When developing a 13 Week Cash Flow Statement in a job shop, forecasting future business seems especially difficult due to the variety of jobs that might be won in future weeks. The solution is to select a few typical product or job types from experience, and forecast those as representative of the type of work that might come in. Choose job types significantly different from each other.
For example, 60% of the work might be small parts you have built before, 30% might be new jobs with simple designs, and 10% might be new complex designs. Probably the more complex jobs will have longer durations, so that you incur cash costs but do not receive cash payments during the 13 week period. You might use different percentages if you choose to do best case and worst case scenarios too.
Once you have a forecast, check it to see if it is reasonable. How does it compare to your cash flow from prior weeks? It should not be radically different. See 13 Week Cash Flow Statement, 13 Week Cash Flow, Part 2 – Forecasting the Knowns, and 13 Week Cash Flow, Part 3 – Forecasting Unknowns.
Do you have enough labor to do the work you forecasted? Do you have enough space and machine time? Does the forecast imply more time spent on quotes and selling than you yourself have available, given the time you will be spending on production and perhaps bank negotiations?
A common error is double-counting labor. Many company bookkeepers show all payroll as a “fixed” cost because that is the easiest way for them to calculate payroll taxes. But that means you cannot know the margin per product, because you don’t assign the labor costs to the product.
In the method described in these posts, we calculate labor requirements as a variable cost, that is, per job. Since people always have some paid time not assigned to particular jobs, a reasonable forecast will need to show non-productive labor time and cost as an overhead or fixed cost, and labor assigned to jobs as variable cost or COGS. Payroll taxes should be split the same way. Non-productive labor time can be as much as 45%, so this is important! Your accounting software (e.g. Quickbooks) entries showing payroll as a fixed cost are only a starting point. You will have to split payroll into productive and non-productive components to forecast cash flow by product type.
The business owner should draw two types of conclusions from the Cash Flow forecast: product profitability and business viability.
Analyzing the cash flow by product or job type as described in Part 3 shows you the margin per product before overhead. If overhead is 30% of total company revenue, and your product generates a 30% margin (revenue less variable cost / revenue), then you break even and have no profit. In this example, if you want a 15% profit before tax, your products must generate a 45% margin on average. If they don’t, you must reconsider your price, perhaps by raising your “shop rate” or discontinuing products that fall short of the target profit.
Business profitability depends on product profitability, as above. The bank asks for a 13 week view because it knows that a near term forecast is more reliable than long term. But the business owner who has long duration jobs often decides to forecast cash flow for six months (26 weeks) to be able to see the cash payments for long duration jobs, rather than just the costs. In this case, a longer view is needed to get the most realistic picture of business viability.
Forecasting cash flow from unknown future work in a job shop can be done by choosing representative product or job types. Key issues include double-counting labor, nonproductive labor time, shop rate, and margin per product or job type.