From the course: Finance Essentials for Small Business

Prepare a cash forecast

From the course: Finance Essentials for Small Business

Prepare a cash forecast

- We know you'll need sufficient capital to get your new business through the critical first few months. Let's assume you've made it through those first few months. You will still need to track your cash inflows and outflows to ensure that you have sufficient cash to pay the bills that are surely coming. Whether you're at the start of your business or well into the lifecycle of your business, managing cash is critical for the well-being of your business and cash management does not happen by chance. It is up to you to ensure that your cash is managed. We will do this by preparing a cash forecast or budget. Let's start our discussion of cash management by distinguishing between two types of costs, fixed costs and variable costs. Fixed costs are exactly that, they're fixed. Budgeting for fixed costs is relatively straightforward. The amount is fixed, at least over the short term. Variable costs are costs that vary relative to some activity or cost driver. For a restaurant, for example, costs might vary based on the number of customers. For a shop at the mall, costs may vary based on the number of hours that the shop is opened, labor costs, utility costs, and so forth. Now, there can be a number of cost drivers or in other words, costs can vary for a number of reasons. It just depends on how complicated you want to get. For our example, we will assume one driver that results in variable costs just to keep things simple. Adding more drivers makes the arithmetic a little more complex but the concept is still the same. Now, step one in cash management is to identify all of your fixed and all of your variable costs, all of those costs. It's easy to forget an expense here or an expense there and before you know it, your cash forecasts are useless. The cash forecast is only as good as the inputs. Now, let's go into the fast food restaurant business. What costs associated with this business will be fixed and which will be variable? Before I can nail down the variable costs, I need to ask this question, variable relative to what? I'm going to assume that certain costs vary based on the number of customers. For a given month, my fixed costs will involve rent on the building, rent on my equipment or loan payments if I'm purchasing the equipment, utilities, insurance and advertising. You get the idea so let's stop there. It's critical that I identity all of my fixed costs. So to this point, we have the following fixed costs. Rent on the building of $5,000, rent on our equipment of $6,000, utilities of $2,500, insurance of $1,000 and advertising of 1,500 for a forecasted total fixed costs for the month of $16,000. These costs will be incurred regardless of whether 10 customers or 1,000 customers walk through the door.

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