What it means
Every decision about the future of a business rests on a view of the cash it will produce and require: whether to expand, borrow, hire, invest, sell, or how much the business is worth. A cash flow projection is that view written down with its reasoning exposed.
It says: if sales grow at this rate, customers pay in this many days, costs behave this way, we invest this much and borrow on these terms, then the cash balance will follow this path. The projection is built in layers.
Revenue assumptions drive receipts, through pricing, volume and collection patterns. Cost assumptions drive payments: cost of sales as a percentage of revenue or per unit, staffing plans with salary dates and on-costs, overheads by category with their payment timing, inflation.
Working capital assumptions (days of receivables, inventory and payables) translate the profit and loss into cash timing. Capital expenditure is scheduled by project.
Financing is added: facilities drawn and repaid, interest, equity raised, dividends. Tax is computed from projected profits and timed to payment dates.
The output is a monthly or quarterly cash flow with opening and closing balances, usually presented with the projected profit and loss and balance sheet so that the three reconcile. The assumptions are the substance.
A projection presented as numbers alone invites belief or disbelief; one presented with its assumptions invites examination, which is what lenders, investors and boards do. Each assumption should be sourced (last year's actual, a contract, a market forecast, a management estimate) and its sensitivity known.
The most common weaknesses are optimism about sales growth and collection speed, omission of the working capital that growth absorbs, underestimation of costs and capital spending, and a base case with no downside. Good practice presents at least three cases: base, downside (sales 20% below base, collections 15 days slower, a key customer lost) and upside, and shows for each the lowest cash balance, the facility required and the point at which the business is self-funding.
The downside case is what a lender reads first. Sensitivity tables show which assumptions matter most; typically two or three drive most of the variation, and those are the ones to monitor.
Projections are living documents. They are compared with actual outcomes as time passes, the assumptions are corrected, and the projection is rolled forward.
A projection that predicted the last six months accurately earns credibility for the next; one that missed badly, without explanation, does not. Businesses that prepare projections only when the bank asks for one usually find that the bank asks for the comparison with the last one.
Uses include: business plans and start-up funding; loan applications, where the projection must show the ability to service and repay; business cases for capital projects; valuations, where projected free cash flows are discounted; turnaround plans, where the projection shows how the business returns to self-funding; and strategic planning, where alternative strategies are compared on the cash they produce.
In practice
Real-world examples.
Example
A start-up projects 36 months of cash flow to show investors when it reaches break-even and how much runway a $3 million round provides.
Example
A retailer projects five years of cash flow under three store-opening scenarios to decide how fast it can expand without external equity.
Example
A company in restructuring projects 18 months of cash flow to show its lenders that a standstill on repayments will allow recovery.
Think of it
“Cash flow projections are long-range financial roadmaps showing where cash position might be in the future.
Formula
Calculation
Projected Closing Cash (period) = Opening cash + Projected receipts minus Projected payments + Financing flows
Projected Receipts = Prior period sales x Collection pattern, applied across the periods in which cash is collected
Working Capital Absorbed = Change in (Receivables + Inventory minus Payables), derived from the days assumptions and projected sales and costs
Worked example. A specialist manufacturer projects three years to support a $2,000,000 loan application for a new production line. Base assumptions:
- Revenue: year 1 $12,000,000; year 2 $15,000,000 (the new line adds capacity from month 4); year 3 $18,000,000
- Gross margin 38%; overheads $3,000,000 in year 1, rising 5% a year
- DSO 55 days; DIO 70 days (on cost of sales); DPO 40 days
- Capex: the new line $2,000,000 in year 1 (loan-funded), maintenance $300,000 a year
- Loan: $2,000,000 at 7%, repaid over five years from year 2 ($400,000 a year plus interest)
- Tax at 25% on profit, paid the following year
- Opening cash $500,000; existing overdraft facility $600,000
Year 1: gross profit $4,560,000; operating profit $1,560,000; working capital absorbed: receivables at 55 days of $12,000,000 = $1,808,000 (opening $1,500,000, so $308,000 absorbed); inventory at 70 days of $7,440,000 = $1,427,000 (opening $1,300,000, $127,000 absorbed); payables at 40 days of $7,440,000 = $815,000 (opening $750,000, $65,000 released): net $370,000 absorbed. Tax paid (prior year) $300,000. Interest $140,000 (loan drawn month 1). Operating cash flow = $1,560,000 + depreciation $500,000 minus $370,000 minus $300,000 minus $140,000 = $1,250,000. Capex $2,300,000; loan drawn $2,000,000. Closing cash = $500,000 + $1,250,000 minus $2,300,000 + $2,000,000 = $1,450,000.
