Basics  for  
Mike Volker

Cash Flow Projections

Contact: Mike Volker, Tel:(604)644-1926, Email: mike@volker.org

"Happiness is ....positive cash flow." (unknown comptroller)

What is Cash Flow?

Profit and Loss (or Income) financial statements tell us little about the actual cash flow in a business. Profit and loss is accounted for on an "accruals" basis - i.e. changes in assets and liabilities - not cash. For example, if we sell a machine for $10,000 on 30-day payment terms, we book revenue as $10,000 and record an increase in our accounts receivable of $10,000. But no cash has "flowed". If the machine cost us $6,000 to build, we've booked a profit of $4,000, but that doesn't show up in our bank account for another 30 days, at least. To make matters worse, we probably have to pay our workers and suppliers the $6,000 which it cost us to build the machine. Where does that money come from? Well, that's the essence of cash flow. Many highly profitable companies have gone out of business for cash flow reasons - not for lack of profitability. Cash flow is like the blood that flows in our veins. Without it, we (the company) are dead! It's as simple as that. That is why happiness is positive cash flow. In fact, life does not exist without cash flow. That is why money is so important to us and makes some of us compromise our principles and leads so many down wrong paths (it is the essence of survival).

Cash Flow Statements

In business, there are several uses for preparing cash flow projections or statements. In early-stage business situations, cash flow projections are needed to determine how much money is needed to start the venture. It is the only way to know how much is really needed (more correctly, the range of values which one needs to consider). On an on-going basis, all companies - large and small - young or old - need to manage their cash flow on a daily basis to ensure that their life-blood is sufficient for their short term survival. And, rest assured that cash flow is a short-term obsession. After all, who cares about what will happen a few quarters down the road? What is important is that we can pay our bills today.

In addition to Profit and Loss statements and Balance Sheets, a third statement is often included by firms. This is referred to as a "Statement of Change in Cash Position". It shows, for a given accounting period, how a company's cash position has changed. But, it does not in any way predict or forecast cash requirements in the future. This is where a properly prepared cash flow forecast is required. This is relatively easy to do and can be done by starting with a Profit and Loss spreadsheet followed by making certain assumptions, and then adding additional rows to this spreadsheet. For examples, take a look at the statements for your favorite technology companies. If they're public, they'll likely have this information on their websites. You can also go to the Canadian repository for all such public disclosure documents, namely SEDAR. Let's now look at an illustration.

Cash Flow Forecasts

Let's prepare a cash flow. Our profit and loss projection should look something like this:
                    MONTH#1 MONTH#2 MONTH#3  ...   FYTOT: 

GROSS REVENUE($):     11200   27720   54886  ...  2162713

COST OF GOODS SOLD:    7680   19008   37636  ...  1483003

GROSS MARGIN:          3520    8712   17250  ...   679710

   Sales:              9060    8167   12222  ...   199954
   R&D:                1100     867    1022  ...    92044
   G&A:                1100    1267    1322  ...    93944

TOTAL EXPENSES:       11260   10300   14567  ...   385942

NET PROFIT (BT):      -7740   -1588    2683  ...   293768

(The following rows have been added for CASHFLOW purposes.)

CASH FLOW #1($):                                Month#7:
   Open Balance:          0   -7680  -26748 ...  
   + Cash from Sales:     0   11200   27720 
   - Cash re Expenses:    0  -11260  -10300  
   - Cash for Prodn:  -7680  -19008  -37636  
   = Closing Cash:    -7680  -26748  -46964 ... -106384
Now, here is the interesting part: How to add cash flow lines to the spreadsheet. To begin, we need a bank account (at least on paper). The bank account is our cash account. Banks only deal in real cash - not promises or commitments. So, cash is always easy to measure. All you have to do is call (or dial-up) your account and whatever is in there - that's your cash on hand. Easy!

