Episode 34: Cash Flow Projections are an Advance Warning System for Your Business

Reviewing the past is helpful for analyzing your business, but seeing ahead helps you make timely decisions to avoid serious cash flow crises. And so maintaining a cash flow projection system is critically important to your creative business.
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Over the past few episodes we’ve been reviewing the importance of understanding and monitoring your key financial documents such as your profit and loss report and your balance sheet. These are historical reports of your transactions. They will tell you exactly how you’ve been performing, which is valuable information to have. But as important as that is, it’s even more urgent to see what’s coming. Reviewing the past is helpful for analyzing your business, but seeing ahead helps you make timely decisions to avoid serious cash flow crises. And so maintaining a cash flow projection system is critically important to your creative business.

Back in episode four I introduced the need for maintaining a cash flow document—and I mentioned a cash flow spreadsheet template that’s available in the resources section of my website. To remind you, a cash flow spreadsheet lines up your expected receivables, month-by-month, alongside the expenses you’ll incur over the same period. This simple practice will reveal your profitability, or lack thereof, in terms of upcoming performance, in contrast to the backward look that your P&L and balance sheet. Both perspectives are important, but if you’re heading for a cliff you want to be looking out ahead, not behind you, to avoid going over the edge.

As you scan upcoming months in your cash flow spreadsheet, you’ll be able to see how far out your current cash and receivables will take you. Assuming you’re operating profitably, you should have plenty of cash and receivables for the current month as well as for the next month or two. A healthy practice should have at least two to three months of positive projected cash flow. A really high performing practice can have four or five months of positive cash flow. It’s difficult to push out much further than that, since most clients don’t commit to projects that far in advance, but in some cases it is possible.

Seeing, on a month-by-month basis, the trendline of how far out you can reasonably project positive cash flow is another barometer of your profitability. If you are operating unprofitably, seeing negative projected cash flows, you will be able to adjust your expenses now, before those cash crunches hit. Your cash flow projection really is like a radar system, or an advance warning system, for managing your financial health. So keeping this system well maintained is essential.

There are some important habits that you’ll need to follow to keep this document accurate and up to date. Some of these are process related, and some are more like policies or standards that you need to keep consistent. And since a spreadsheet is a flexible and manually updated document, not a structured financial system like Quickbooks, it’s much easier for human error to slip in. And when you’re relying on this document for real time management decisions, you don’t want to be operating on faulty information.

One critical practice you need to adopt when updating this document, especially when you update the cash in your bank account, is to be absolutely sure that you immediately remove all corresponding invoices and expenses that are now reflected in your updated cash balance.

For instance, if you deposited a $5,000 payment for an invoice listed in your cash flow, and then update your cash balance, which now includes that payment—but you fail to remove that receivable below—you’ll be double counting that payment and overstating your actual cash flow by $5,000. Likewise, if your new bank balance includes your most recent rent payment, which is listed among your expenses, but you don’t delete that at the same time, you’ll be understating your cash flow by that amount. Which, while a better mistake to discover later, it still distorts your important cash flow projections.

One tip to avoid these kinds of mistakes is to jot down your subtotals for the current and following few months before updating. These should stay relatively consistent before and after the update. If, after the update, they’ve changed significantly—it’s usually because you have failed to remove some corresponding invoice or expense.

Because cash flow is so important, I’ll share more best practices for maintaining this document, and keeping it accurate over the next few weeks.

So until next week: don’t let the business of creativity overwhelm your creative business.