So, you want to learn
Bookkeeping!
Cash
by Bean Counter's Dave Marshall

Lesson 5
Cash Forecasts / Projections / Budgets


Introduction Lesson 1 Lesson 2 Lesson 3 Lesson 4 Lesson 5 Lesson 6
Bean Counter
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 ?

  • A Cash Forecast is simply a tool that a businesses uses to plan:
  • How Much and When is Money Coming In and From Where (source) ?
  • How Much and When is Money Going Out and For What (types of payments) ?

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 ?

  • Let's list a few of the "biggies".
  • Purchases of Products for wholesale and retail types of businesses that sell products.
  • Payroll and Fringe Benefits.
  • Manufacturing Costs for businesses that make and sell products.
  • Federal and State Taxes and Licenses.

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 ?

There are five basic steps to creating a cash flow projection:
  • Gather up your historical financial information, develop and state your assumptions, and select the time period(s) covered.
  • Estimate sales and their collections for the time periods you want to cover by period.
  • Identify and estimate amounts and the period collected for other sources of cash.
  • Identify and estimate amounts for all items that you have to pay for and when (period).
  • Enter and formally summarize information on worksheet(s).

Why do you need a Cash Forecast ?

Hopefully this does not picture you and how you have to handle your creditors or employees when they need to be paid !
The answer to this question is simply to ensure that you have enough cash on hand to pay your bills, employees, and notes when they become due and obtain any needed equipment. The forecast helps you identify potential shortages of cash and allows you to take actions to correct the problem before it occurs. The day you run payroll and don't have the cash to cover it is not the best time to try and find a solution.

How does a Cash Forecast benefit you ?

Forecasting allows you to plan for, identify, and take action in the following areas:
  • Identify Business or Seasonal Fluctuations (peaks and valleys in your sales).
  • Ensure that cash is available to handle employee's payroll.
  • Ability to foresee and handle Note Repayments.
  • Ability to foresee, handle and make timely payments to Suppliers.
  • Be alerted to Short-Term Borrowing Needs.
  • Plan for Long-Term Financing Needs.
  • Plan for Reducing your Outstanding Loan Balances.
  • Plan for Needed Equipment Purchases (Capital Expenditures).
  • Take Advantage of Supplier Early Payment Discounts.
  • Plan Inventory Levels and related Purchases.
  • Monitor Customer Payments and Revise Customer Credit Policies and Terms if needed.
  • Determine what to do with "Excess" Cash if your fortunate enough to have this "problem".
    In other words, how much you have that you can invest and increase your earnings.

What Are Your Forecast Period Options?

In other words, how long into the future do you prepare the Cash Forecast for ? This is often referred to as the Time Horizon. All this fancy word means is the number of period(s) that you want to prepare an estimate for.
  • Your choices are:
  • Short-Term - one week to one month (you could if you wanted to even forecast one day)
  • Medium-Term - one month to one year
  • Long-Term - one year or longer

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:

  • Prepare and use an Analysis of Prior Periods Actual Yearly and Monthly Sales Patterns
  • Prepare and use an Analysis of Prior Periods Actual Yearly and Monthly Sales Credit Terms and Collection Patterns
  • Prepare and use an Analysis of Prior Periods Actual Yearly and Monthly Purchases Credit Terms and Payments Patterns
  • Prepare and use an Analysis of Prior Periods Actual Relationships of your Costs and Expenses to Sales.

Financial Statements
Much of the information that you need to use as a starting point to base your estimates on for your Cash Projection is contained in and provided by your Income Statements and Balance Sheets. You do prepare these statements or have them prepared for you by your accountant or bookkeeping service don't you ? I hope you answered yes - if not I recommend that you start. These statements should be accurate and preferable prepared on a monthly basis.

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.

What do these statements look like ? I hope and pray you already know but let's see.
Sample Balance Sheet and Income Statement for Ma & Pa's Antiques:
Ma & Pa's Balance Sheet
Ma & Pa's Income Statement

Analyses
In addition, you should already have or prepare analyses of your collection and payment patterns and the relationships of your costs and expenses to sales. These analysis, while not absolutely necessary, should if possible be based on several years worth of historical information in order to recognize trends applicable to your business.

Future Plans
Using your actual financial information and analyses as a guide, you need to "tweak" your figures to arrive at your final estimated amounts that you will use in your Cash Forecast. What do I mean by "tweak" ? All this means is adjust. While historical information is useful, things change and any foreseen changes should be considered and used in preparing your future estimates.