Year 2: gross profit $5,700,000; overheads $3,150,000; operating profit $2,550,000; working capital: receivables rise to $2,260,000 ($452,000 absorbed), inventory to $1,784,000 ($357,000 absorbed), payables to $1,019,000 ($204,000 released): net $605,000 absorbed. Tax paid $390,000 (year 1 profit $1,420,000 after interest x 25%, approximately). Interest $140,000 falling to $126,000 as principal reduces: say $133,000. Operating cash flow = $2,550,000 + $700,000 depreciation minus $605,000 minus $390,000 minus $133,000 = $2,122,000. Capex $300,000; loan repayment $400,000. Closing cash = $1,450,000 + $2,122,000 minus $300,000 minus $400,000 = $2,872,000.
Year 3: operating profit about $3,530,000 (gross profit $6,840,000 less overheads $3,308,000); working capital absorbed about $605,000 again; tax about $605,000; interest $105,000; operating cash flow about $2,920,000 including depreciation; capex $300,000; repayment $400,000. Closing cash about $5,090,000.
Downside case: revenue 20% below base each year, DSO 70 days. Year 1 operating profit falls to about $650,000; working capital absorbs about $280,000 (the longer DSO is largely offset by the lower sales base); operating cash flow about $430,000; closing cash after capex and loan = $500,000 + $430,000 minus $2,300,000 + $2,000,000 = $630,000. Year 2: operating profit about $1,410,000; operating cash flow about $1,500,000; after capex and repayment, closing cash about $1,400,000. The loan is still serviced with headroom in the downside; the monthly detail shows the lowest point at $150,000 in month 5 of year 1, within the overdraft facility. The lender approves the loan on the downside case with a covenant of debt service coverage above 1.3.
Sensitivities: each 5 days of DSO is about $165,000 of cash in year 1; each 1 point of gross margin is $120,000 of cash; the new line's start date, if delayed three months, costs about $250,000 of year 2 cash. The finance director monitors those three assumptions monthly against the projection.Case study
Seen in the real world.
A distributor applied to its bank for a $1,500,000 term loan to fund a warehouse extension, presenting a projection showing revenue growth of 25% a year, cash rising steadily, and the loan repaid in four years. The bank's credit analyst asked three questions: what collection period the projection assumed (30 days; the company's actual DSO was 58), what the working capital lines showed (they were omitted; receipts had been projected as equal to sales), and what happened if growth was 10% rather than 25%. The company's finance manager rebuilt the projection with actual working capital days and a downside case.
The base case now showed cash falling for two years as growth absorbed working capital before rising, with a low point requiring an additional $800,000 of facility; the downside case showed the loan serviceable but with little margin. The bank approved the term loan and a working capital facility together, with a covenant on DSO, and the finance manager's note to the owners said that the first projection had described a business that collected its sales on the day it made them, and that the bank had been right not to lend to it, because it did not exist.
Watch out
Common mistakes.
- Projecting receipts as equal to sales and payments as equal to costs, ignoring the working capital that timing and growth absorb.
- Presenting one case. A projection without a downside is a hope, and lenders and investors will build the downside themselves, less kindly.
- Leaving assumptions implicit. The numbers are only as good as the assumptions, and the assumptions are what a reader needs to test.
Questions
People also ask.
What is the difference between a cash flow projection and a cash flow forecast?
Usage varies. Commonly, a forecast is the near-term view built from actual invoices and commitments (13 weeks), and a projection is the longer, assumption-based view (1 to 5 years) used for planning and financing.
How far ahead should a projection go?
As far as the decision it supports: three to five years for a loan or investment, the full term for a project appraisal, twelve to eighteen months for operational planning.
How accurate can a projection be?
Year one, within 10% to 15% on cash if the assumptions are sound; later years are increasingly uncertain, which is why the downside case and the sensitivities matter more than the base numbers.
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