Cash flow is the difference between cash inflows and outflows. A positive cash flow means that a business has sufficient funds to pay its bills. Businesses estimate future cash flows for various reasons, such as evaluating alternative investment projects or assessing the value of potential acquisition targets. Cash flow estimates also help identify and plan for potential funding gaps. Preparing a realistic cash flow estimate helps in the strategic decision-making process.
Create a table for the cash flow estimate. Sales, operating expenses and profit could be some of the row labels. The column labels depend on the estimation period -- for example, the months of the year for a monthly forecast, or "Year 1," "Year 2" and so on for an annual forecast.
Choose a sales and operating profit margin growth rate going forward. Morningstar recommends that you use industry data (e.g., consumer trends and projected demand growth), macroeconomic trends (e.g., interest rates) and the evolving competitive landscape to determine the growth estimates. Growth projections can vary over the forecasting period. For example, a small business might have zero growth in the first couple of years, rapid growth from years three to year 10, and then slow and steady growth from year 11 onwards.
Assess the competitive landscape when estimating sales and profit growth. For example, a home renovation business might face stiff competition before it can establish a reputation in the market and a stable client list. On the other hand, a biotechnology start-up might have no competition in the local or even the regional market, but would face regulatory and distribution challenges as it tries to build sales.
Consider operational efficiencies due to economies of scale. In other words, your per-unit fixed expenses should decline as you sell more units, which would increase your per-unit profit margin. Producing in bulk is cheaper. Fixed expenses include administrative salaries, facility costs and selling expenses. Increased profit margins mean higher cash flows.
Estimate the future operating cash flow, which is equal to the operating income plus depreciation expenses. This simplified model assumes cash transactions only. Operating income is equal to sales multiplied by operating profit margin. Depreciation is the annual allocation of fixed asset acquisition costs. Unless you are planning major fixed asset investments, other than the normal maintenance and upgrade of existing equipment, your depreciation expenses should be the same over the forecasting period.