How to Calculate the Projected Cash Flow Statement
Published June 7, 2009 | 
A cash flow statement is the financial document that presents income actually received and expenses actually paid and this statement usually shows beginning cash balances, cash inflows, cash outflows, and ending cash balances, while the income statement tells you whether or not you are profitable, the cash flow statement tells you how much money you actually have and how much money you need and when.
In its simplest form, a cash flow statement is presented as follows:
–>Beginning Cash Balance
–>Plus Cash Inflows
–>Minus Cash Outflows
–>Equals Ending Cash Balance
Plugging in some sample numbers into the cash flow statement might look like this:
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XYZ Projected Cash Flow Statement |
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January |
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February |
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Beginning Cash Balance |
$1,000 |
$1,400 |
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Cash Inflows |
$4,000 |
$4,500 |
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Cash Outflows |
$3,600 |
$3,900 |
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Ending Cash Balance |
$1,400 |
$2,000 |
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While the income statement might have a negative net profit or “bottom-line number,” a cash flow statement should never have a negative ending cash balance, and if you have a negative ending cash balance it means you are in essence bankrupt or out of cash, as more than 51% of all businesses that file for bankruptcy protection in the US are “profitable” on their income statements, but because they could not collect on their sales (through accounts receivable) or because they didn’t plan their cash needs, they find themselves without any cash and out of business. For these reasons, the projected cash flow statement is one of the most important documents in managing a small business.
The month that your cash flow statement should begin should mirror the month you started your income statement and in a similar fashion as your income statements you should right near the top your 12 months going across the page, and give yourself some space on the left-hand side of the page to place your cash flow statement account titles and after your 12th and final month, added the word, “Total” at the end of this road so you can add up all of your numbers for the year.
You are beginning Cash balance is the amount of cash you start each month with and to get the first month beginning balance number:
–>If you are a startup business, then you get this number from the necessary amount of working capital use estimated you needed (usually found in the startup cost assumptions).
–>If you are an existing business, you can use the cash balance right off your accounting system or reconciled bank statement.
For the months after the first month, the beginning Cash balance is simply the ending cash balance from the previous month, for instance, if you have an ending cash balance of $2400 in March, then you will have a beginning cash balance of $2400 for April.
Cash inflows are any monies coming into the business in a given month, and examples of cash inflows might include cash sales from that month, any accounts receivables collected from previous months, the proceeds of any new loans or debt secured by the business, and the proceeds from any new equity or ownership cash injections made.
Probably the most difficult cash inflow number two estimate is your accounts receivable number and accounts receivable are those monies owed to your business for the completion of a sale you made on credit to a customer, and if you have a “cash” business, then you need not worry about calculating this number since your sales from your income statement will just carry over to your cash inflows on this statement.
For accounts receivable assumptions, you should consider what percent of your sales will be collected every 30 days or so, for example, 0 to 30 days (65%), 31 to 60 days (20%), and 61 to 90 days (15%), for a total of 100%. You must select the collection time frame that best fits the norms in your industry and the key to this is to make sure whatever numbers you use that they total 100% of your sales.
In order to find the dollar amounts for accounts receivable, you simply take the applicable percentages for each month and multiply by the appropriate sales number found on the income statement.
Cash outflows are any amounts of cash leaving the business usually to pay expenses or liabilities and cash outflows include both your variable and fixed cost, and it’s important to remember that a cash flow statement shows expenses going out when they are actually paid. On income statement however will show such things as variable cost only at the time an item is sold, in other words, you may have to actually pay for raw materials and labor many days before you actually sell the product and recognize it on your income statement.
The best way to build this section of the cash flow statement is to first add any variable cost you have and you have already calculated these cost of sales on your income statement, so you merely just have to carry them over to this section of the cash flow statement, but be aware there are two exceptions including depreciation and interest expenses.
Although you may have added “depreciation” to your income statement (usually under administrative expenses) it does not go on the cash flow statement since it is a non-cash expense. Depreciation is the allocation of the cost of an asset over a period of time for accounting and tax purposes or a decline in the value of a property due to general wear and tear or obsolescence; the opposite of appreciation. The main point is to be sure and subtract out any depreciation from your fixed operating expenses before bringing them over to the cash flow statement (under Cash outflows).
Another kind of expense you may have put on your projected income statement is interest expense, unfortunately, you just don’t pay interest back to a bank or lender, as you also pay the original loan amount or principal back as well as part of your total loan payment, and since a loan payment (which includes both principal and interest) is a cash outlay the entire loan payment needs to be included on the cash flow statement as opposed to the interest portion found on the income statement, and you can use any “amortization calculator” found on the Internet to regulate such monthly loan payments.
