actually have to pay for them.
This analysis is similar to the analysis that you perform for your collections of your sales. Instead of calculating your collections history you now calculate your payments history.
Using your purchases and accounts payable collection patterns based on your historical analysis from the past to your purchases estimate is the best way to predict your cash payments needed for your purchases.
Blank Sample Purchases Payment Analysis Worksheet
Let's use an illustration to help us understand exactly what this analysis is telling us.
Suppose your business made 10,000 of purchase in a month. After reviewing your detail records, $2,000 of these were "cash" purchases (paid for at the time of purchase) and $8,000 were made on credit (suppliers allowed you to pay later). In addition our analysis found that of the $8,000 of purchases on credit that $6,000 of these credit purchases were paid in the following month and $2,000 was paid two months after the purchase.
For this particular purchases period, we now know that 20% ( $2,000 / $10,000) of our purchases were "cash" purchases and paid in the month of purchase, 60% ( $6,000 / $10,000 ) were paid in the following month ( one month after the purchase), and 20 % ( $2,000 / $10,000) were paid two months after the purchase. When you apply this method to 12 months of actual purchases activity, you will have an excellent indicator of when you have to pay (cash outflow) for the products that you purchase from your suppliers. If the results are roughly the same for each of the 12 periods that you analyzed and calculated, you can use an average percentage calculated for the entire years worth of purchases. If your payment patterns vary with the time of year, you may want to use monthly data rather than averages.
below for a sample of a completed worksheet.
What major factor do you think might affect the time that it takes to pay for your purchases ? Similar to sales, the credit terms that your suppliers grant to your business affect when you'll have to pay for your purchases. Again, common sense tells you that the longer the period of time that your supplier allows you to pay, the longer you will be able to hold on to your cash without having to part with it.
In conjunction with your analysis of the future expenditures you should use an Accounts Payable Aging Report to schedule these prior year amounts that need to be paid in your future periods.
An accounts payable aging schedule is a report that lists all of the amounts that you owe to your suppliers and groups the unpaid invoices that make up the total into categories to indicate if any are late.
Blank Sample Accounts Payable Aging Report
below for a sample of a completed Accounts Payable Aging
Analyze Relationships of Your Costs and Expenses To Sales
We need to prepare estimates of our cash outlays for the following categories:
If you recall, we learned earlier that your sales forecast is the first estimate that is prepared and it sets the expected level of business that you plan to conduct during your forecast period. In addition, the amounts estimated for many other types of expenditures and payments depend on the amounts that you estimate for sales.
You use your sales forecast along with your analyses to calculate your estimated amounts for costs and expenses that are related to the level of sales (variable costs and expenses). Your estimates for fixed cost and expenses should consider your estimated anticipated future sales volume along with prior year(s) historical information and future plans.
You now need to prepare analyses of your prior year(s) cost of sales, purchases, inventory levels, payroll, and operating expenses. You'll find the prior year(s) information you need for these analyses in your prior year(s) income statement or general ledger.
In addition, in order to properly estimate your costs and operating expenses, you need a basic understanding of cost behavior.
Fixed and Variable Costs /
Our Formal Definitions
A few examples of types of expenses that fit into the each of these categories:
Did you catch me ? I listed payroll expenses in both the variable and fixed categories.
Salaries & Wages are classified as variable or fixed based on your employee's type of job.
Salaries, wages, and commissions paid to salespeople would be an example of payroll expenses that are normally classified as variable expenses because they are related to changes in sales. If you planned on increasing your sales, you'd probably need to hire more salespeople.
In a manufacturing business, an example of a variable type of payroll expense would be production jobs where the employees actually make your product. If you planned on increasing your sales, more than likely you would need to produce more products which in turn would require you to hire more employees.
What about salaries and wages that are classified as fixed ? Examples of these type of jobs would be your bookkeeper, managers, and supervisors. A reasonable increase in your sales would normally not require you to have to hire any additional bookkeepers or managers.
Purchases / Cost Of Sales / Inventory
For those businesses that buy and sell goods and products, Purchases for Inventory is one, if not the biggest, cash outlays that you need to prepare an estimate for.
The three terms purchases, cost of sales, and inventory are all interrelated.
The following simple formula
illustrates this relationship.
This simply means that what you have on hand plus what you buy less what you sell determines what you have left. Nothing complicated about this - right ?
This simple formula allows us to calculate the value for any of our four variables beginning inventory, purchases, cost of goods sold, or ending inventory if we know the values of any three of the four variables.
We'll illustrate what I mean.
Since the amount of your Purchases, Cost Of Sales, and Inventory Levels are related to your Sales (depend on how much you sell), you need to analyze your prior year(s) historical data and calculate some percentage and other relationships.
Before we continue, what do you think the major factor is that determines how much a business has to spend on buying the products that they sell to their customers ? You should know me by now, I don't usually ask you difficult questions.
Remember, as we learned earlier, many of your costs and expenses depend on (are related to) sales and that's why the very first thing you prepare when preparing a Cash Forecast is your Estimated Sales or Sales Budget.
The more sales that you plan on having, the more you'll need to plan for and estimate to cover your purchases requirements and their resulting cash outflow (payment).
Earlier I said that you needed to analyze historical financial information and prepare some calculations to use as a guide to use to calculate your purchases, cost of sales, and ending inventory amounts for our Cash Forecast. Now we're going to do it.
Let's first review a sample worksheet that provides some of the information and calculations you need in order to prepare your Estimated Purchase and Inventory Amounts Schedule by Period.
Click below for an Illustration of Purchases, Cost Of Sales, and
Inventory Historical Analysis and Calculations
Where do you get the information for these calculations ? Normally, your monthly and/or annual Income Statements and Balance Sheets.
Gosh, we're rolling right along. You now need to prepare a Worksheet To Calculate your Estimated Purchases and Inventories By Period. There are many acceptable ways to skin this cat that vary from simple to a little complex. A simple method would be to use purchases as a percentage of sales to calculate the amount of your purchases and cost of sales as a percentage of sales to calculate your monthly cost of sales estimates. You could then use these calculated amounts to calculate your ending inventories.
I used a
little different method to illustrate how you can even come up with
your own methods and formulas for calculating your estimated
purchases and ending inventories. Let's take a look and see what I
All we did in the illustration was:
What should be clear is that our Cost Of Sales, Purchases Needed, and Ending Inventory Calculations all depended on or were related to our Estimated Sales Amounts (sales volume).
A little experience will aid you in determining what calculations will more closely approximate your future actual amounts.
Prepare Estimated Purchases Payment Schedule
What else do we need to do regarding our Estimated Purchases ? Not much. We now know when and how much we need to buy, now we need to determine when we have to pay for these Purchases. You now need to prepare your Estimated Purchases Payment Schedule.
You'll use your Estimated Purchases Amounts Schedule By Period along with your Purchases Credit Terms and Payment Patterns Analysis that was prepared earlier to prepare your Estimated Purchases Payment Schedule and to determine in what future periods these estimated purchases have to be paid for (the period of the actual cash payment for these purchases).
look at a sample of an Estimated Purchases Payment Schedule for a
three month period.
Payroll, Payroll Taxes, and Fringe Benefits
This is typically another expenditure that represents a significant amount of cash that is spent by a businesses. In order to develop estimates for your future salaries and wages to use in your Cash Projection, again as a starting point, you need to analyze what has happened in the past.
As we learned earlier, some salaries and wages will change as the level of sales increases or decreases (variable expenses) while others are not affected by increases and decreases in sales (fixed expenses). In other words some salaries and wages are related to the level of sales while others are not. An analysis of your salaries and wages that groups your salaries by jobs into fixed and variable expenses is an excellent starting point.
In preparing your estimates for payroll, not only must you consider your wages and salaries; but, also any local, federal, and state payroll taxes and any applicable law or rate changes, and any fringe benefits that you currently provide and any plans for providing any additional fringe benefits.
Methods use to estimate future payroll expenses vary from simple to complex. For larger businesses a detailed Manpower Requirements Budget by Department is often prepared. For smaller outfits, labor (wages, salaries, etc.) as a percentage of sales may serve the purpose.
You need to list and analyze each operating expense that appears on your income statement or in your General Ledger in order to develop a reasonable method for estimating the future amounts for these expenses.
Examples of operating expenses your business might have include:
Once again, you should be aware that some of these expenses will vary with sales (variable expenses) while others will not be affected (fixed expenses) by increases and decreases in your sales.
your anything like me, it's helpful when people discuss and explain
things to me, but an example of what their talking about
"unmuddies" the water for me. That being said, let's take a look at
a sample analysis of payroll and operating expenses based on Ma's
the information obtained from her analysis of her Income Statement,
Ma prepared the following estimates of her operating expenses.
Now What ?
ready ? All the analysis and information gathering we discussed and
illustrated comes together in this completed and formal
information is summarized and where does it come from ?
What Should You Watch Out For ?
How Can I Improve the Estimates that I Use for my Cash Projection ?
Use your Cash Flow Projection also as a Budget and Record and Compare your Actual Receipts and Payments with your Estimated Receipts and Payments by period. In other words, compare your actual results with your forecasted amounts. This comparison helps the small business owner identify areas that may require investigation or improvements or changes to the method(s) used for estimating amounts contained in the Cash Forecast.
Your Plan Requires Actions To Make It Work.
Just by putting your plans on paper does not make anything happen. In business as in life, to get anything done and accomplished requires Action. Use your Cash Forecast as a tool and take any actions necessary to ensure that your business is not one of those that fails because they couldn't pay their bills.
What are some possible actions you might have to take ?
Remember these things don't just happen by themselves, you have to make them happen.
Forecast Is Prepared Am I Thru ?
What Did We Accomplish ?
I don't know if you realize it or not, but we covered quite a bit in this lesson, but you'll be able to lay back in your easy chair and coast thru the next lesson, which is our last. As always, if you need a break to let the information "soak in", grab one.
A Few Last Words Of Advice
When IBM introduced their Personal Computer (PC) ,now many years ago, I immediately jumped on the band wagon and bought one. Of course I also needed to search around and find some good business software (at the time there wasn't a whole lot available) to use with my new computer. Without the software, it would have just been an expensive paper weight.
I did this because I didn't want to become an obsolete accountant. Using the software and computer I could perform many of the tasks for my clients such as bookkeeping and projections in a fraction of the time that I could do these same tasks manually.
Hopefully you small business owners have also jumped on the computer band wagon. With the low price and availability of computers and good software, I'm hard pressed to think of a valid reason not to.
With a personal computer, your business can have the added advantage of quick cash-flow projections as well as many other useful tools such as bookkeeping, document processing, and payroll applications.
While a computer is not an absolute necessity for a small business, it is a business tool which in my opinion you can't do without.
Cash Forecasting and Budgeting Software
This lesson included my Forecasting Template, Bean Counter's Forecasting Workbook, for free.
If you haven't already, Download Bean Counter's Cash Forecast Workbook.
Download Bean Counter's Cash
Forecast Workbook Excel Version
Download Bean Counter's Cash
Forecast Workbook Open Office Version