The following is an explanation of how to put together a cash flow statement that shows you cash flows on a month by month basis. I’m assuming you have read my other article explaining the rationale for making a profit and cash flow forecast for your small business. I won’t repeat myself here. I promised to get to the nuts and bolts of actually doing a forward-looking plan. Let’s get started.
First, of course, is SALES. In order to come up with good numbers, you should approach the issue from several angles, long-term history, short-term history, trends in the economy, seasonal trends, and sales by customer. Each of these perspectives will combine to give you a consensus monthly pattern for the next 12 months.
Look at the last 2-3 years, what were the annual sales? Was there any detectable seasonal pattern through the year? What is the short-term trend, up or down? What is the very near term look like, what are the quoting trends, ordering trends of late, what is your backlog telling you? Knowing what type of economy we are in, and knowing that things probably won’t pick up much before the 3rd or 4th quarter, how will that impact sales? Finally, list your major customers that make up the bulk of your sales. What do you anticipate from each of them in the coming 12 months? Add that up. Put numbers to each of these questions and you can now aggregate them into a month-by-month sales forecast that you can be reasonably certain about.
Now COST OF SALES. For this, we don’t want your gut feelings; we want pure, historical facts. Pick a good, long-term time frame, like the last full year and also pick the last 3 months in case something has changed recently. Print out those P&L’s (Income Statements). Calculate the percentage of sales of materials, labor, and anything else directly used in the product or service you sell. These are called direct or variable expenses, or cost of goods sold, they vary directly with the level of sales and are expressed as a percentage of sales- always. If you are building a spreadsheet or use specialized software like my company uses for our clients, make sure these are percentages tied to sales. If you change the sales number, these will change too.
Sales minus cost of goods sold equals gross profit or gross margin. What is the total COGS as a percent of sale, and gross profit or gross margin as a percent of sales? Is it accurate based on your history? If not, go back and correct your work until it is.
And now you will list all your other items from your P&L that typically fall into the categories of General and Administrative and Selling Expense. These TEND to be fixed costs (or overhead). Rent is fixed. Utility bills will vary with the weather. Sales commissions will be variable with the level of sales so it’s a percentage. You might have a cost that’s a percentage of another cost; so, you’ll have to build that in. You will want to generally use longer-term average monthly dollar amounts (NEVER use percentage of sales for fixed costs!) for most of these numbers.
Finally, to forecast cash flow, which is really what you are after in this whole process. It is cash flow that matters most to you. It’s YOUR business. First, you need to establish the collection pattern of your sales. The method I like best is figure out historically how much is collected (percentage) in the month of sale, the month following, 2nd month following, etc. Then you will apply those percentages to each month’s forecasted sales to tell you how cash will come in. Next figure the pattern for how bills are paid. Payroll will always be an immediate cash outlay; vendors would be paid in the month following or longer. That will show how cash will flow out from your company.
Finally, the payoff for all this hard work! Put all this together and you will have a plan for the sources and uses of cash. You might see cash crunches in certain months but you can now plan accordingly to deal with it ahead of time. You will be well armed to meet the next 12 months knowing what you need to do, where you might need to cut costs, to make a profit and have adequate cash when you need it.
Congratulations! You will have put your business on a much stronger financial footing because you will be looking at the future, not the past!
I hope this has been helpful.
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