Cash flow example

- Let's tie this together in one example. Let's suppose that I forecast customer demand for my fast food restaurant over the next three months to be in month one, 4,000 customers, in month two, 4,500 customers, and in month three, 5,000 customers. Let's also assume that I have $10,000 in the bank right now. I also estimate my fixed costs to be $16,000 per month, and my average selling price and estimated variable costs to be as follows. I estimate my average selling price to be $7 per customer in month one, $7.50 per customer in month two, and $8 per customer in month three. The reason for the lower selling price in month one is to entice customers to come in and give my business a try. As word gets out and my business earns its reputation, I forecast being able to increase the average selling price per customer. I also estimate that my variable cost will be $4.30 per customer for the first two months, and increase to $4.40 per customer in the third month. Now you can start to see how my cash will begin to flow, both into the business and out of the business. We are going to assume that all bills are paid in the month they are due and that customers will pay me in cash. We can certainly relax these assumptions, but let's keep it simple to get started. Now my next step is to forecast my cash flows for this three-month period. I do that by beginning with my cash on hand at the start, add to that my expected cash inflows from customers and subtract my cash outflows for my fixed and variable cost. The result is the cash budget that you see here. Whoa, where did these numbers come from? Let's look at the first month as an example. I forecast 4,000 customers at $7 per customer. That results in a forecast of cash inflow of $28,000 for the first month. The $17,200 comes from the variable costs of $4.30 per customer times 4,000 customers. The $16,000 represents my forecasted fixed costs for the month. I then did the same thing for subsequent months. Now what's the first thing you notice? I sure am glad I had $10,000 to start. This gets back to having sufficient capital to start your business. Next, my cash outflows exceed my cash inflows for the first two months of my business. I finally turn the corner and start generating cash in the third month, assuming my forecasts are accurate. As you can see, forecasting my cash flows is critical in determining what my cash position is going to be every month. Over time, I will get better at forecasting customer demand and forecasting my costs. Another advantage to managing my cash using this cash forecast is it allows me to see well ahead of time when I might be short of cash. It is much more pleasant to deal with the banker when you have identified your cash flow shortage three months in advance rather than three days in advance. Bankers would much rather deal with someone who's on top of the cash flows and has identified a cash need well in advance. Managing your cash flows is critical. And hopefully, you have learned the importance of breaking your costs into their fixed and variable components, and the importance of accurately forecasting the demand for your product and service. Over time, you can get very good at forecasting cash flows. You can even begin to develop quite a complex cash forecast that incorporates selling something this month and receiving payment next month. You can do the same thing with your cash expenditures. These cash forecasts can get quite complex. Successful business operators take the time to get a glimpse into the future by making their best assessments of what they expect their cash inflows and outflows to be. Without proper cash flow forecasting, you are adopting a common strategy of many new business owners; cross your fingers, close your eyes and hope things go well.