Most companies are focused on cash inflows and generating revenue — and rightfully so.
However, it is important to remember that money flows both in and out of a business. Profits are just one part of the equation, as businesses have monthly expenses and debt obligations they must meet.
A cash flow budget is a vital tool for measuring, managing and balancing income vs. expenses. Every organization should be capable of creating and using these financial planning tools.
The importance of having a cash flow budget
Business owners must pay strict attention to their reserves to ensure they always have enough cash on hand. This is called cash flow budgeting, and it is an important process for every organization, from traditional manufacturers to entirely virtual operations.
Cash flow budgeting is the practice of tracking all cash inflows and outflows:
- Inflows are your cash receipts: This includes any accounts receivable expected within a certain period of time, immediate payments made to a business and income from other services.
- Outflows are the fixed and variable costs that companies incur: This includes everything from electricity and gas payments, insurance premiums and building rent to equipment fees and employee wages — essentially, any expense.
Developing your cash flow budget is a matter of adding up your projected cash inflows and subtracting your outflows monthly or more frequently. The remaining balance is your cash on hand or cash flow. If it is a positive number, you are effectively managing expenses. If it is negative, there are issues.
While it may be difficult to identify and cut unnecessary costs and take other specific actions that shift cash flow to the positive category, the insight provided by a cash flow budget is invaluable. When a problem is evident, it can be further defined and analyzed before a business attempts to address it. In cases where a company doesn’t have the necessary visibility into its cash flow projection and position, a concern can sit unnoticed, growing more serious until severely negative consequences become apparent on an income statement.
Steps to creating a cash flow budget
To create a cash flow budget on a weekly or monthly basis, you can simply:
- Use a basic spreadsheet application or software.
- Tally up what you expect to receive from accounts payable, recurring revenue and carry-over surpluses.
- Add together your expenses; estimate your variable expenses to the best extent that you can. Consider overestimating slightly to leave wiggle room in your cash flow budget.
After calculating your cash flow budget, you will have identified your cash reserve, also called net cash flow. Your company can draw from this sum for ad hoc costs, reinvestment in your business and other cash needs.
A cash flow statement is a document depicting your inflows and outflows. It is mandated for publicly traded companies to file such statements with regulatory authorities. While small businesses may not be required to provide statements, there are benefits to cash flow tracking. For one, visualizing cash flow can help you to better manage it. Also, potential investors generally demand that level of insight into operations before extending financing.
Effective cash flow forecasting
Cash flow budgeting is critical because profitability on paper does not always translate to real-world income. A business can have high annual revenue and strong overall profitability but still be left scrambling to address debt in the short term without sufficient cash flow.
For instance, consider industries where clients typically pay a month or two after services were rendered or goods were provided, a common arrangement across the economy. A new account that leads to substantial sales can make company leaders feel like all is well. However, a cluster of bills due in just a few days or a major unexpected expense, like repairs after a natural disaster, can arise before those funds are received. The promise of payment in full does little, if anything, to return things to normal as quickly as possible or keep the business in the good graces of key service providers.
Companies that regularly face this type of issue have to contend with long-term risks like supporting strong vendor relationships, avoiding fees and penalties and, most important of all, maintaining basic business continuity. While there are many root causes of inconsistent and negative cash flow, forecasting is a critical step in revealing the existence of a potentially serious issue.
To avoid such problems, it is essential to use cash flow forecasting. This process is basically the same as crafting a short-term cash flow budget. However, with a cash flow projection, you are looking ahead at the months, quarters or years to come.
How to use cash flow forecasting
Businesses can model different scenarios from a cash flow perspective to determine their viability. Including a major potential expense like an equipment upgrade, construction of a new facility or a significant hiring increase in a cash flow forecast will help decision-makers understand how moving forward can impact the cash on hand needed for established expenses.
Projecting cash flow variables ahead of time can help businesses better track and allocate assets, as well as protect their solvency and ability to meet obligations. For instance, adjusting cash flow expectations to account for upcoming seasonal changes could prevent a harsh winter and high energy costs from creating balance sheet problems. This type of insight can even help business leaders address more widespread issues that arise independently of the company’s own decisions and operations, such as a recession.
It is also a good idea to construct forecasts for when large debts or loans come to bear. Unexpectedly slow revenue or late payments could affect your ability to make those debt payments.
Learn more about cash flow budgeting with Comerica Bank
All told, cash flow budgeting is a must for businesses. It provides valuable insight into operations and financial management. However, it can be a complex process with many different factors.
If interested in improving your cash flow management, talk to Comerica Bank today about services and products that can assist.
