Preparing Cash Flow Projections Module 7 24/1/11 /11/10 Preparing Cash Flow Projections

What this module is about… CIPSED Project State University of Gorontalo [UNG] Entrepreneurship ToT Program

Contents: Purpose of this module Cash flow concepts The Benefits of Financial Planning Income Statements Cash flow versus Income Projected Versus Actual Cash Flows An exercise to create a cash flow projection

Purpose of this Financial Planning Module: To understand the benefits of financial planning. To understand the need for a business to be profitable AND to maintain a positive cash flow. To undestand the elements and applications of both income statements and cash flow projections. To understand the power of cash flow analysis. To learn to generate your own cash flow projections. Profit AND Positive Cash Flow: NOT the same thing Different calculations, different purposes In the end: CASH IS KING!!

Cash is King! CIPSED Project & State University of Gorontalo [UNG] Entrepreneurship ToT Program

Accounting Relationships Income Balances CASH FLOW CIPSED Project & State University of Gorontalo [UNG] Entrepreneurship ToT Program

A Cash Flow Projection is a Visual Representation of Money Flowing Into and Out of a Business Sales forecasts: How much money will the business bring in from selling its products/services? Cash flow forecasts: How much money will the business have at the end of each month? Each expense item and the amounts estimated to be spent in the future should be listed and supported by explanatory notes. Cash In (Sources) Cash Out (Uses) Cash is the life blood of the business: no cash, no business Reasonably accurate cash flow forecasting is essential management tool Cash goes in and cash goes out 3 categories: Operations – cash in from sales; cash out for inventory, other expenses Finance – cash in from owners, investors, lenders; cash out for repay loan (principal), return to investors Investment – cash in from interest, other investment; cash out for real estate, equipment

Cash Flow Categories cASH IN (SOURCES) CASH OUT (USES) 3 CATEGORIES: OPERATIONS FINANCING INVESTMENT IN Sales revenue Owner investment Loans received Investment income B U S I N E S S OUT Inventory purchase Expenses Return on investment Loan repayment Equipment purchase Facilities construction

Worksheet #1: Cash Flow Categories Refer to worksheet 1 for an exercise on identifying categories for cash flow items:

Will the Business have Enough Cash To Pay Bills at the End of Each Month? Etc. Will the business have enough cash to pay the rent each month as it becomes due? Will the business always be able to meet its payroll obligations, from the first month on? Does the business need a line of credit – if so, what security can be offered for that credit? Does the business need a term loan to buy equipment? Can the proponent of this new business prove to a banker that the business can be viable and pay a loan back? Important questions that can only be answered through cash flow forecasting AMOUNT + TIMING Etc.

Cash Cycle Over Time Example of TIMING Cash from sales does not coincide with cash spending needed to create sales MUST stay above the line

Financial Plan - Cash Flow Investment, Loans, Revenue Investment, Loans, Revenue Inflows must exceed outflows in order to keep the tub from going empty! BUSINESS Wages, Expenses, Debt, Taxes Wages, Expenses, Debt, Taxes When the tub is empty….game over! Forecast inflows and outflows by month for 1 year

Can The Business Make a Profit? For example: A retail T-Shirt business is to be started. Among the many questions that must be asked, the following are just the beginning of deliberations: To break even, how many shirts, and at what price, must be sold each month? Based on a market analysis, will customers pay this price for t-shirts? Cash flow doesn’t necessarily answer question of profitability Positive Cash Flow NOT SAME AS Profit Need to consider cost-volume-profit analysis (CVP) To be profitable, have to cover: A) variable costs – costs that vary with each sale (cost of goods, piece work) B) fixed costs – costs that are same over period Can vary somewhat but most are fairly stable Many businesses underestimate Make allowances in pricing PROFIT IS REQUIRED…BUT NOT ENOUGH Need to maintain positive cash balance Ultimately accumulate positive cash flow Can that many shirts actually be sold in a month in a specific market area?