We can start with a zero cash balance (a good starting point) or we can put a little bit (of start-up cash) into the account if it makes us feel better. To figure out our cash in and out-flows during our first month of operations, we must first make some proverbial assumptions (it is these very assumptions that can make or break us if we're not careful. We should make a few sets of assumptions and test each case - to be safe!). Let's start with some typical, and straightforward set of assumptions for Cashflow#1, i.e.:

Using these assumptions, we can calculate our cash-on-hand (i.e. what is in the bank account) at the end (and beginning) of each month. In the first month, the only cash transaction is to pay for the production materials (i.e. the cost of sales) because although we received the items one month prior to shipping same, credit has been given by suppliers requiring payment one month later - which coincides with the month in which the goods are shipped. We have no expenses to pay out, nor have we received any cash from customers. From the example, then, only $7680 in cash is flowed out on a net basis in the first month. In the second month, we again have to pay for production materials ($19,008) and we also have to pay the previous month's expenses of $11,260. However, we have cash flowing in from our customers in the amount of $11,200 for the prior month's sales (not in this case that shipments are synonomous with sales). The net cash outflow for month 2 is thus $19,068 which produces a cumulative cash outflow for the first two months of $26,748. As we roll-out the spreadsheet, we will see that our maximum end-of-month cash deficit grows to $106,384 in month 7. By month 10, the deficit is reversed and there is a positive cash balance.

So, it appears that for this first set of assumptions, we need at least $110K to get this business started. But, what if we now change our assumptions? Let's make some conservative changes. For example, consider only two changes to give us Cashflow#2:

Cashflow#2 rows now replace the Cashflow#1 rows to produce the following spreadsheet details:
CASH FLOW #2($):                                Month#10:
   Open Balance:     -26688  -64324 -142651 
   + Cash from Sales:     0       0   11200 
   - Cash re Expenses:    0  -11260  -10300 
   - Cash for Prodn: -37636  -67067  -97750
   = Closing Cash:   -64324 -142651 -239501 ... -721842
Now, let's see what happens. Using the same procedure as before, we can see that at the end of the first month, we have had to come up with $64,324 in cash to pay for the shipments for months 1, 2 and 3. Also, cash in-flows from sales do not start until the third month. At the end of month 3, we are already out-of-pocket by $239,501 - a tidy sum! The peak negative cash balance occurs at the end of month 10 with a whopping deficit of $721,842! WOW! Hard to believe, isn't it! Well - now you know why a cash flow is so important.

Back to the question: How much do we really need to start this business? Is it $110K or is it $721K? Or, something in-between? Well, there is no right answer for this. It might be nice to have $721K at the outset - but is this realistic? Who in their right mind would give this much to a start-up company? The less capital raised - the riskier the deal. The lower figure might be our best case scenario - i.e. what is needed in the best (i.e. most desirable) case whereas the higher figure might be our worst case estimate based on the worst (i.e. least desirable) set of assumptions we might conjure up. On the other hand - more is tougher to get and more equity would have to be given up, in any event, in order to get it. 

But... but... this all depends on having reliable top line (i.e. sales) numbers, right? RIGHT! So, to be prudent, we should run a few scenarios under which we have a sales shortfall. For example, what happens if sales are only 50% of target. Or what if we have production delays of 6 months? Then what happens to our cash flow? These scenarios must also be analyzed in order for you to earn the "prudent manager-of-the-month" award. Going through these various "what if" questions is often referred to as sensitivity analysis. It allows us to see how sensitive our projections are to various changes to our assumptions. The fact is that the more we do this, the more reliable our projections become. At the outset, the key point to bear in mind is that our forecast should be a plan - not a forecast. If we have a good plan, based on sound facts and knowledge, then the outcome of this plan (i.e. the forecast) is more likely to be realized! N'est-ce pas?


The month in which cash flow turns positive is referred to as "break-even", i.e. the business is generating sufficient cash income from sales to cover all cash obligations, incurring neither a need for additional cash nor providing a surplus of cash. After this point, the business will start to generate cash rather than consume it. It is very useful to know in which month this occurs because until this time, management must be particularly careful about not exceeding spending budgets while working hard to ensure that income budgets are satisfied. Again, by changing the various assumptions, one can readily see the impact on the break-even point. 

A word of caution: the term "break-even" is often used in two contexts. The forgoing refers to breakeven on a cash basis. Companies often refer to breakeven on a "profit and loss" basis as well. In this case, breakeven refers to the point at which sales are sufficiently high so that the gross margin generated (on a P&L basis) covers all of the operating expenses. In other words, it is the month (or the sales level) when there is neither a loss nor a profit. Breakeven month (or volumes) are quite different. A business may break-even on a P&L basis in month #6 but it may not break-even on a cash flow basis until much later. To avoid ambiguity, the context should always be noted.

For More Information....

Many, many books have been written on the subject. Some of the course references (check on home page) will point you to some of these. But, really, there's little more they can tell you! 

Copyright 1997-2007 Michael C. Volker
Email:mike@volker.org - Comments and suggestions will be appreciated!
Updated: 071113
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