Go Beyond The Operating Cash Flow Formula
Forecasting your operating cash flow can help your business tremendously. There’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 you’ll have excess cash to support growth-related spending. These things matter whether you’re a fledgling business with one eye on your next investment round or your enterprise is long-established.
A Simple Cash Flow Formula
A formula to calculate your operating cash flow can be as simple as this:
Operating cash flow = total revenue – 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
- Shareholder, owner, or other investment
Enter the figures in the week/month when you expect the cash to be in hand–-when you know your customer’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:
- 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
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.
It’s Not Necessarily that Simple
The above cash flow forecasting method is easy and useful. However, you don’t want to over-simplify because you’re using these figures to chart your company’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 business’ 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 inclusive–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.
Karl Neset is an accomplished professional offering over 20 years of expertise in improving organizational finance and operational processes. He serves as a solid foundation and knowledgeable advisor and manager, utilizing excellent leadership and communication skills to provide guidance and direction to executive leaders, governing boards, staff, and business partners. Karl effectively analyzes financial data, recommends improvements, executes financial tools, systems, and accounting measures that drive profitable performance, limits costs, and significantly improve overall profit margins and cash flow. He has been with Redpath and Company as Business Development Manager and Fractional CFO since 2022.
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