Many small businesses rely on their CPA to keep tabs on the financial health of their business. But as a business owner, you need to understand cash flow estimates.
Knowing how to estimate your company's cash flow at any point in time can help you make more informed capital budgeting decisions.
This article details some of the different types of cash flows you need to understand.
We've also shared some useful cash flow estimation formulas and templates, as well as some business strategies you can use based on your cash flow.
What does "cash flow estimate" mean?
Simply put, the cash flow estimate (or cash flow forecast) is a prediction of the amount of cash inflows and outflows a business will have at a given time.
It's a little more complicated, of course, especially when non-monetary factors like depreciation and compound interest come into play.
Either way, these predictions can help you decide when to invest in your own business and when to look for more funding.
When you can make accurate and informed cash flow estimates, you will make much wiser investment decisions for your business.
How to estimate cash flow
The easiest way to create a cash flow forecast is to use this equation:
Initial cash + Projected revenue on a given date - Projected expenses on the same date
This formula will help you get a rough estimate of how much cash flow you will have at your chosen time.
If you want a more accurate design, you need to consider factors such as taxes, asset depreciation, and deflation, which we'll cover in the next few sections.
Cash Flow Type
There are different types of cash flows.
- free cash flow
- Operating cash flow
- Incrementeller cash flow
Each type represents different financial factors and all are useful for different reasons.
We will define each of them below.
1. Net cash flow
Net cash flow is the total cash inflow and outflow of a company. This figure includes the inflow and outflow of cash equivalents, e.g. B. Investments.
To calculate your net cash flow, you must add:
- exploratory activities
- investment activity
- financing activity
What are operational activities?
In principle, all expenses necessary to maintain business operations are considered operating activities. Goods, services, marketing costs, manufacturing costs, and employee salaries all fall into this category.
Operations make up the bulk of a company's expenses.
What are investment activities?
Investing activities involve the purchase or sale of goods, facilities and equipment, such as real estate, machinery and vehicles.
The relevant cash flows would be related to the sale of current assets or the cost of an investment.
What are funding activities?
Financing activities include the costs or earnings of debt, equity or dividends that a company owns.
For example, a company may pay interest on a debt and collect interest on a debt owed to it. Both count as funding activities.
How to Calculate Net Cash Flow
To find your net cash flow, add up the sum (income and expenses) of your operating, investing, and financing activities.
In other words:
Net cash flow = operating activities + investing activities + cash flow from financing activities
2. Free cash flow
Free cash flow differs from net cash flow in that it only represents operating expenses and capital expenses.
Capital expenditures include the acquisition and maintenance of equipment and property and any non-human tangible assets that help you produce your goods or services. As we said before, running costs include things like rent,payroll, insurance, inventory and supplier payments.
Free cash flow shows more than just cash coming in and going out - it shows how the company is balancing its working capital.
A free cash flow estimate shows how profitable you think your business will be without accounting for non-cash factors. It illustrates how much money you'll have after you "pay the bills" so to speak.
The more free cash flow an operating company has at the end of the month, the more opportunities it has to grow and deleverage.
How to calculate free cash flow
To estimate your free cash flow, use this equation:
Operating costs - capital costs
3. Operating cash flow
Operating cash flow describes the difference between your EBIT (earnings before interest and taxes) and your operating expenses.
It is a cash flow that does not represent an investment or financial activity.
However, operating cash flow takes into account asset depreciation.depreciationIt is the tax deduction a company can get for the cost value of a large investment over time.
A company's tax liability can be reduced by accounting for the depreciation of its assets as an expense. This reduces the amount you pay in taxes.
Depreciation expense is added to net income before operating expenses and taxes are deducted from the balance sheet.
How to calculate cash flow from operations
Here's a simple formula to help you out:
Operating cash flow = operating profit + depreciation – taxes + change in working capital
Operating cash flow x free cash flow
These two types of cash flows look similar but are actually very different.
While operating cash flow indicates whether a company can continue operating on its current earnings, free cash flow indicates whether a company can continue to pay off debt and dividends or even make investments to grow.
This is important information foroutside investorssince they obviously want to see growth.
