Why Cash Projections Create Freedom for Entrepreneurs

By Jarrod Musick, Client Wealth Strategist, CFP®

When was the last time you evoked a four letter word when you realized that you needed a lot more cash than initially thought? Quarterly tax payments can usually do the trick, as can forgetting large payments that are soon due or vendor payments for a project that you greenlighted six months ago.

Every entrepreneur has had one or many of these experiences, and their typical reaction is to prioritize finding the cash in the least disruptive way. Not much else moves until this issue gets solved. They sometimes revert into a scarcity mindset and immediately make plans to halt all other big ticket spending. Once they find the cash, move money around and avert the pending crisis, they end up back where they started and feel a bit grumpy at themselves for letting this shortsighted thing happen in the first place.

It Doesn’t Have to Be This Way

Starting the year with a focus on currently available resources and mapping out upcoming large inflow and outflow events allows you to avoid a mad dash for cash. At the beginning of each year, Entrepreneur Aligned goes through this process with our clients and their internal finance leads to ensure that they account for all upcoming major events. We then map that over known cash needs throughout the year.

Cash Flow Mapping

Here are the major phases of our cash flow mapping:

1. In a spreadsheet, we create a column for each month of the year.
2. In the rows, we use column A to list the following:
   1. Beginning cash + liquid investment total
   2. Anticipated business distribution
   3. Anticipated salary drawn
   4. Baseline personal spending
   5. Major personal spending
   6. Estimated tax payment
3. We drop your known inflow and outflow events throughout the year, sum the monthly total in the last row and create a formula so that the beginning cash + liquid investment cell total for that month is the prior month’s ending value.
4. We then graph your monthly net number so that you can see your projected high-water and low-water mark for the year.

Now, you can visualize expected values. Notice that these are all personal outcomes. Repeat the process with business accounts and in those cases, projected owner distributions will count as outflows.

Analyzing Total Available Reserves

The question we most often get from first time clients is, “How should we analyze our total available reserves?” Notice that in our list above, we are only showing cash and liquid investments. This isn’t a judgement on where you should specifically look to access capital but is rather an observation of where there is the least amount of access friction.

Cash is cash, ready and available. Money market funds and certificates of deposit are also readily available, accessed with few transaction costs and should be counted as cash equivalents. Stocks, bonds, mutual funds, exchange traded funds and cryptocurrencies on an exchange would all be considered liquid investments and can be turned into cash with a few keystrokes. There are often brief time delays for transactions to settle, transaction costs and tax consequences, but we consider these investments as available because they require a short amount of time to be accessible.

Three Tiers

We also explore total available resources in three tiers:

1. Tier I Assets are cash and liquid investments, as we just described.
2. Tier II Assets surface when we analyze longer-term needs with a possible 6 - 12 months of access time. We examine things like secured lending via HELOCs, 401k loans, cash value life insurance balances and certain types of private investments with the right to redeem periodically.
3. Tier III Assets are those that have the most friction to access and typically take 12 months or longer to convert to cash without significant financial consequences. Assets in Tier III would be real estate, private investments without redemption rights and equity in your business.

For the purposes of this article, we are only focusing on Tier I assets and how to plan for them throughout the year, but Tier II and Tier III assets should be part of your longer term planning.

Moving Forward and Planning

Now that we have made the financial year ahead visible, what do we do with the information?

First, identify any projected problem spots where you may be below your desired minimum reserve. How will you fill those? Do you postpone specific projects or discretionary outflow events? Can you decrease your owner's distribution or salary? What about using credit to weather a low period? Should you pursue a home equity line of credit?

Second, analyze your confidence in the projections (specifically, the owner distributions). If you think you have a 75% chance to hit your distribution amounts as listed, that is probably enough to run with. Go ahead and reduce the amounts or delay the anticipated timing to see what it does to your graph. If you are in good shape, even with the less rosy picture, great! If not, think about a contingency plan.

Third, if you have significantly more cash coming in than you need in order to meet your obligations, consider adding another row titled Anticipated Investing, and start planning ahead for what to do with the excess.

The Year Ahead

We begin our client year looking at cash needs and doing this type of cash flow mapping in order to understand where we are likely to be throughout the year. We also do this in order to review financial goals and priorities to ensure that excess cash is directed to support the things that matter most and is not lost to other situations that happen in the moment. Having accurate cash flow projections allows entrepreneurs to start each year with strong foundations in order to avoid financial firefighting and to better focus on ensuring that their money supports what matters most to their families.

Important note and disclosure: This article is intended to be informational in nature; it should not be used as the basis for investment decisions. You should seek the advice of an investment professional who understands your particular situation before making any decisions. Investments are subject to risks, including loss of principal. Past returns are not indicative of future results.