To summarize the two critical differences between the projected income statement and the projected cash flow statement, remember:
–>Simply move all of your variable cost expenses and fixed operating expenses from your income statement over to this section of the cash flow statement (Cash outflows).
–>Next, be sure to subtract any depreciation amounts.
–>Finally, be sure to subtract out any interest expenses and then added back in a total loan payments (which is in effect adding the principal portion of the loan payment to the Cash outflows).
Once you have added your Cash outflows to the statement, be sure to total time for each month and now you are ready to calculate the ending cash balance for the months. To get this, simply take your beginning cash balance for the month and add any total cash inflows and thence attract any Cash outflows, and the result is your ending cash balance. Place this amount at the bottom of your cash flow statement and this ending cash balance then becomes the beginning cash balance for the next month, so you can also place this value there as well, then just repeat the steps for cash inflows and outflows until all 12 months are complete.
Once you have calculated the ending cash balance for each one of the 12 months on your projected cash flow statement then you are done for the moment and it helps to also look at an example of a good projected cash flow statement. So remember, the cash flow statement tells you how much money you have and the timing of the movement of his cash in and out of the business, but it doesn’t show you the complete picture of where the business stands at a point in time, and for this, you need the last statement which is the projected balance sheet.
How to Understand Financial Projections
Published May 30, 2009 | 
Financial projections are a collection of statements that present a numerical model of your business and any good business plan must pass two separate tests that include the story test and the number test, the story test asks “Does the story makes sense?”, and the number test asks “Does the story at up?” A well prepared set of financial projections helps to address that indeed the story doesn’t add up, but it also does much more than that, as the projections reveal the entrepreneur’s basic assumptions which are usually synthesized together in many entrepreneur’s mind only.
It doesn’t matter whether you are applying for your first bank loan or your 10th, or whether you are seeking venture capital or debt financing, sooner or later, you’ll have to prepare a set of financial projections. Lenders will look for a strong likelihood of repayment using your projections, and investors will calculate what they think is the value of your company based upon these numbers, and it’s even common for suppliers and major customers to ask for such numbers today in verifying the stability of your business.
The real frustration encountered by any entrepreneur who must prepare a set of financial projections is the future, as the future is unknowable, especially if the entrepreneur is doing anything new whatsoever, and what’s really ironic is the fact that investors are the ones who usually require entrepreneurs to create such financial statements about the future. But it’s the entrepreneur who upsets all probabilities on which predictions about the future are based.
So if the future is unpredictable and unknowable then why create a set of financial projections in the first place, and the answer is simple but powerful, which is learning. Constructing a set of projections allows you to play with your business model in a safe environment and playing on paper is a valuable form of prototyping that can raise many questions before you make a decision, and under most conditions, fast learners are going to outperform even the most brilliant planners. Remember, the key is not to think of your numbers as a “plan” that is set in stone, but as a learning environment where you can test out different scenarios and decisions.
A comprehensive set of financial projections normally include a list of assumptions, Projected Income Statement, Projected Cash Flow Statement, Projected Balance Sheet, and Breakeven Analysis.
It may seem hard to believe, but banks and investors used to request financial projections to “look out” five years into the future, and as you might imagine, five years is quite a long time to an entrepreneur whose “long-term” horizon usually consist of before lunch and after lunch. But investors have come to realize the difficulty and lack of value of such forecast, and today, most investors and banks want to see you one year of extremely thorough projections (presented monthly) documented with assumptions, and then they might also ask to see a second or third (presented quarterly) depending on what they see in the model. But many loan packages can get by with just one year of solid numbers.
Most entrepreneurs are technicians by nature and hate to deal with “the numbers,” and “that’s what an accountant is for,” they often lament, and so the natural tendency for an entrepreneur is to let someone else do the projections just so they can get the money they need. While getting help on the projections is fine, however, once they are complete, you must be able to understand how they work and explain the model yourself, and remember, the real reason a lender or investor wants to see such a model is to see how well you understand your own business, and if you have trouble explaining the projections, that tells an investor that you don’t understand your own business model or its path forward.
More Key Questions to Ask When Buying a Business
Published May 11, 2009 | 
You should plan on asking all of your questions over the course of two meetings and the questions listed up to this point make for great content for your first meeting, and following are some additional questions you might want to pose on a second meeting with the Seller, since this second meeting gives you another chance to check out the business and see if anything appears to have changed in either the story of the owner or the physical condition of the business itself.
Question: Can I get a tour of the business?
- In the tour, you want to look to see if the business “looks like” it’s successful and there is a certain successful “buzz” to their place, and ask yourself if in its current state, and would you be proud to show off the business as your own?
Question: Are you “the business”?
- Depending on the size of the business most owners will answer “no” to this question, since obviously, if they are the only ones who work there then the answer is straightforward get some while still tell you: “no, the business runs on its own”, and unfortunately, in most midsize businesses, the owners are the business that this is mostly a problem that they are responsible for creating exclamation this is not necessarily a bad thing, however, by gaining an understanding of the business and what drives the sales and profits you can easily determine the impact (positive or negative) that your arrival, and the Seller’s departure will have on the business.
Question: If you were starting out again, what would you do differently or what area would you tell the new owner to focus upon?
- Sellers are usually very upfront about this question and most Sellers will tell you that they would focus on a different part of the business than they have, and if they know that a specific part of the business should have received more attention than why haven’t they done so? In any case, this should give you an idea as to whether or not your area of expertise is compatible with what the Seller believes is the greatest need and the driver of the business.
Question: Do you have a business plan?
- If yes, ask them for a copy, it’s no, ask them why, and if there is no plan rest assured there is disorganization and restricted growth, since a business without a plan is a ship without a rudder, and if the business has done reasonably well with no plan to imagine how well it can do with one! If they do not wish to give you a copy at this time, ask them why not and more importantly ask them when you can see it. They might question why you want to see it altogether and tell them you are interested in knowing what the business’ focus is and how effectively the plan has been executed.
Question: What are the biggest challenges facing the business for the future?
- As mentioned previously, Sellers will generally be honest but guarded when it comes to criticizing and analyzing their own business and this is common in many businesses where they do not perform regular evaluations to see where they are, what they’ve done, what’s working, what’s not or where they do not conduct realistic self-evaluations, so be sure and not fall into the same trap once you own the business, as constant evaluation is critical.
Question: Are the financials available for review?
- If you have somehow got to this point (despite what you have been told) and still have not seen the Financial Statements, you must address this issue right now, even if your broker stated they would not be available and even if your broker said he did not want to ask for them at this stage, go ahead and ask, since this is a perfect time where apologizing is easier than asking for permission. Explain to the Seller that you must have a clearer picture of the finances before you can proceed, and be blunt and ask if they wouldn’t want the same thing if they were in your shoes?
As much as you want to know about the Seller and their business, so too do they want information about you and you can probably anticipate most of the questions, but it is well worth you thinking about these questions before hand.
Question: What is your background and expertise?
- Things to cover include where you grew up, your education, job history, business successes and failures, etc. and give them a copy of your Bio. Be as specific as possible; this is an important question and it might be the chance for you to give the Seller an indication of fewer compatibility with the business, and remember, the Seller’s answer to what the business needs most, so ask the owner at this point how he sees you are expertise in packing the business.
Question: What’s your financial situation?
- Be straightforward and tell them that they asking price of the business falls into your level of affordability and you would not waste your time meeting with the Sellers if it didn’t, and they may also ask you what type of income you want to generate, since if they are making $30,000 per year and you are looking for $200,000, then chances are you are looking at the wrong business. Because your mandate for drawing a salary is important, if you can live on the current owners salary tell them so.
Question: Do you plan on bringing in your own people?
- Be careful with this one, because if the Seller gets the feeling that you might be making personnel changes to any business that you buy, it might leak out to the employees prior to the sale, and if this happens, and the staff since is that they purchase by you is likely, they may, and probably will, began an exodus.
Question: What is your timeframe for buying a business?
- Your answer should be “yesterday”, and let them know you have the money, the drive and the commitment to buy a business, be clear about the fact that you are not “window shopping”, and by the same token, let it be known that you are not the type to make rash decisions but when you find the business that meets your criteria, you are prepared to move forward quickly with a Letter of Intent.
Question: Do you have partners?
- If you are planning to have active partners, financial backers or any other parties who will have a say in the purchase, you must advise the Seller and you might even be wise to respond yes even if you don’t, since there is all Terrier motive for this. Once negotiations progress, there may be times when you will be put against the wall to make a decision and this gives you a way to buy a bit of time for you can always say: “I have to discuss this with my (partner, backer, advisor, etc.)”, and you can even say something to the effect that you are in this alone but you are relying on your accountant’s input.
How to Create a Sales Forecast
Published May 4, 2009 | 
Creating a sales forecast is as much an art as it is science, but nonetheless, it is an important exercise to conduct when putting together a business plan and while there is no standard approach to constructing a forecast, we will attempt to provide a model that you can use and follow in arriving at a projected sales level for your business. You should know in advance this will not produce a single number, but rather many prospective numbers, as with many things in the course of managing your business, rational thinking and logic will ultimately get you only so far, and ultimately, the choice of which number you go with will be made from your intuition.
The first thing to do and constructing a forecast is to get an idea of the average sales levels of businesses similar to yours located in the geographical area you will operate and serve and this is primarily achieved by market research, and some of the more frequently used resources to find this type of information include the US Census Bureau’s Economic Census Data, IRS Statistical Data, RMA Financial Statement Studies (found at most public libraries), Dun and Bradstreet’s Key Business Ratios and Financial Norms (found at the most public libraries), and trade association financial studies and reports.
The final approach to calculating your sales forecast is to set aside your market data and to model your numbers from the ground up on the basis of assumptions and goals and every business basically makes money by selling a unit of product or service at a selling price in dollars, for example, a retail store may sell a pair of shoes for $50, a consultant may sell on our of their time for $100, a service such as an oil change center may sell a service for a flat fee of $30, and in each case, it is a unit times and average selling price.
There are a couple ways to help with estimating sales for a retail establishment including by sales per square foot and by inventory turns and many trade associations in retailing associations publish sales per square foot and inventory turns data, and these numbers can be very useful in not only estimating the sales of your establishment but as a retail management tool as well.
Businesses that work on a project basis can be especially difficult to forecast and businesses that fall into this category include job shops, project based service businesses, contractors, and consultants. For these sorts of businesses it’s important to think of this sales forecast is more of a goal oriented exercise, and also you should try to break down your projects into several different categories, for example, a consultant may break their projects into small, medium, and large projects. They would then estimate what the average small project might bring in for income and what expenses it might take to complete the work, and they would then perform the same exercise for the medium and large projects.
By this point, you have a large array of numbers that you have probably researched and calculated and you have a break even sales level, you have market data about the average sales level of firms like yours and you have a goal oriented sales forecast. You need to keep in mind about the market data is that it is based primarily on existing and established businesses, and therefore, if you are a startup, you may want to keep this in mind as it will probably take several years before you reached these types of sales level. It’s now time for your intuition to take over, and remember, there is no right or wrong answer, however, you should justify your final choice by using your research and the calculations you conducted, and your sales figure it must take into account your business goals, marketing structure, and strategy as much as anything. Finally, you need to think of this more as goal setting rather than predicting the future.
The General Partnership
Published April 3, 2009 | 
Partnerships are formed when two or more people join together to conduct a trade or business, and it is slightly more difficult to set up than a sole proprietorship and works on the concept of basis accounting which is more complicated than that of the sole proprietorship.
An organization with two or more members is generally classified as a partnership for federal tax purposes if its members carry on a trade, business, financial operation, or venture and divide its profits. However, a joint undertaking merely to share expenses is not a partnership and any person may be an owner in a partnership, and under this definition, corporations, tax-exempt entities, insurance companies, certain foreign-owned organizations, and real-estate investments trusts cannot be owners in a partnership.
In essence, a general partnership is like a “marriage”, with all partners individually responsible for the obligations of the business and for the actions of their partners, and although not required by most states, a written partnership agreement is strongly recommended.
A written partnership agreement should set forth the rights and responsibilities of each partner, and it also should include items such as how to allocate income and how things will be handled should the partnership dissolved in the future.
When a business is legally structured as a partnership, no taxes are imposed on the business itself, instead, all income is passed through to the owners, and it is the partners’ responsibility to file their own taxes, and losses from the business can be passed through and are deductible by the partners to the extent of their interest in the partnership.
Some advantages to forming a partnership may include flexibility, easy to forming operate, possible tax advantages, losses that can be passed through to the owner, increased capital may be available, and increased expertise.
The disadvantages of forming a partnership may include unlimited partner liability, responsible for actions of partners, and difficulty in disposing of ownership interest and ownership.
A partnership must have at least two co-owners, whereas most of the other structures only require one owner, and for limited liability issues, a partnership does not provide the same amount of protection that they Corporation or L LC would, and there are also some advantages of partnership taxation over ’c’ corporation taxation.