Break-even Point Identify the point at which revenue is sufficient to cover costs (Profit = 0) Variable costs: Directly related to cost per unit of goods sold Total varies according to amount of sales Fixed costs: Operating costs that must be paid regardless of sales level Break-even calculation: Break-even units = Fixed cost / Gross Profit per Unit* Break-even revenue = Fixed cost / Gross Margin %** * Gross Profit per Unit = Price per unit – Cost per unit ** Gross Margin % = Gross Profit per Unit / Price per Unit

Break-even Calculation Break-even units = Fixed cost / Gross Profit per Unit* Break-even revenue = Fixed cost / Gross Margin %** Example: Fixed cost = 100,000 Gross profit per Unit = 2,000 Break-even units = 100,000/2,000 = 50 units Break-even revenue = 100,000/.02 = Rp 5,000,000 * Gross Profit per Unit = Price per unit – Cost per unit ** Gross Margin % = Gross Profit per Unit / Price per Unit

Income Statements Versus Cash Flow Statements Business owners must pay attention to both profit and cash flow. Businesses Need to make a profit: If a business loses money on every item it sells, It cannot be sustainable. A business must plan for cash shortfalls. The cash flow projection is the ideal planning tool for identifying potential cash shortfalls Profit is essential But: Accounting calculation – measure of economic activity Accrual prinicipal (revenue & costs recorded in period in which they occur) Matching principle (revenue matched with related costs and recorded at same time) CASH IS KING Real world, not subject to manipulation through accounting methods Cash comes in, cash goes out Positive cash flow is ultimately the ONLY source of (financial) value to the business

Worksheet #2: The Income Statement Review the Income Statement presented in Worksheet #2, and then try to answer the questions that follow it. Answer Question 3: Break even is when the revenue is sufficient to cover BOTH variable + fixed costs. In this example, revenue must be Rp 283,000,000. Answer Question 5: The only non-cash expense shown is depreciation. Others: Answer Question 6: The major cash outlay not shown on the income statement is loan principal repayment.

Worksheet #3: The Cash Flow Compare the Income Statement on Worksheet #2 with Cash Flow Statement on Worksheet #3. Try answering the questions that follow Worksheet #3. Answer Question 4: Net Profit Before Taxes is Rp 27,000. Add back 2,000 for Depreciation and subtract 5,000 for Loan Principal Repayment and the answer, Rp 24,000 is the cash on hand at year end. Note re Question 9: It is important to stress that not every line item under ‘Other Expenditures’ should be included in the cash flow of a micro-business. For example, they don’t need a security guard. The cash flow should be as simple a picture of reality as possible.

Worksheet #4: Cash Flow Projections and Actual Cash Flow Review Worksheet #4: Cash Flow Projection and the Actual Cash Flow. We will discuss these examples together.

Worksheet #4: Discussion What are some possible reasons for flucuations in sales from month to month (particularly September)? How did Kiki compensate for lower than expected cash from the land sale? How did this affect other aspects of the business? What are the major differences between the Projected and Actual cash flow? What do they mean for the business?

Four Simple Rules for Cash Flow Projections ‘Cash In’ / 2 ‘Cash Out’ X 2 Does the cash flow projection still indicate the business opportunity is viable? Support every number in the cash flow projection with written assumptions and sources for your information. Make sure all the numbers add up correctly. Avoid headaches. round-off to the nearest Rp 100,000 and, for micro-businesses, to the nearest Rp. 10,000. Remember, a Cash Flow Projection is a carefully conceived vision of the future; but it is still only an educated guess. Most importantly, the business owner[s] must believe it is true –then they can sell it to others. Also remember: Liars figure, but figures don’t lie!!

Initial Profitability Analysis Start cash flow projection with initial profitability analysis Use Worksheet #5: Profitability and Initial Cash Flow Make note of prices, costs, major expenses Consider cash sources and uses for starting up

Worksheet #6: Sales Forecast Within your groups, use Worksheet #6 to create an initial forecast of monthly SALES for your business as a starting point for Cash Flow forecasting:

Worksheet #7: CASH FLOW Within your groups, use Worksheet #7 to create an initial forecast of monthly CASH FLOW for your business:

Wrap Up: Cash flow projections are a powerful tool for managing a business. They should be as simple as possible, but still reflect reality. If analysis shows the business will have a cash deficiency at the end of a given month, corrective measures can be taken in advance. That is: talk to the banker before the business needs to borrow money, not when it is desperate to borrow it. Remember, cash flow projections are just simple arithmetic. Business people can do them by themselves without help from accountants. All of the numbers should come from the business proponent anyway – and it is important that the proponents know where they come from, and that they believe in them.