Projecting the timing and amount of cash outflows

From the information listed above, Scott has determined that his cost of goods sold has been averaging about 59.95 percent of his total sales over the last four years. Scott will use this percentage to predict his cash outflows for the six month cash flow budget he is preparing for 2014. In his budget he will assume that his cash outflows for the cost of goods sold will continue to average about 59.95 percent of his forecasted sales. The following chart summarizes his budgeted cash outflows for the cost of goods sold.

Projecting outflows for expenses

A cash outflow falls under this category if it is cash paid out for operating expenses. Operating expenses are all the expenses you incur while operating your business. Examples of operating expenses include payroll and payroll taxes, utilities, rent, insurance, repairs and maintenance. A good rule of thumb is that if the cash outflow doesn't fit under any of the other three categories (debt payments, cost of goods sold, or major purchases), it's probably an operating expense.

Predicting cash outflows for operating expenses when preparing a cash flow budget can be quite easy in some instances, and difficult in others. Rent, for example, is one operating expense that should be fairly easy to predict since it is usually the same amount month after month. Other operating expenses, such as payroll and utilities, may not be so easy to predict.

As when you predict cash outflows for the cost of goods sold, the best way to predict operating expense outflows is to base them on your sales forecast. This prediction is based on a simple relationship—in order to achieve a certain level of sales, your business will have to incur a given amount of operating expenses.

Using sales information and operating expense information from prior years should allow you to determine this relationship and express your operating expenses as a certain percentage of your sales. Industry information may be available for your type of business if you don't have prior sales and operating expense information to work with. This information may serve as a starting point for predicting your operating expense cash outflows.

Projecting outflows for major purchases and reconciling all of the projections

They say the devil is in the details, but sometimes, it's in the big picture. When preparing a cash flow budget, you must predict the cash outflows for major purchases, such as property or equipment, vehicles, computers or other office equipment. Sometimes it's easy to obsess about the little things and forget about the large purchases you'll need down the road.

Major purchases are usually the result of a business expansion, a business improvement or a business replacement expenditure. Cash outflows in this category are generally large and don't occur that often during your business year.

As the owner of your business, you are probably the best predictor of the cash outflows in this category. If you look for your business to expand during the budget period, then you probably have a pretty good feel for the additional equipment, office space or office equipment needed to undertake the expansion. You also probably know when it's time to replace the old delivery van with a newer model, or when it's time to get rid of an aging computer and replace it with a new one. For more information on how to analyze major purchase decisions, see major purchases and projects.

Tip

The cash flow budget is an excellent tool to help you determine when or when not to make major purchases. If your cash flow budget shows that additional funds may be available at a certain point, this should provide you with the opportunity to make advance purchase decisions.

Planning ahead may allow you to take advantage of lower prices, discounts or better financing options. Likewise, if your cash flow budget shows that your cash supply might be a little tight, it's probably not a good idea to make a major purchase, or take on an additional monthly loan payment.

Putting the inflow and outflow projections together

The final step in preparing a cash flow budget is putting together your projected cash inflows and outflows to come up with your cash flow bottom line. In its basic form, the competed cash flow budget combines the following information on a month-by-month basis:

Beginning Cash Balance
+ Projected Cash Inflows
- Projected Cash Outflows
= Your Cash Flow Bottom Line (the ending cash balance)

You'll definitely want to include a little more detail in your cash flow budget than what is listed above. However, the basic form of the cash flow budget will always remain the same.

The ending cash balance for the first month becomes the second month's beginning cash balance. The second month's cash flow bottom line is determined by combining the beginning cash balance with the second month's anticipated cash inflows and cash outflows. The ending cash balance for the second month then becomes the third month's beginning cash balance. This process continues until the last month of the cash flow budget is completed.

A positive cash flow bottom line indicates your business has a cash surplus at the end of the month. A negative cash flow bottom line indicates that your business has run into a cash flow gap — a period where cash outflows exceed cash inflows when combined with your beginning cash balance.

If a cash flow gap is predicted early enough, you can take cash flow management steps to ensure that your cash flow gap is closed, or at least narrowed. These steps might include:

• Increasing your anticipated cash inflows from accounts receivable collections
• Decreasing your anticipated cash outflows by cutting back on inventory purchases or cutting certain operating expenses
• Postponing a major purchase
• Looking to outside sources of cash, such as a short-term loan to fill the cash flow gap

In other situations, filling the cash flow gap may require you to look to external financing sources.

Understanding projected cash inflows

The following are examples of some of the detailed cash inflows that you may want to include when for your cash flow budget.

Projected cash inflows (receipts):

• Sales and receipts
• Collections on accounts receivable
• Loan proceeds
• Other cash inflows

Understanding projected cash outflows

The following are examples of some of the detailed cash outflows that you may want to include when projecting your cash outflows for your cash flow budget.

Anticipated cash outflows

Cost of goods sold

• Inventory purchases
• Shipping and handling
• Manufacturing costs

Operating expenses

• Payroll
• Payroll taxes
• Advertising
• Subscriptions and dues
• Professional fees
• Office and postage
• Rent
• Utilities
• Insurance
• Taxes and licenses
• Supplies
• Repairs and maintenance
• Credit card fees
• Bank service charges
• Other operating expenses

One-time purchases

• New property or equipment

Debt payments

• Interest
• Principal

Other cash outflows