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 ?

  • What sales and/or % of sales increase do you expect for the future ?
  • Do you anticipate increasing or decreasing your selling prices ?
  • What is the current state of the market for your type of products or services ?
  • If you anticipate increasing sales will you need additional employees or space ?
  • What is your percentage of cash sales to credit sales ?
  • What are my current Gross Margin Percentages and Cost as a % of Sales By Product Line ?
  • What is my current Sales Mix ?
    Sales mix is just a fancy term that describes what the percentage is for each of your main product groups or categories compared to your total sales.
  • What payment terms are you currently providing to your customers and any plans for changing these terms ?
  • What payment terms are your suppliers providing you and do you anticipate any changes ?
  • Do you anticipate any cost increases for any of your products supplied by your suppliers ?
  • If you have any employees, what plans do you have for raises or adding any additional employee benefits ? How often are your employees paid (weekly, bi-weekly, monthly, etc) ?
  • What is the interest and principal payments on current loans and do you anticipate needing any additional loans ?
  • How much inventory do you need on hand to meet your current sales volume and will you need to increase or decrease this level ?
  • What plans if any do you have for purchasing additional equipment ?
  • How are your operating expenses related to your sales ?

Where do you start ?

Sales

Sales is the "engine" that runs our car (Cash Forecast).

In preparing the Cash Flow Projection start with your Estimated Sales for the period(s). Why ? The reason is that most of the other estimated amounts are related directly or indirectly to sales.

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

  • Organize your sales into groups or categories such as product lines that have similar characteristics and gross margin percentages. If you don't already know, a gross margin percentage is your gross profit (sales less cost of goods sold) divided by sales.
  • If you don't already have one, prepare a monthly sales analysis by category for at least three years.

    If you haven't been in business for three years, or don't feel that your prior years are indicative of the future, you should at least use your business's previous year's sales amounts as a starting point for your estimated sales forecast. By using last year's sales amounts at least you'll be considering such factors as seasonal fluctuations and trends when preparing your sales forecast.

  • Research and find current information and trends applicable to your particular type of business.
  • Research and check out what your competition is doing.
  • Think about and analyze variables that affect your level of sales (sales volume).
    • Analyze Prices that you charge and what prices your competition is charging and determine whether you need to increase or decrease your prices.
    • The current capacity of your business and any plans for increasing or decreasing your capacity. A store with 5000 square feet only has room to stock so many products.
    • Product availability and the status and financial condition of your suppliers.
    • The magnitude of your sales area (local or national)
    • Current and future marketing plans.

Click below to take a look at a sample of a simple sales analysis for our fictitious business Ma and Pa's Antiques.
Sample Sales Analysis Worksheet

You can also get fancy and use software and spreadsheets to aid you in developing sales estimates that include trend and probability analysis.

After Estimating Sales Where Do I Go To From There ?

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

Month Of
Sale
Total Sales Amount Cash Sales Amount % of Cash Sales Credit Sales Amount % of Credit Sales Collected Month
Of Sale
% Collected Collected One Month
After Month Of Sale
% Collected Collected Two Months
After Month Of Sale
% Collected Collected Three Months
After Month Of Sale
% Collected
Month 1                          
Month 2                          
Month 3                          
Month 4                          
Month 5                          
Month 6                          
Month 7                          
Month 8                          
Month 9                          
Month 10                          
Month 11                          
Month 12                          
                           
   Totals                          

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.

Click below for a sample of a completed worksheet.
Sample Filled In Sales Collection Analysis 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

Customer's Name Total Amount Owed Current Balance (Not Due) 1-15 Days Late 16-30 Days Late 31-60 Days Late 61-90 Days Late Over 90 Days Late
               
               
               
   Totals              

Click below for a sample of a completed Accounts Receivable Aging Report.
Sample Filled In Accounts Receivable Aging Report

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.

What do you think an Estimated Accounts Receivable and Sales Collection Schedule might look like ? Find out by clicking below.
Sample Accounts Receivable and Collection Schedule

Other Sources Of Receipts
Determine and Estimate any other receipts that you anticipate will occur during your forecast period.

  • Additional Loan Requirements
    If you are planning on a significant increase in sales, you will need to consider whether you will need to borrow any money. Likewise, if you will need additional equipment you need to include an estimate for any additional loan needs. These borrowings are included as an additional Cash Receipt in your Cash Forecast.
  • Sale Of Equipment or Obsolete Inventories
    If you plan on disposing of any old equipment or obsolete inventory you need to include the proceeds from their sale as a Cash Receipt in your forecast.
  • Additional Owner Contributions or Sale of Stock
    Include amounts for any planned additional capital contributions.
  • Any Other Miscellaneous Type of Cash Receipt.
    Include amounts for any other sources of cash receipts.

