Cash flow projections: what they are and how to create them

Cash flow projections play a crucial role in managing your business’s liquidity and keeping up with ongoing obligations. 

This guide explores what you should know about them, including how they work and why they’re so important. We’ll also discuss how to create them using different methods and common mistakes to avoid.

What are cash flow projections?

Cash flow projections are estimates of your business’s future cash inflows and outflows under specific assumptions. They’re built around various “what if” scenarios, letting you model the impact of potential strategic adjustments on your cash position.

For example, that might include:

• Raising prices by 10%
• Hiring new employees
• Losing a major client
• Launching a product line

While the terms are often used interchangeably, this is what separates a cash flow projection from a cash flow forecast. 

Forecasts assume past trends will continue and model out your most expected cash flow outcome. Typically, you’ll need to use cash forecasting and projections in combination to guide your cash flow management.

For example, say you create a cash flow forecast and discover you expect a cash shortage in six months on your current trajectory. 

You might then create cash flow projections assuming you raise prices by 3% and reduce materials costs by 5%, to see if that would resolve the issue.

Why cash flow projections matter for your business

Cash flow projections are important cash flow management tools for your business. By modeling different prospective scenarios, they help you understand how specific assumption changes could affect your company’s liquidity.

This is an essential financial planning practice, even for the most profitable businesses. 

You can be generating significant revenue on paper and still fail to meet your ongoing obligations, like payroll or debt payments. Combined with forecasts, projections are the key to maintaining a sufficient cash balance to avoid that.

More specifically, projections help you plan for uncertainty, such as cost increases and demand fluctuations. They allow you to test how sensitive your business is to those changes before they happen.

Similarly, they’re invaluable for evaluating strategic decisions. Hiring employees, investing in equipment, or taking on financing all create cash obligations. Projections help you assess whether your cash flows can support those commitments.

Together with cash flow forecasting, these applications help you shift from a reactive to a proactive approach to cash management. Instead of taking action after the fact, you can identify potential cash shortages early and make adjustments while there’s still time.

Cash flow projections also matter beyond internal planning. 

For example, lenders and investors may use them to assess financial stability before engaging in any financing activity. 

Having a robust set of scenario-based projections alongside your cash flow statement can help you build credibility with these stakeholders.

How to create accurate cash flow projections

Accurate cash flow projections start with strong underlying financial data. If the books are unreliable, any projection built on top of them will be too. Before modeling the future, make sure your historical financial statements are clean, complete, and up to date.

With that important foundation established, here are some additional steps you can take to improve the accuracy of your cash flow projections:

• Incorporate actual trends: Review records from previous years to identify seasonal trends, recurring expenses, and typical payment cycles. For example, if customers routinely pay in 45 days instead of the stated 30, your projections should reflect that reality rather than ideal terms.
• Split cost projections by type: Separate fixed costs, like rent and salaries, from variable costs that scale with revenue. Then, link variable expenses directly to sales assumptions. This ensures that when you model revenue growth or decline, your projected cash outflows move in tandem instead of staying flat.
• Emphasize timing, not just events: An accurate cash flow projection focuses just as much on when cash will move as how. Consider increasing the granularity of your projections from monthly to weekly, or even daily.
• Revisit cash projections regularly: As new financial data becomes available, revisit your projections and compare them against actual cash flow. If incoming cash consistently arrives later or outgoing cash runs higher than expected, adjust your assumptions going forward.

As important as accuracy is, it’s often practical to err on the side of caution. This makes it so that even if your net cash flow projections are wrong, they don’t create unpleasant surprises for your business.

For example, consider using conservative revenue growth rates, assuming slower collections, and building in elevated expenses. It’s far safer to end up with an excess cash surplus than to come up short when obligations are due.

Direct vs. indirect cash flow projection methods

When building cash flow projections, there are two fundamental approaches: the direct method and the indirect method. While both aim to estimate your future cash flow and cash positioning, there are significant differences.

The direct method is often the most intuitive for business owners. It involves listing out each projected cash inflow and cash outflow at the transaction level, building a cash flow projection model from the ground up.

As a result, the direct method is often effective for short-term cash flow projections, such as for the next few weeks or months. However, it requires a lot of detailed manual work, which can make it difficult to maintain over longer time horizons.

Meanwhile, the indirect method works in the opposite direction. Instead of projecting each cash movement, it begins with projected net income and adjusts for non-cash expenses and timing gaps, like depreciation and accounts receivable.

This structure makes the indirect method more suitable for long-term cash flow projections. However, because it works backward from projected net income, it requires you to already have a forward-looking set of financial statements.

In practice, many businesses use both cash projection methods. A common approach is to rely on the direct forecasting method for cash management over the next month and the indirect method for the next 12 months.

Common mistakes to avoid in cash flow projections

Accurate cash flow projections can be invaluable for strategic decision-making, but simple mistakes can produce misleading results. Avoid these common mistakes to help ensure your cash flow projections remain realistic and useful:

• Assuming ideal payment behavior: Many businesses assume customers will pay according to stated payment terms rather than actual cash collection patterns. However, this can create a false sense of security and mask cash gaps.
• Overlooking irregular expenses: Non-monthly payments are easy to forget. Remember to include costs like quarterly tax payments, repairs and maintenance, and annual insurance premiums.
• Failing to scale expenses with revenue changes: Revenue growth almost always brings higher variable costs, such as direct materials and direct labor. Projections that increase sales without adjusting related expenses often overstate future liquidity.
• Failing to revisit and update projections: Cash flow projections lose value if you don’t refresh them regularly. As real-world results come in, make sure you adjust your assumptions to reflect evolving business conditions.

Tools and software for cash flow projections

Cash flow projections built in spreadsheets can be effective for small businesses with simple operations. Tools like Excel or Google Sheets are often budget-friendly and offer unlimited financial modeling options.

However, spreadsheet projections also require significant manual work. As your transaction volume grows, maintaining accuracy becomes increasingly time-consuming, and the risk of human error rises.

Beyond a certain level of size and complexity, cash flow forecasting software becomes more efficient. 

These tools pull cash flow data directly from your accounting system and offer intuitive tools for generating projections. As a result, they often pay for themselves in time savings and better startup cash flow management.

If you’re looking to streamline your projection process, try Zeni. Our automated bookkeeping service keeps your records up to date in real time, ensuring your projections are built on accurate financial data. 

Combined with our dedicated support team and AI accountant agent, you get reliable insights without the manual burden.

Thanks to our AI CFO agent, you can also use Zeni to generate cash flow forecasts and projections using natural language. Instead of building out a complex spreadsheet by hand, simply say: “Show me cash flow projections if we cut vendor spend by 10%.”

In addition, every subscription includes a full suite of financial tools, including bill pay and reimbursement software. Schedule a demo today to see Zeni in action.

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