Below, you’ll get nine actionable steps to help you create accurate cashflow forecasts and projections. We also cover the essential financial planning and forecasting terms every founder should know.
Cashflow forecasts, projections, and financial management are mission-critical for startups.
Founders must have a clear picture of the amount of revenue required to hit targets.
It’s also essential to have a real-time fix on how much is in your bank account, and your costs (outgoings and overheads) for every month and quarter.
Accurate cashflow forecasts and projections are essential management tools for startup founders.
And, if you’re seeking investment, an investor wants to see that you can manage costs while setting ambitious and achievable revenue targets.
An accurate forecast is beneficial when fundraising and gives investors an idea of the future exit potential of a startup.
What is a cashflow forecast?
A cashflow forecast is a plan or projection of the amount of revenue a business expects to generate and payout (costs) over a fixed timescale.
For planning and fundraising purposes, startups usually forecast finances at least 1 to 3 years into the future.
If you’re raising investment, potential investors look at the amount of money you’re actually generating and the revenue you could generate if they invested in your startup.
Overstating revenue or revenue targets and underestimating costs aren’t helpful to investors or founders.
You might discover that your cash runs out faster than expected if your cashflow forecast is inaccurate.
Cashflow forecasts aren’t the only resource you need when speaking with potential investors.
Forecasts are useful in isolation, but investors also want to see your market and competitor analysis, Total Addressable Market (TAM), Serviceable Available Market (SAM), and Serviceable Obtainable Market (SOM) figures.
Founders know that accurate cashflow forecasts are valuable tools for operational purposes. A forecast allows you to see where you currently are vs. where you’re going.
A forecast is a guide to the amount of revenue your growth activities must generate to cover your outgoings.
You are then in a position to see how the business is really doing in comparison to projections, and how much cash remains in the bank (either profit or the burn rate after raising investment).
What should you include in a cashflow forecast?
Cashflow forecasts should include the following:
- Actual revenue (monthly recurring revenue (MRR) and annual recurring revenue (ARR))
- Projected revenue goals and targets
- Costs, such as:
–The cost of providing your product or service (known as your Cost of Sale)
–Staff and employment-related contributions
–Employment-related tax and pension obligations
–Software subscriptions (the cost of your tech stack)
–Communications costs (phones, broadband, etc.)
–The cost of maintaining debt payments or credit facilities
–Any other unexpected expenses and overheads
It’s important and beneficial — not only for investors but also for financial planning purposes — to be as accurate and realistic as possible.
Forecasts, when done well, act as a North Star, a constant and consistent guide for founders and Chief Financial Officers (CFOs).
Bootstrapped founders should take particular note of the above because they don’t have investor funds in reserve to drive forward growth.
9 cashflow terms founders need to know
- Cash Inflow or Revenue: every penny that flows into your business. That includes revenue and other sources such as tax rebates, loans, grants, and investments.
- Cost of Sale: the direct cost of providing your product or service to customers. For example, software companies should include the cost of servers, the tech stack, and developers’ salaries. On the other hand, service-based businesses need to add the cost of every team member involved in delivering that service for customers, including founder salaries.
- Overheads: fixed or variable costs that don’t directly relate to the cost of providing your product or service (also known as cost of sale). Your regular overheads include rent, electricity, internet, marketing, and advertising.
- Cash Outflow: the total amount of money leaving your business in a single period, e.g., in a month or year. Cash outflow includes your overheads and the cost of sales.
- Gross Profit: this is your top-line number; it’s calculated from sales (revenue) minus the cost of delivering that service (the cost of sale).
- Net Profit: the figure above (gross profit) after deducting other costs like overheads (salaries, office costs, etc.) to get the net profit.
- Net Cash Inflow: an accountant’s way of saying that your business is bringing in more revenue than it’s paying out. You’re making money. Well done!
- Net Cash Outflow: the opposite of the above. Your business is still spending more than it’s making. This is a common problem among investor-backed startups. According to Silicon Valley Bank (SVB) and CB Insights, 29% of VC-backed startups fail because they run out of money — burning cash too fast, with revenue unable to cover costs. A business will only solve this problem by generating a healthy revenue run rate that results in their cash inflows outweighing costs — to produce a positive net cash inflow.
- EBITDA: earnings before interest, taxes, depreciation, and amortization; an alternative way of measuring profit compared to a company’s net income. By removing taxes, depreciation, and costs like interest payments on debts, EBITDA shows whether a business is generating positive cashflow and has money in the bank after deducting every expense.
9 ways to create accurate and actionable cashflow forecasts and projections
These 9 practical steps will help founders create actionable cashflow forecasts and projections:
- Pick the right tools. You could use accountancy and projection software such as FreshBooks, QuickBooks, Crunch, or dozens of others. But there is always Excel or Google Sheets if you don’t want (or need) the extra expense.
- Decide your forecasting period. Most investors need to see three years ahead, with projections showing the positive impact of investor funds and how that money will be used. Founders need even more detailed and accurate forecasts for their current fiscal year and the following year. Focus on those before projecting further forward.
- Don’t overcomplicate it. Formulas are handy in Excel — and built into many forecasting tools — but unless you’re proficient, formulas offer an easy way to make mistakes and mess up your numbers. Stick to basic functions like SUM and TOTAL.
- Know your Total Addressable Market (TAM), Serviceable Available Market (SAM), and Serviceable Obtainable Market (SOM) numbers. Use SAM and SOM accordingly, to inform your projections, depending on whether your startup is pre-revenue or already generating revenue.
- List every source of revenue — projections/targets and actual revenue. You could break this down to a granular level. Enter the amount you’re making from every client in a separate spreadsheet and feed the total into the revenue line in your forecast spreadsheet.
- Add other revenue sources such as equity or debt financing, grants, loans, and secondary income streams, e.g., consulting.
- Now list every outgoing: cost of sale, fixed and variable overheads.
- Add outgoings that are coming up, e.g., taxes and the months those payments fall due.
- With all this data in your spreadsheet, it should be clear whether your business is generating a profit (or will generate one) if you hit targets. If you’re not in the black, you will need sufficient liquid capital to cover your overheads until you generate enough revenue to cover your burn rate and turn a profit. For VC or debt-backed startups, a forecast combined with financial management strategies should give you an idea of your startup’s run rate (the number of months it will take to turn a profit or run out of money).
Key takeaways: Why startups need cashflow forecasts and projections
Cashflow forecasts and financial management are two parts of the same process.
Founders and startup leadership teams need forecasts and projections to set the direction of their business.
Financial management flows from that — helping founders navigate the route as financial data updates in real-time and money flows in and out of a startup’s accounts.
Whether or not you’ve raised investment, you need to stay in control and have a clear picture of your income and expenditure.
Forecasts and projections will continue to guide your cashflow management to ensure you make financially sound decisions.