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

Month Of Purchase Total Purchases Amount Cash Purchases Amount % of Cash Purchases Credit Purchases Amount % of Credit Purchases Payments Month Of Purchase % Paid Payments One Month After Month Of Purchase % Paid Payments Two Months After Month Of Purchase % Paid Payments Three Months After Month Of Purchase % Paid
Month 1                          
Month 2                          
Month 3                          
Month 4                          
Month 5                          
Month 6                          
Month 7                          
Month 8                          
Month 9                          
Month 10                          
Month 11                          
Month 12                          
                           
   Totals                          

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.

Click below for a sample of a completed worksheet.
Sample Filled In Purchases Payment Analysis 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

Supplier's Name Total Amount Owed Current Balance (Not Due) 1-15 Days Late 16-30 Days Late 31-60 Days Late 61-90 Days Late Over 90 Days Late
               
               
               
   Totals              

Click below for a sample of a completed Accounts Payable Aging Report.
Sample Filled In Accounts Payable Aging Report

Analyze Relationships of Your Costs and Expenses To Sales

This task involves preparing analyses and information that will aid you in determining future monthly amounts for each type of cost, expense or payment. Some costs and expenses will be based on a percentage relationship to sales (variable costs / expenses) while others will be fixed such as building rent and insurance. With a little practice, you should be able to prepare and come up with reasonable and realistic estimates for your cash projection.

We need to prepare estimates of our cash outlays for the following categories:

  • Cost Of Sales (Cost Of Goods Sold) / Purchases / Inventory Levels
  • Payroll (including payroll tax deposits)
  • Operating Expenses

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 / Expenses
Variable costs are costs that change as the amounts of products and/or services sold increase or decrease. On the other hand, fixed costs do not change (remain the same) regardless of how many products and/or services are sold or not sold.

Our Formal Definitions

  • Variable Costs (Expenses) are costs that change directly in proportion to changes in activity (volume).
  • Fixed Costs (Expenses) are costs that remain constant (fixed) for a given time period despite wide fluctuations in activity (volume).

A few examples of types of expenses that fit into the each of these categories:

Expense Category Explanation
Payroll Salaries and Wages Variable As sales increase or decrease the amount spent for payroll increases or decreases
Purchases Variable As sales increase or decrease the amount spent for purchases increases or decreases
Advertising Variable As sales increase or decrease the amount spent for advertising increases or decreases
Credit Card Fees Variable As sales increase or decrease the amount spent for credit card fees increases or decreases
Building Rental Fixed A sales increase or decrease has no effect on this expense - amount stays the same
Equipment Rental Fixed A sales increase or decrease has no effect on this expense - amount stays the same
Building Insurance Fixed A sales increase or decrease has no effect on this expense - amount stays the same
Payroll Salaries and Wages Fixed A sales increase or decrease has no effect on this expense - amount stays the same

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.
Ending Inventory = Beginning Inventory + Purchases - Cost Of Sales

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.

To Calculate Formula To Use
Ending Inventory
(Our Original Formula)
Ending Inventory = Beginning Inventory + Purchases - Cost Of Sales
Beginning Inventory Beginning Inventory = Ending Inventory - Purchases + Cost Of Sales
Purchases Purchases = Ending Inventory - Beginning Inventory + Cost Of Sales
Cost Of Sales Cost Of Sales = Beginning Inventory + Purchases - Ending Inventory

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.

Sales !!!

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.

  • Key Calculations Include:
  • Cost Of Sales Percentage Calculation using your actual historical Cost Of Sales and Sales amounts.
  • Inventory Calculations using your historical Inventory Levels (How Much Inventory You Normally Keep On Hand)
  • Inventory Turnover and Number of Months/Days Sales On Hand

Click below for an Illustration of Purchases, Cost Of Sales, and Inventory Historical Analysis and Calculations
Ma & Pa's Example

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 did.
Sample Estimated Purchase and Inventory Amounts Schedule By Period

All we did in the illustration was:

  • Calculate Estimated Cost Of Sales Amounts based on a historical percentage of sales.
  • Calculated Ending Inventory Amounts based on future sales, cost of sales, and number of months sales normally maintained in inventory.
  • Used our Inventory Formula to calculate the Purchase Amounts Needed for each Period.

