Working with cash flows and budgets

In the excitement of growing your business, it can be easy to neglect the financial side. Many entrepreneurs are not excited by finance and accounting – they‘re more focused on what they do or make.

However, financial management is important to keep your business on target both to ensure it’s profitable and to avert a money crisis.

Cash flow forecasts and budgets provide two complementary and reasonably simple tools to help you make the right decisions.

The purpose of a cash flow forecast

A cash flow forecast is an attempt to predict in advance what your future business bank statements will look like. It aims to predict the:

  1. Expenses that will flow out each month to pay bills.
  2. Sales revenue that will flow into your business each month.

The first part – predicting expenses – is easier than the second as most costs (business overheads such as rent, utilities, and communication costs) are relatively fixed or easy to research if you’re starting up.

Predicting sales is the difficult part – particularly if you’re starting a business and don’t have any previous sales data.

Cash flow forecasting skills generally improve with practice. The closer your predictions are to future bank statements, the better your money-management skills.

The benefits of cash flow forecasting

A cash flow forecast focuses on the timing of cash flows into your business. It can help you:

  • Predict and deal with upcoming cash surpluses or shortages.
  • Plan how to meet tax obligations.
  • Time new equipment purchases.
  • Identify if and when you need a small business loan or line of credit.
  • Change figures to experiment with ‘what if?’ scenarios.

How cash flow forecasts and budgets differ

Cash forecasts and budgets deal with the same data in different ways. For example, if you pay accounting fees of $2,400 once a year, you would:

  • Enter this in your cash flow forecast as one lump sum in the month the bill is due.
  • Smooth this out in your budget into 12 monthly amounts of $200.

Similarly, if a customer pays you $120,000 upfront for project work, you would:

  • Record the full $120,000 in your cash flow forecast when it’s paid into your account.
  • Spread this over the year in your budget – drip feeding $10,000 a month to pay operating costs while the balance earns interest in a savings account.

Managing effectively with a budget

Your budget is an essential companion to your cash flow forecast. The difference is:

  • A cash flow predicts the timing of cash flows.
  • A budget plans your sales revenue and what you intend to spend on expenses.

Most accounting software programs can easily generate monthly or yearly budgets based on your preferences. Once you’ve entered your desired budget amounts, the budget reports will display ‘actual’ against ‘budgeted’ figures as the year unfolds.

The actual figures in your budget report are an important way of keeping your cash flow forecast current and relevant.

Key uses of a budget

Here are some of the main uses of a budget.

"Every business has some room to trim excess costs and especially cost increases not matched by any increase in sales or profits."

Being able to track expenses

One of the most useful functions is tracking expenses. Every business has some room to trim excess costs and especially cost increases not matched by any increase in sales or profits. Budget reports can highlight costs that have increased or decreased, allowing you to take timely action.

Rising costs can be a useful prompt to shop around for new suppliers. The easiest path for a business is to stick with familiar suppliers, but an easy option can also become an expensive one. Calling for proposals or quotes for important supplies and services can reduce costs.

Tracking sales goals

It’s useful to take the latest budget report into management meetings to discuss both variances in costs and also gaps between actual sales and budgeted sales. The budget provides no-argument, hard evidence if the business has fallen short of sales goals and this can focus everyone on finding solutions.

Building a cash buffer

Many businesses have seasonal swings or ups and downs in revenue streams. The cash flow forecast should help you pinpoint times when you’re likely to have cash surpluses or cash deficits. You can then use your budget to:

  • Set aside a regular amount each month into a savings account as an emergency fund to tide the business over a lean period or cope with the unexpected.
  • Allocate any spare cash to pay off debt or buy assets.

To match against industry benchmarks

Industry data can be useful when you’re setting your budget. For example, knowing what similar businesses spend on advertising (as a percentage of their sales) can be a useful guide when you’re planning your marketing.

This doesn’t mean that you have to follow the industry standard blindly − every business is different, but knowing what competitors are spending or achieving can sharpen your goals.

Budgets are a valuable tool

Budgets are a useful discipline for managing your business. Analyzing your performance through budget reports helps to make everyone aware that money is not an unlimited resource.

Money can be used wisely or it can be wasted. Costs need to be controlled and budgeted sales need to be achieved. All money resources need to be focused on getting the business to achieve its goals.

Keep updating your forecasts and budgets

Finally, the purpose of cash flow forecasts and budgets is to help you make more informed decisions. They are only useful management tools if their figures are kept current.

Review and update them at least once a month, or more frequently if things are changing quickly.

Next steps

  • Complete a cash flow forecast and investigate the kinds of budget reports your accounting software can generate.
  • Ask your accountant, your banker, or your industry association if they have average budget and performance data for your industry or for similar businesses.
  • Keep your accountant and banker informed of your business progress by bringing an updated cash flow forecast and a budget report to meetings.
  • Investigate the SBA assistance in your area that could help improve your financial management skills.

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