A cash flow budget is not just a cost cutting tool designed to keep you from spending money. Learn the true benefits of this business tool. A proper cash flow budget can help your business profitably expand to the next level. This article explains how to create a cash flow budget correctly to maximize its benefit for your business.
Many business owners mistakenly think of a cash flow budget only as something negative that deals with cost cutting and denying them permission to buy anything fun or new. Others look at it only as a spending plan based on the past history of their business spending. While the spending plan concept is certainly much closer to the actual purpose for a cash flow budget, it is an incomplete picture.
To create an accurate budget, it is important to understand the complete purpose behind this tool, and how it can benefit you and your company.
A cash flow budget serves four important purposes.
• It helps the business owner identify where cash flow is being wasted.
• It alerts the business owner to “cost creep” and can identify when it’s time to raise prices.
• It identifies exactly how much cash flow the business needs to do better than break even and ensure adequate profitability
• It helps the business owner plan for the future needs of the business so the business can expand.
Cash flow is the heart of a business and sustains the business. I often refer to it as the fuel in the gas tank of the company. When creating an accurate business cash flow budget, it is important that it accurately represents, as closely and as detailed as possible, these six categories: current cost of goods sold, current expenses, current credit and mortgage debt, future anticipated expenses, future desired spending, and a savings plan.
To build your budget correctly and have it serve all of the purposes, it needs to be detailed, instead of generalized. The place to start is to pull a Profit and Loss statement for the past consecutive 12 months of operation. This ensures you don’t miss those expenses that get paid bi-annually or only once per year like a property tax bill, or a bill from your CPA for preparing your corporate tax return. It also keeps you from including a one-time expense that will not re-occur. Using a current Balance Sheet is also helpful, as it will include the liabilities you owe such as credit or mortgage debt that must be paid that does not appear on the Profit and Loss Statement.
After that, it is a planning exercise to anticipate how much cash flow will be needed for future anticipated expenses such as replacing a delivery van or upgrading computers, planning how much of the income the company needs to set aside for future desired expenses such as adding another manufacturing line to increase production, how much cash flow will be needed to promote the company like it should be promoted, how much cash will be needed for handling unexpected financial emergencies such as repairing a leaky roof, and how much cash is needed for a savings plan for retirement. Creating an accurate cash flow budget is the first step in proper cash flow management.
You can use a simple spreadsheet program to list the line items and have it calculate the monthly or weekly cost of each line item and add them up to find the total. For the purpose of finding your income planning target I recommend you break it down to the weekly number by dividing the total by 52 weeks. Large numbers can cause a person to freeze up and immediately think that target cannot be reached. For a sales team in a small business, it may be easier to confront having to bring in $23,076 per week and plan out how to accomplish that than it is to confront bringing in $100,000 per month in sales.
Detail is important so that nothing is missed and areas of waste and cost creep can be identified. For example, instead of lumping all insurances into one line item called insurance, have a separate line item for each type of insurance you pay: auto, life, health, malpractice, liability, property, disability, etc. That way nothing gets missed and you know exactly where your cash flow is going. It also makes it easier to identify cost creep in these items so you can shop for better rates.
When listing expenses, the more detailed the better. Do you have hefty amounts under Repairs and Maintenance? How much was for building repairs? How much did you pay for computer repairs? How much was equipment or landscaping repairs? Were any of those a one-time major expense that will not re-occur and so should NOT be included on the budget?
It is recommended to have your Cost Of Goods Sold separate out the cost of inventory you resell from industry specific supplies you use in the course of doing your work so you know when those categories have gone up disproportionately to sales. This is a good way to figure out if it is time to raise prices and pass cost increases on to your customers, or if you have waste or theft occurring.
If you are implementing operational planning in your company against a budget number that is too low, you are guaranteed to lose cash flow and profits. Under-estimating your budget needs can be fatal. With an accurate budget in place, based on real budget numbers rather than guesses, the business is much more likely to meet the demand for income targets you discover from the creation of a detailed cash flow budget.
You have a much better chance of making your income targets by demanding the amount of income you really need by first creating an accurate cash flow budget.
For additional information on how to create a cash flow budget on a step-by-step basis, check out my latest book on Amazon. Here is the link that will take you to that destination.
You have a much better chance of making your income targets by demanding the amount of cash flow you really need by first creating an accurate cash flow budget.