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).

Take a look at a sample of an Estimated Purchases Payment Schedule for a three month period.
Sample Estimated Purchases Payment Schedule By 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.

Operating Expenses

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:

  • Rent - Building
  • Rent - Equipment
  • Utilities
  • Repairs and Maintenance
  • Insurance
  • Car and Truck Expenses
  • Travel
  • Entertainment
  • Postage
  • Office Supplies
  • Advertising
  • Marketing / Promotion
  • Professional Fees
  • Training and Development
  • Bank Charges
  • Credit Card Fees

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.

If 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 Income Statement.
Income Statement Analysis

Using the information obtained from her analysis of her Income Statement, Ma prepared the following estimates of her operating expenses.
Ma's Operating Expense Analysis

Other Payments
Determine and Estimate any other payments that you anticipate will occur during your forecast period.

  • Owner's Draws / Dividends
    Include estimated amounts for any anticipated owner draws or payments of dividends to stockholders.
  • Current Debt Payments
    If you currently have any notes such as borrowings for equipment purchases you also need to include these payments (both principal and interest) as a Cash Payment in your Cash Forecast.
  • Additional Equipment Needs
    Speaking of equipment, if you do need additional equipment, whether you plan on borrowing or paying cash, you need to include the Cost of the Equipment as a Cash Payment in your Cash Forecast.
  • Income, State, and other Business Taxes
    Shucks, you wouldn't want to forget your friendly governments would ya ? You need to prepare estimates for any future income taxes, state business taxes such as franchise and excise taxes, and other business taxes that your specific type of business may be subject to.
  • Any Other Miscellaneous Type of Cash Payment.
    Include amounts for any other cash payments.

Now What ?

Now you need to assemble and use the information that you previously gathered and developed to prepare your formal Cash Forecast. Hopefully, you have some software that you can use to make the job and calculations a lot less tedious and time consuming. It just so happens that you do ! My free template included in this tutorial should be a tool that hopefully makes the task a little easier.

Yes, you can still do it the manual ole fashioned way, but while I'm out enjoying a round of golf you'll still be sitting in your office pulling your hair out.

Are you ready ? All the analysis and information gathering we discussed and illustrated comes together in this completed and formal document.
Sample of a Formal Cash Forecast For 12 Months

What information is summarized and where does it come from ?
Cash Forecast Summary Explanations

What Should You Watch Out For ?

  • Overstating Sales Forecast ( Too optimistic)
  • Understating costs and expenses
  • Ignoring past experience and trends
  • Assuming your friendly banker will always bail you out

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 ?

  • Change Customer Credit Terms.
  • Monitor your customer collections to have them paid on time - nicely "tweak" them if their late.
    Shucks, use the sledgehammer if you have to.
  • Negotiate better supplier payment terms.
  • Speed Up Cash Collections
    • Lock Box
    • Faster Billing

Remember these things don't just happen by themselves, you have to make them happen.

Once My Forecast Is Prepared Am I Thru ?

Initially preparing the forecast, although important, is just the first step. You should continually monitor and update your estimates as conditions warrant and better information becomes available. In addition, you should also compare your actual amounts with you're planned amounts. You should probably spend at least a couple of hours a week "tweaking" your Cash Forecast.

Now that you've completed this lesson on cash forecasting hopefully you'll no longer have to resort to picking the bills that your business needs to pay like my little cartoon dart throwing buddy does.

Now that you know how to prepare a Cash Forecast, let's visit Ma and Pa's Antique Store and help Ma prepare a Cash forecast for her upcoming new year.

Click On
Help Ma Prepare A 12 Month Cash Forecast

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.

What did we learn and accomplish ?

  • Cash is a business's most precious asset and managing Cash Flow is one of the most important tasks every top manager and business owner should understand.
  • What a Cash Forecast is.
  • What's involved in preparing a Cash Forecast.
  • Why you need a Cash Forecast.
  • The benefits of preparing and using a Cash Forecast.
  • The information needed to prepare a Cash Forecast and where to get it.
  • And, last but not least, we actually prepared a Cash Forecast.

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 BC Cash Forecast - Excel
http://www.dwmbeancounter.com/BCCF/BC.zip

Download Bean Counter's Cash Forecast Workbook Open Office Version
Download BC Cash Forecast -Open Office
http://www.dwmbeancounter.com/BCCF/BCOO.zip

 

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