How to project cash flow months out if paid up front for a year?

May 18, 2011 3:29 PM

How do I project monthly revenue for my service business 12 to 24 months into the future if I am paid in lump-sum prepayments good for 6 months to a year of services? Also should I be referring to this as "cash flow" rather than "monthly revenue"?

I have a service business for which people currently pay by the month. Before I started, I was able to make projections of monthly revenue based on numbers of clients at various service levels. This was relatively simple.

Now I'm considering offering a discount if people pay up front for a year's worth or six months' worth of services. I can't figure out how to project out how that would impact my month-to-month revenue. I'm not even sure what phrases to Google for. I tried a few cash-flow related phrases and didn't find what I need. Thanks for any suggestions, concepts to explore, or book recommendations.

posted by Franzilla to Work & Money (6 answers total)

Search for "accrual accounting" or "accrual basis". That method of accounting is based on the idea that, regardless of when you got the cash, you book the revenue when the service is rendered.

I am not an accountant, but I think that if you choose to use accrual basis for your business, then you will have to use it across the board: for income AND expenses. I also think that once you go from cash accounting to accrual accounting, it may be very difficult to go back (if you ever need to go back).
posted by hammurderer at 3:43 PM on May 18, 2011

Response by poster: I've been using accrual accounting from the start. My client-management software (which takes payments via cc but otherwise is not financial software) gives me revenue reports on the accrual basis. But, that's past money being reported on. I'm basically doing a new business plan that needs projections looking forward a year or two. Income would now be a mix of: Lump sum lasting 12 months, 6 months, or 3 months; or monthly payment plans for any/all the above; and for each above there are four levels of service. I understand that lump-sum income is accrued and accounted for as it is earned rather than as it is received. But, how to do projections?

Should I just decide how many people I believe are going to do each type of purchase within each month, then divide each lump sum up into future months as projected earnings on the accrual basis? I guess I can do that, but it will be so labor intensive that I want to first make sure I'm doing the right thing and that there's not an easier way.
posted by Franzilla at 4:02 PM on May 18, 2011

If you already understand how to handle this via accrual, it sounds like what you really want to know is "what percentage of my customers are going to opt for discount X", because otherwise it's no different from monthly.

You're pretty much going to be guessing, but you might look and see how many of your customers have existing histories of more than six or twelve months. Those are good candidates to take the plunge right away. It also depends on the nature of your service, your refund policy, and probably plenty of other variables..
posted by toomuchpete at 4:09 PM on May 18, 2011

I think regardless of the way you account for this (the term here is "unearned revenue") you're still not changing the fundamental guesswork of how many clients will opt for it and what your revenue will be at the end of the year. Accounting-wise, all the upfront payments sit in an account that gets adjusted at the end of the each month to 'earn' the monthly fee (then it's revenue, until then the unearned revenue account is actually a liability because if you don't provide the service, then presumably you'll have to give it back). So it isn't like you are actually changing much of the revenue, just when you get the money itself - accounting can't really tell you that but toomuchpete has some good ideas about how to decide which customers might go for it.
posted by marylynn at 4:24 PM on May 18, 2011

Best answer: Hi Franzilla. The concept you're grasping for is cash flow vs. income. Income = Revenues - Expenses, while Cash Flow = cash inputs minus cash outputs. Why are these not the same? They generally are if you use the cash accounting method, because you record revenues when you receive payments. But in accrual accounting, you record revenues when you earn them i.e. when you perform the service.

It sounds like you're trying to prepare an income projection, which is different from a cash flow projection. It'll help you to prepare both, actually. Both are important financial statements.

First prepare your cash flow statement, because it will be easier: record cash coming in when you expect it to come in, and cash outputs the same way. This will help you understand when you can make large purchases and help you budget for the months when cash coming in is less.

Next prepare your income statement: this will require some extra work. You WILL have to estimate when lump sum payments will come in, and then spread them over the months they apply to. It's exactly what you described above. Keep in mind that you must be consistent; as hammurderer mentioned above, you have to use accrual accounting for both revenues and expenses. This means, if you pay for a service that spans more than one month, you should record the expense in the proper months. For example, if you pay a local paper upfront for 3 months of advertising, you should divide the total by 3 and record a portion in each month.

This article may be helpful (especially the cash flow vs. income part).

Google terms that might help you are unearned revenue, prepaid expenses, matching principle, cash flow statement, income statement.

Feel free to memail me if you have more questions :)
posted by yawper at 9:16 PM on May 18, 2011 [1 favorite]

Response by poster: That is very helpful. I'll read the article and start on my spreadsheet. Really appreciate it.
posted by Franzilla at 9:41 PM on May 18, 2011