How to Prepare Cash Flow Projections
The Cash Flow projections, as part of your Business Financial Plan, reflect the actual funding needs for the business. In the previous part, we saw how the projected Profit and Loss Statements and Balance Sheet are prepared. The Cash Flow projections are also prepared for the same time horizon as the other two statements – either for three years or five years.
This process also starts with the Marketing Plan and the Manpower and Capital Expenditure Plan. A typical Cash Flow Projection statement appears as shown here. Conventionally, the Cash Flow statements are prepared under three sections:
- Cash Flows from Operating activities
- Cash Flows from investing activities, and
- Cash Flows from Financing activities
Some important differences between the Profit & Loss Projections and the Cash Flows from operating activities, as you will notice, are in the figures between Sales and the Cash receipts from Customers on the inflow side; and the difference between Cost of Sales / Expenses in the P&L and the Cash Paid to Suppliers / Cash Paid to Employees /Other expenses on the outflow side (shown as negative figures in the statement). As you must be aware, this arises because of the credit periods applicable both for receipts and payments.
Figures under investing activities are derived from the purchased fixed assets under the Capital Expenditure Plan, and any Research and Development Expenses which you may want amortized over a longer period than one year.
For determining the amount of Loans required, we turn to the Financing activities past of the Cash Flow Projections. The closing cash balance for each year (before assuming any additional funding) will give you the gaps that need to be filled through external funding. This funding, as we had said earlier can come in the form of private equity, or Venture Capital equity, or IPO, or Loans from Banks and Financial Institutions. Depending on the terms of the Loan, the Repayment figure for the Cash Flow Projections, and the Interest figures for the Profit & Loss Projections will be computed. Thus this is an iterative process.
Based on the iterations, once you have arrived at satisfactory closing cash balances in all the future years for which projections are being prepared, you are ready with your Business Financial Plan. From this Business Financial Plan, you will know the Profits (or Losses) expected, the amount of Equity funds you need to pump in, any amount of private equity or venture fund equity you plan, and the external borrowings you will need to fund the operations.
Importance of Ratio Analysis
It is now important to understand how the stakeholders will view your Business Plan and the Business Financial Plan. The text in your Business Plan gives the reader a comprehensive idea about your Vision, Mission, Goals and Business Model, followed by an idea of the market characteristics and the Market Mix you are proposing. Similarly it also gives the reader a picture of your Human Resources strategies and Technology strategies. However, it is the Business Financial Plan that gives a potential investor or Funding agency a measure of the health of the business.
There are no thumb rules to determine the health of a firm. However, there are some benchmarks relating to your industry based on
which your Business Financial Plan will be evaluated. Some of the key ratios that stakeholders look for are given in the picture here. The pulse and blood pressure of your firm are usually judged based on the following classes of indicators:
- Profitability Ratios
- Liquidity Ratios
- Financing Ratios, and
- Investment Ratios
Each of these ratios gives an idea about the expected performance of the firm as per different health parameters, and also indicates the extent to which the firm leverages debt financing against equity financing. There are no hard and fast rules related to the range of values expected for these ratios. Definitely, due concessions will be given to the fact that the Financial Business Plan is prepared for a startup or for a firm entering a new line of business, and accordingly the projected performance of the firm will get evaluated.
Thus we have now seen the full gamut of projections that need to be prepared as part of the Business Financial Plan, and these are essentially ways of translating your operational plans into numbers so as to give a clear picture of the financial implications of all the components of the Business Plan that we have seen so far. You now have a good idea of everything you always wanted to know about a Business Plan and a Business Financial Plan.
To conclude, therefore, as we had said in the very beginning, the process of writing a formal Business Plan boils down to putting down on paper the mental picture that you already have for your business. In summary, as you must have realized, preparing a structured Business Plan using the step by step approach that we have seen, definitely provides very useful insights about the business and hence is a very useful exercise both from your own point of view, as well as from the perspective of all stakeholders.
This post is part of the series: Writing a Business Plan: Step by Step
- Writing a Business Plan – Simplified
- Business Model and Marketing Plan Components of a Business Plan
- Manpower and Capital Expenditure Components of a Business Plan
- Writing a Business Plan (Part 4): Projected Profit and Loss Statement and Balance Sheet
- Writing a Business Plan (Part 5): Cash Flow Projections and Ratio Analysis