Question

Harvard University is considering the addition of a new programme - Law. Even though management is content with the profitability projections of the program, the Chief Financial Officer recommends the preparation of cash budget in addition to the financial projections. Explain why the Chief Financial Officer will be insisting on the inclusion of the cash budget.

Answer 1

What Is a Financial Projection?

In its simplest form, a financial projection is a forecast of future revenues and expenses. Typically, the projection will account for internal or historical data and will include a prediction of external market factors.

In general, you will need to develop both short- and mid-term financial projections. A short-term projection accounts for the first year of your business, normally outlined month by month. A mid-term financial projection typically accounts for the coming three years of business, outlined year by year.

Formatting Your Financial Projection

There are many online templates for financial projections that are a good place to start when you are preparing to draft your projections. It is also recommended that you include charts and tables when explaining copious amounts of numerical data; it is a much cleaner and engaging presentation than just paragraphs of numbers and figures.

Key Elements of Your Financial Projection

All financial projections should include three types of financial statements:

Income Statement: An Income Statement shows your revenues, expenses and profit for a particular period. If you are developing these projections prior to starting your business, this is where you will want to do the bulk of your forecasting. The key sections of an income statement are:

• Revenue – This is the money you will earn from whatever goods or services you provide.

• Expenses – Be sure to account for all of the expenses you will encounter, including Direct Costs (i.e. materials, equipment rentals, employee wages, your salary, etc.) and General and Administrative Costs (i.e. accounting and legal fees, advertising, bank charges, insurance, office rent, telecommunications, etc.).

• Total Income – Your revenue minus your expenses, before income taxes.

• Income Taxes

• Net Income – Your total income without income taxes.

Cash Flow Projection: A Cash Flow Projection will demonstrate to a loan officer or investor that you are a good credit risk and can pay back a loan if it’s granted. The three sections of a Cash Flow Projection are:

• Cash Revenues – This is an overview of your estimated sales for a given time period. Be sure that you only account for cash sales you will collect and not credit.

• Cash Disbursements – Look through your ledger and list all of the cash expenditures that you expect to pay that month.

• Reconciliation of Cash Revenues to Cash Disbursements – This one is pretty easy: you just take the amount of cash disbursements and subtract it from your total cash revenue. If you have a balance from the previous month, you’ll want to carry this amount over and add it to your cash revenue total.

• Note – One of the key pitfalls of working on your cash flow projections is being overly optimistic about your revenue.

Importance of cash budget:

A cash budget is a finance tool geared toward limiting a company's expenditures to the amount of cash it actually has available. The alternative to a cash budget is one that is based on the availability of credit, or money that will have to be repaid down the line.

Practical Benefits:

The most immediate practical benefit of a cash budget is restricting your spending so you do not incur debt. A cash budget involves a realistic assessment of how much money you will have coming in during an upcoming period. Your determinations of how much money your business has available to spend are based on these forecasts, forcing you to spend within your means. It forces you to restrict discretionary purchases to items that you can pay for out of the cash you have on hand.