For many, the term “cash flow” conjures up visions of a daunting task that requires the expertise of a team of accountants. In reality, however, it is a handy, easy-to-use planning tool. While we typically think of it as primarily used by corporate entities – again with a line-up of accounts in their employ – it is equally helpful for small businesses and non-profit organizations of any size. It is even a great personal aid for planning a vacation, buying a house, or when you need to know when and how much available cash you will have at a future date.
In broad strokes, calculating cash flow for the coming year can be a simple, back-of-the-envelope exercise. As a personal planning tool, it can help you determine how long it will take you to save for a trip, home renovation or new car, or help you think about what actions you might take to achieve your goal sooner.
So, let’s say you want to buy a new car and the sticker price is $50,000. Start by totaling your checking and savings account balances (less any outstanding checks), the value of your investments, and the balances in any other liquid accounts. Then add all planned income for the year – salaries, dividends and interest, monetary gifts, etc.- as well as anticipated income – maybe you are hoping to sell your second car, your home or other property, are hoping for a monetary gift, or are predicting income from a new side business. For example:
Bank balances $35,000
Salary, dividends, and gift from Mom & Dad $150,000
Sale of undeveloped property $ 30,000
Total income $215,000
Then look at outflows. Include everything that you spend money on all year: the mortgage, car loan, gas, parking and maintenance, insurances, utilities, internet, phone and streaming services, household needs, groceries and meal deliveries, movies, beer and other entertainment, clothing and personal items… Add to that, other anticipated expenses; for example, if you know you need to have the plumber in to fix a faucet or pipe, or you plan to by your child a musical instrument, or want to do some landscaping or start using a lawn or cleaning service, estimate those costs and add them in. Let’s say that all amounts to $185,000.
Subtracting total expenses from total income leaves a balance of $30,000, or $5,000 more than what you started with. Assuming that the expense estimates will remain relatively the same in future years – including consistent costs for one-time expenses and repairs and maintenance – it will take 10 years to save the $50,000 needed for the new car. But this calculation can prompt ideas for other ways to move closer to your goal, such as increasing income, perhaps by asking for a raise, looking for a better paying job or taking on a second job, focusing on investments with better returns or growth potential, or turning a hobby into an income generating enterprise. Alternatively, maybe some expenses could be reduced or eliminated. Instead of buying a new, expensive musical instrument, maybe lease or buy a refurbished one. Start a car-pool with colleagues, take lunch to work instead of eating out, or forego a new phone every year in favor of upgrades every 3 years. Replace worn out appliances with energy-saving ones to save on utility bills and minimize maintenance requirements. Take on some of the home repairs or consolidate repairs to better negotiate with contractors. Mow your own grass; clean your own house. A combination of increasing income and lowering expenses could significantly reduce the time it will take to achieve your goal.
Alternatively, consider other ways to accomplish your goal. Instead of waiting until you have saved enough to cover the sticker price, consider financing. The trick will be to make sure the car payments and increased insurance costs do not exceed $5,000 that should be available each year. You might even consider lower payments in order direct a portion of that annual excess to an emergency fund.
This simple cash flow calculation gives you all the information you need to find creative ways to achieve your personal goals.
Cash flow calculations are just as easy to do for a small, medium or larger business and equally informative.
Similarly, begin by totaling cash and cash equivalents as of the previous calendar or fiscal year end: checking and savings accounts, money market funds, certificates of deposit and other investments, interest income, deposits, etc. Also include outstanding, unpaid invoices for services or products billed during the previous year (accounts receivable). Add to that anticipated revenues for the coming year: income from sales, services, and other organization activities, ongoing grants and awards, planned expansions of existing programs or products, estimates of dividend, interest and other investment income, and proceeds from other normal activities. Then add projected revenues from new sources: these can be one-time occurrences, or development of new services or products, initiation of a new program or project, and realistic expectations of grants or awards. Finally, incorporate the amounts of any unique income-generating situations. Projections for the upcoming year will not always increase from year to year; consider economic conditions that could impact revenue projections, such as the 2008 market crash and COVID pandemic, both of which dramatically reduced collections for governments, large and small business, and individuals of all economic status.
Tally these figures to estimate the projected income for the coming year.
Start with what you know
To calculate projected expenses, start with what you know. Use the prior year’s financial statements to estimate the anticipated operating costs for the upcoming year. Multiple that by the estimated inflation rate to get a more accurate total. Include outstanding bills carried over from the previous year (accounts payable). Add to that other, non-operating costs, including, but not limited to, product and service costs, one-time expenses, and the costs of planned acquisitions, which could range from inventory to property and equipment. Then add the costs of proposed activities, including the costs associated with the roll out of new products or services or start-up of a new activity, sponsorship of an event, and other unique expenditures. Finally, add any other costs that might reasonably be expected.
Once again, make every effort to think of every source and make reasonable, preferably data-driven, estimates. And consider economic conditions that may prompt additional spending. Revenue and expense projections for 2019 could not have anticipated the impact of the COVID pandemic, but it’s impacts and expectations for recovery should be factored into plans for subsequent years. Total the expenditures estimates.
Subtract the total projected expenses from the total projected income; then subtract the starting cash balance. The remaining balance should be used to inform strategic planning and decision-making for the upcoming year. If the difference is significant, it signals opportunities for growth. The organization could consider investing more of its cash, buying back stock, exploring partnerships or acquisitions, increasing salaries or bonuses, updating equipment, expanding research, debuting new programs, and other expansive endeavors that are only limited by your imagination.
What does this number mean?
A smaller margin between revenues and expenditures that is not the result of capital investments in equipment or research or other illiquid (assets not easily converted into cash) purchase, is cause for concern. If the organization is barely bringing in enough revenue to cover operating and other expected costs, cash flow can indicate opportunities to explore creative ways to increase current or develop new sources of revenue and review spending and investment decisions. Perhaps spending just a little more or cutting spending in one or more areas in order to adopt new technologies or expand a successful program, or increasing fees for products or services are the way to go.
Regardless of the type and size of the entity, cash flow is easy to use and a great conversation starter in your business venture. There is no better way to plan for the future!
About the Author
Dr. Karen Kunz teaches courses on public financial management, public budgeting, economic fiscal policy and advocacy, and public leadership at West Virginia University in Morgantown, WV. Her research interests include public finance and fiscal policy, political economy, and financial markets regulation. Dr. Kunz brings over 25 years of professional experience in the financial markets industry to her academic endeavors. She began her career in the municipal bond market before starting one of the first female-owned consulting firms in the industry. Her clients included institutional investors and traders, and boutique, regional and multinational firms. Dr. Kunz serves on the board of directors for the American Association of Budget and Program Analysts and West Virginia Food & Farm Coalition and is a Commissioner with the Morgantown Utility Board. She has authored two books, When the Levees Break: Re-visioning Regulation of the Securities Markets, and The Cost of Congress (forthcoming). Her work can be found in academic journals as well as in print and online media sources.
You can reach Dr. Kunz via email [email protected]