Go Beyond The Operating Cash Flow Formula

Go Beyond The Operating Cash Flow Formula

by Redpath and Company

Forecasting your operating cash flow can help your business tremendously. Thereโ€™s a simple formula, but you will want to customize it to work best for you.

Cash flow is crucial to ensure smooth-running business operations. Hoping for the best or banking on the fact that you have plenty of revenue right now are not good financial strategies. Things change, and you want to grow. While you cannot be clairvoyant, you can use what you know to make reasonably reliable forecasts so you can plan effectively and remain flexible when the unexpected happens.

Even well-established, profitable businesses can still have fluctuating cash flow. Knowing how much cash you expect to have on hand and when enables you to:

  • Pay your bills on time
  • Plan for new expenses, large and small
  • Accrue resources for paying taxes or building your capital reserve
  • Gain insight over time into patterns that can help improve future forecasting and business planning

If it appears cash will run short at some point, you can plan your response ahead of time to reduce the impact and related stress. On a positive note, you can see when youโ€™ll have excess cash to support growth-related spending. These things matter whether youโ€™re a fledgling business with one eye on your next investment round or your enterprise is long-established.

Role of a CFO in a startup
How a Fractional CFO can help with growth

A Simple Cash Flow Formula 

A formula to calculate your operating cash flow can be as simple as this:

Operating cash flow = total revenue โ€“ expenses (over a given time period)

However, there will be complexity that will be specific to your business. Think about all of the income and expense elements that drive your business. There are several methods you can use, but the receipts and disbursements approach is simple and easy to follow using these four steps:

Step 1: Pick your timeframe

You can create a forecast for the near term or many months out, though newer companies may not have the data or experience to make accurate longer-term predictions. You can work toward that. Keep in mind that forecasts are always a working document you can adjust as new data comes in or things change with your business.

Step 2: List all your revenue

Make a chart with columns for each week or month and rows for each of your income sources. Sales may be what comes to mind first, but income also may come from:

  • Tax refunds
  • Royalties or licensing fees
  • Grants
  • Shareholder, owner, or other investment

Enter the figures in the week/month when you expect the cash to be in handโ€“-when you know your customerโ€™s payment will be received, for example, not when you close the deal.

Total each column to see income for the period.

Step 3: List all your expenses

Now make a chart with columns for the same time periods as above and rows for each type of financial outgo. Think in terms of:

  • Rent
  • Salaries (and payments to non-employee service providers such as your attorney, accountant, or independent contractors)
  • Supplies or raw materials
  • Loan payments and related fees or charges
  • Advertising and marketing spending
  • Assets

Total each column to see your outgo for the period.

Step 4: Do the math to see your running cash flow

For each week or month, subtract the outgo amount from the income amount. If the income is higher, you will have a positive cash flow; if expenses are higher, you will have a negative cash flow.

Itโ€™s Not Necessarily that Simple

The above cash flow forecasting method is easy and useful. However, you donโ€™t want to over-simplify because youโ€™re using these figures to chart your companyโ€™s future. Have you included every income or expense source? Should you be looking at a different time frame?

Many businesses have capital cycles that are seasonal and this will impact cash flow forecasting. Your businessโ€™ way of collecting accounts receivable and handling inventory management will be important to figure into the equation as well. You will also want to optimize your accounts payable processes. This could mean moving to a paperless system, organizing and prioritizing invoices, and establishing reliable fraud and duplicate payment detection measures.

A fractional CFO can help you create cash flow forecasts that are comprehensively inclusiveโ€“and, therefore, more accurate and more valuable. With their in-depth accounting knowledge and experience working with different types and sizes of businesses, they can ask questions and offer insight you may not have considered to ensure nothing is overlooked.

Resource: Finance questions CEOs should ask

Bringing in an outside expert can also help you make best use of your forecast as a planning tool to reach your business goals. They can help you plan effectively to weather periods of predicted negative cash flow, smooth operations, maintain momentum, and strategically plan for the future.

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Redpath and Company

Redpath and Company

Redpath and Company help clients make more informed decisions that contribute to their financial well-being by providing proactive, innovative, and value-driven CPA and advisory services for closely-held businesses, private equity, government entities, and nonprofit organizations. Core commercial industries served include retail, manufacturing, distribution, construction, real estate, engineering, and technology. Areas of service expertise include audit and assurance; personal, business, and international tax; state and local tax; sales and use tax; and succession and estate planning. Redpath also guides clients throughout the entire business life cycle with M&A advisory services (corporate and deal strategy, transaction support, and integration); accounting and financial management outsourcing; and valuation services. The firm was founded in 1971 and is employee owned (ESOP). With offices located in St. Paul and White Bear Lake, Minnesota, the firm ranks as one of the top CPA and advisory firms in Minnesota and is a top 120 firm nationally. Redpath is a member of HLB International, a global network of independent advisory and accounting firms. For more information, visit www.redpathcpas.com.