4. Inkrementeller cash flow
Many businessmen useIncrementeller cash flowEstimates to determine whether a potential investment is worth the projected return.
The investment could be something like buying new equipment or upgrading your technology to create a new product.
How to calculate incremental cash flow
Estimating incremental cash flow is easy. Take the project revenue and subtract the initial investment and project expenses.
The formula looks like this:
Incremental cash flow = projected revenue - minus expenses
If this formula has a positive solution, the project is a good business move.
You can get a more accurate forecast of an investment's profitability using its discounted cash flow (usethis calculatorHelp).
DCF is similar to incremental cash flow, but considers inflation, interest rates, changes in tax rates, and other factors that change over the life of an investment.
How to use your cash flow estimates
Once you have some numbers, you can use that information to make some business decisions.
What to do when free cash flow is high?
If your estimates project high cash flow, it means your business is heading in the right direction.
Now it's time to make some capital investments. You can invest some money to improve your business by buying new equipment, hiring more employees or increasing your marketing budget.
So your book value is high and you are a good candidate for investors. You can take advantage of this and start a new project.
Before taking that step, however, you need to determine whether the potential value of an investment project is worth it. We'll discuss this in more detail later.
What to do when free cash flow is low?
Unfortunately, there may be times when your financial statements predict low cash flow. This is normal for any growing business.
To continue your business and cover your current liabilities, you may need to find outside financing or take out a loan.
Of course, you don't want to spread it out too thin. Be sure to factor in interest costs.
This is where the importance of cash flow forecasting becomes very clear. It's good to spot downtrends before you experience negative cash flow, which could bankrupt your business.
But now you have time to sort out all the problems that can lead to big financial tragedies.
In addition to the amount of free cash flow, there are several other factors that companies can consider when making investment decisions.
See too:Cash Flow Planning (Beginner's Guide)
Additional Tips for Cash Flow Estimates
Here are some other helpful tips to keep in mind when forecasting cash flow:
Understand the internal rate of return
Another term you'll hear a lot when discussing cash flow estimates isinternal rate of return, the TIR.
IRR is often used to determine whether to invest more in an existing project or start a new one. You can use IRR to determine what would be most profitable.
The internal rate of return is the expected annual rate of return on an investment with zero NPV.
The term Net Present Value or NPV is also used to determine the profitability of an investment.
It uses the time value of money to determine the value of an investment made now, using the discount rate of the resulting future cash flows.
To calculate the rate of return, use this formula:
Yield = (Amount with interest and dividends minus initial amount) ÷ Initial amount
Be sure to consider seasonal cash flow
Most companies have annual recurring periods where cash flow increases or decreases. This could be due to incoming expenses during a particular season or the nature of your business.
For example, small businesses that provide pool services or merchandise have lower cash flow during the winter months, but this increases as temperatures rise and more people spend more time in their pools.
Tracking your cash flow from year to year will help you adjust spending for each season.
Don't miss the opportunity to invest in your business in times of high cash generation.
New business is unpredictable
Many small businesses face the unpredictability of startups, especially when they are just starting out.
Whenever you try to do cash flow calculations for these capital expenditures, be as conservative as possible.
With startups, you don't have a track record to base your calculations on. You must weigh sunk costs against the potential return on your investment.
ransom valueit is much less than the market value and if your project fails you may have to rely on the residual value of your investment.
Do not use receivables in the calculation
Many companies make the mistake of calculating accounts receivable and accounts payable when estimating cash flows.
While you have control over when you pay your vendors, you don't know when or if you'll receive payments on your invoices.
If you want to have a more reliable cash flow, you can always do itAccelerate bill paymentswith an accelerated bill payment service.
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Large companies use estimates of future cash flows to reassure shareholders, justify valuations, and show that they are anticipating year-over-year earnings growth.
However, for small businesses, these formulas are used to make smart investment decisions. This gives them better information about how and where their financial movements should be adjusted.
If you're feeling the pressure of low cash flow, you can increase it by charging unpaid bills.
The best way to do this is to open an Accelerated Billing Solutions account, as many of their biggest customers follow their own bill payment schedule.
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