While projecting when your business will receive cash from customers is critical, the flip side of the coin is equally important. Knowing when you'll have to pay out money can give you insight to make the right business decisions.
The importance of projecting your cash outflows
Projecting your cash outflows for your cash flow budget involves projecting your expenses and other cash outflows over a certain period of time to help you ensure you keep enough cash on hand to pay the bills. Projecting your expenses for the next month or six months may seem like a difficult task.
You may even feel like you're guessing when projecting some of your business's expenses. After all, there are a number of different variables that ultimately determine the amount of each expense.
An accounts payable aging schedule may help you determine your cash outflows for certain expenses in the near future — 30 to 60 days. An accounts payable aging schedule lists all of the amounts you owe to your suppliers. This will give you a good estimate of the cash outflows necessary to pay your accounts payable. Another tip for projecting your cash outflows is to classify each of your business' expenses. The cash outflows for every business can be classified into one of four possible categories of cash outflows:
- Debt payments
- Costs of goods sold
- Operating expenses
- Mmajor purchases
See also our case study on projecting your outflows for cost of goods sold.
Projecting outflow for debt payments
This category of cash outflows includes all regularly scheduled and unscheduled loan payments.
Cash outflows in the debt payment category are probably the easiest to predict when preparing your cash flow budget. Debt payments, such as a mortgage payment, are usually made at the same time each month, and for the same amount each month. Cash flow budgeting for this category is just a matter of including the same amount for each month in your cash flow budget.
Projecting outflow for cost of goods
A cash outflow falls under this category if it is for the purchase of inventory items resold to your customers, or for inventory items used to manufacture an end product. This category includes all your cash outflows for expenses included in your cost of goods sold.
If you're in retail, your largest cash outflow is probably for the purchase of resale items. If your business involves manufacturing goods, a large portion of your cash outflow may fall into this category if you purchase raw materials and other goods used in manufacturing your final product. If you have a service-related business, it's likely that only a small amount of your cash outflow will fall under this category.
Predicting the cash outflows in the cost of goods sold category can be a little tricky, but it's not impossible. The best way to complete your cash flow budget with your costs of goods sold is to base the amount of your cost of goods sold 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 corresponding amount of cost of goods sold to support it. Using sales information and the cost of goods sold information from prior years should allow you to determine this relationship, and express your cost of goods sold as a percentage of your sales. Industry information may be available for your type of business if you don't have prior sales and cost of goods sold information to work with. This information may serve as a starting point for predicting your costs of goods sold.
Illustration of predicting the cost of goods
To make the principle a little easier to grasp, we've provided this example that predicts the cash outflows in the cost of goods sold category in order to prepare a cash flow budget. A cash outflow falls under this category if it is for the purchase of inventory items resold to your customers or for inventory items used to manufacture an end product.
Scott Derby owns a store called "The Top Hat." His store specializes in selling—you guessed it—hats. Scott purchases all his hats from special hat suppliers and resells them to his customers.
Scott is preparing a cash flow budget for the first six months of 2014, and needs to predict his cost of goods sold to complete the budget. To determine his cash outflows for the budget, Scott will use the sales and cost of goods sold information listed on his tax returns from the previous four years. Using this information allows Scott to determine the percentage relationship between sales and the cost of goods sold.
The following chart summarizes the information from his tax returns, and shows the cost of goods sold percentages for the previous four years:
