Cash Flow Series #3: Making Projections Using Your Cash Flow Forecast

Welcome back to our forecasting series. At this point, you’ve set your goals and used them to create your very first cash flow forecast. Now it’s time to interpret the results and start taking action. 

In our last article, we briefly walked you through the last three tabs of the Small Business Cash Flow Forecasting template—the Profit and Loss, Balance Sheet, and Cash Flow tabs. Now, we’re going to dive deeper into those tabs and show you how to use them to make vital business decisions, like:

• Applying for loans and other financing options
• Hiring or laying off employees
• Personally taking money out of or putting money into your business
• Increasing or decreasing prices

You can also check out our video walkthrough of how to build and use the model below:

As you review your financial model, you’ll likely make adjustments based on your results and analysis. That’s okay! Forecasting is a holistic process in that many financial elements are working together to create your business model. Even small changes and adjustments can have a significant impact on your cash flow.

Case study

To demonstrate how to analyze each tab, we’re going to use a case study. In our second article in this series, we referred to a digital marketing agency. Let’s build out that example even more. Here are some quick facts about our case study:

• Business name: Marketing Is Fun
• Business type: Digital marketing agency
• Services: Provides project-based website design and retainer services for ongoing website maintenance, SEO support, and Facebook ads management.
• Company size: Currently, they have five employees and are planning to build their team in the next 18 months. 

Marketing Is Fun has set the following goals for the next 18 months, and their forecast reflects these goals:

• Increase website visitors by 1,000 new visitors per month 
• Obtain one new SEO management retainer client per month
• Obtain one new Facebook ad management retainer per month
• Hire additional SEO and Facebook ads managers, designers, developers, and project management and administrative support

Marketing Is Fun is also facing the following challenges and questions:

• At what point do the current staff hit their capacity and make it necessary to hire new employees? Can they afford these new hires?
• Do they need to apply for a loan? If so, when and for how much?
• When can the owner take additional distributions from the company?

For each tab, we’ll go over how to interpret the results and then refer to the case study to demonstrate how a business would use these results in real-life scenarios. 

Profit & Loss

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Hiring and Growth

The Net Income (Loss) line of this tab shows if the business model you’ve built is profitable. If you have a positive number, that means your business will earn a profit. If it’s a negative number, that means your company will have a loss. 

Just because you’re profitable doesn’t mean you’re earning enough profit. When reviewing your net income, also consider whether your net income is enough. Think through how you use your profit. Examples are:

• Reinvesting in your business by purchasing assets 
• Building a cash reserve
• Paying your taxes
• Paying yourself or other owners
• Paying off your business debt

Once you know how you allocate your profit, review your net income and see if there’s enough to meet your allocation needs. The Balance Sheet and Cash Flow tab, which we’ll talk about later, will also help you assess this. 

What happens if you aren’t earning enough profit? Well, then you’ll need to go back to your model and adjust the following:

• Revenue: To increase your income, you can increase the monthly quantity sold, the price, or add a revenue stream. 
• COGS: Decreasing the COGS for each product or service will increase your overall profit. 
• Operating Expenses: Like COGS, if you decrease your operating expenses, you’ll increase your profit. Start with reducing your variable expenses and then move on to your fixed expenses. 

Keep in mind that it’s not uncommon to operate at a loss for several months or even a year if you’re in the early stages of building a business or scaling your business. If your model does produce a loss, review the other tabs before radically changing your business model. 

Let’s look at the Profit & Loss tab for Marketing Is Fun. Here, we see that for Month 1 and Month 2, the company will have a loss. 

Why is that? Going back through the model, we see that Marketing Is Fun is relying heavily on subcontractors for the first four months. The company does plan to hire three new employees in Month 4 and 5, which drastically reduces its subcontractor cost. 

Knowing this, Marketing Is Fun can now decide if they want to decrease their subcontractor costs or leave them as is and take a loss in Month 1 and Month 2. How do they know what they should do? Reviewing the other tabs will help them decide. 

Balance Sheet

The Balance Sheet tab gives you a snapshot of your overall financial picture and how that picture changes based on your financial model. 

Cash Flow

Perhaps one of the most critical lines on the Balance Sheet tab is the Cash line, which shows if you’ll have enough cash to cover your bills and expenses. If the number is negative, you’ll need to decide how you’ll cover the cash deficit. 

So how do you create more cash in your business? You can:

• Increase your revenue
• Decrease your COGS
• Decrease your operating expenses
• Adjust your accounts receivable terms to collect more revenue up front (you can experiment with this by adjusting your percentages in the Prep Sheet tab under Assets)
• Adjust your accounts payable terms to give you more time to pay your bills (you can adjust this for your COGS on the Prep Sheet tab under the COGS section, or for your operating expenses under the Liabilities section)
• Take out a loan
• Put your personal money into the business

Let’s look at Marketing Is Fun’s Balance Sheet. We see that in Month 2, Marketing Is Fun has negative cash flow, and that lasts until Month 7.  

Earlier, we mentioned that Marketing Is Fun is questioning if they should take out a loan and, if so, how much. Here’s where we can answer that question. 

Based on the Balance Sheet tab, we know that Marketing Is Fun needs to increase its cash flow before Month 2 if it wants to have positive cash flow. The company can experiment with different loan amounts to see how much it would need to borrow to cover its negative cash flow. 

As we enter different loan amounts, we see the Cash line fluctuating. These fluctuations clue us into what loan amount will solve our cash flow dilemma. 

When experimenting with loan amounts, don’t forget to enter the loan payments that you’ll need to make, as those will also affect your cash flow. You can use a basic loan payment calculator to estimate your monthly payments. 

Based on the immediate need for cash, the owner of Marketing Is Fun decides to contribute $5,000 of their own money in Month 1 and take out a $35,000 loan in Month 2. 

Owner Contributions and Distributions

The number on the Cash line helps you decide when you can take money out of your business and how much. Remember, even if you have a profit, that doesn’t automatically mean you can take a distribution. You may still have other bills and liability payments not reflected in the Profit & Loss tab. 

Reviewing the Cash line, the owner of Marketing Is Fun decides that they don’t have enough cash to take a distribution until Month 8. At this point, they will begin monthly draws from the business. 

Equity

Another useful line on the Balance Sheet tab is the Total Equity line, which shows you how much your business would be worth if you liquidated your assets and paid off your debt. Some people call this the net worth of their business. 

Reviewing this line, you can see how your decisions impact the overall value of your business. If you have a dream of selling your business, this line can monitor how your business’s value might increase (or decrease) based on the decisions you make. 

Reviewing Marketing Is Fun’s equity line, we see that by Month 18, the business is worth $1.5 million. Knowing this, the owner of Marketing Is Fun decides that it’s okay to take a loss for the first two months so that they can build a business model that will generate profit later. 

Cash Flow

Remember that handy Cash line on the Balance Sheet tab? The Cash Flow tab shows you all the details of that line and why there are cash flow changes. Here you can see how each one of the decisions you made in your forecast affects your cash flow. 

You won’t make any changes to the Cash Flow tab. Instead, as you make adjustments to your model, you’ll use this tab to see how those changes impact your cash flow and answer important questions about your model. 

For example, before starting their forecast, Marketing Is Fun was wondering if they can afford new hires. Based on their projections, and the capacity of their current staff, Marketing Is Fun has decided that it will hire:

• One employee in Month 2
• One employee in Month 4
• Two employees in Month 5
• One employee in Month 10
• One employee in Month 18

So, can Marketing Is Fun afford these new hires? 

Without the loan, the company can’t afford to hire in Month 2, 4, or 5. The $35,000 loan is necessary to scale the business, which recovers from the cash flow shortage in Month 9. Now Marketing Is Fun has a compelling case (with real numbers) for why it needs the loan and it can share this case with prospective lenders. 

Tips for using your cash flow forecast to predict funding needs

Here a few best practices to follow as you use your financial model to make financing decisions for your business:

1. Apply for loans several months before you’ll have negative cash flow. The beauty of the cash flow forecast is that you can see many months in the future. This helps you anticipate when you’ll need funding and plan in advance. Don’t wait until you’re out of money to apply for a loan! Loans take time—and there’s no guarantee that you’ll secure a loan the first time you apply. Give yourself at least two to three months of lead time. 

2. Identify what impacts your cash flow. Reviewing your cash flow forecast, what patterns or trends lead to negative cash flow? These patterns could build up over time (like a steady increase in operating expenses) or be sudden (like a surge in hiring). Knowing these patterns can help you anticipate cash flow needs when the unexpected occurs. 

3. Run different scenarios. The cash flow forecast is a projection, which means what will actually happen in your business is still unknown. However, you can still use the forecast to develop benchmarks for when trouble is ahead. One way to do this is by running the same forecast with 75% and 50% less revenue. If you only make 50% of your revenue goals, when do you need to borrow money? Later, you can compare these scenarios with your actual numbers and, based on your percentage to goal, predict when you’ll need to borrow money. 

Tracking your actuals 

Now that your forecast is complete and you’ve analyzed your results, it’s time to implement your strategy and review the results of your hard work. 

In the implementation phase, it’s important to compare your actual numbers to your forecast every month. You’ll want to see if the assumptions you made in your projections (like acquiring 1,000 new website visitors per month) had the result you intended (like earning more revenue). 

Here’s what numbers you’ll need to track monthly:

• Revenue, the total and a break out by income stream (ideally the same product or service groupings in your forecast) 
• COGS
• Compensation costs (salaries plus benefits)
• Operating expenses, total and break out by category (ideally the same categories in your forecast) 
• Capital expense purchases
• Net income

If this seems like a lot to keep track of, the good news is that a profit and loss report from your accounting software will provide most of this information. You can use a balance sheet to see your capital expense purchases. 

You’ll also need to track the key performance indicators (KPIs) that you identified in our first article and measure your goals against your actuals. Your KPIs directly impact the success of your model. For example, if your goal was to acquire 1,000 new website visitors per month and you only gain 500, you probably won’t meet your revenue goals. 

On the flip side, if you met your KPIs, but your revenue hasn’t increased, you’ll need to examine the other assumptions you made and identify why your income isn’t growing. Comparing your actual numbers and KPIs to your forecast can help you identify problems and proactively optimize your business. 

You can also use your KPIs and actual numbers to adjust your forecast to reflect your business trajectory more realistically. Let’s say that you’re only acquiring 500 new website visitors a month and the growth you planned is slower than anticipated. Knowing this, you can adjust your revenue, hiring strategy, and other factors in your forecast to account for slowed growth. These adjustments can also help you identify if your funding needs have shifted. 

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You’ve officially completed and analyzed your first cash flow forecast! Each time you go through the forecasting process, it will become easier and more accurate. A cash flow forecast is a living document. Use the template as a playground for your business’s goals, and don’t be afraid to experiment and make adjustments as your business evolves.