No business can know exactly what the future holds, but budgeting and cash flow forecasting can reduce the level of uncertainty, helping you anticipate problems, learn from the past and improve your ability to control the business. Cash flow forecasts and budgets provide two complementary and reasonably simple tools to help you make the right decisions.
A budget is your prediction of what could happen in the future and allows you to play with different sales and expense scenarios, where a cash flow shows actual expenses and sales revenue that flow into your business each month.
Cash forecasts and budgets often deal with the same data in different ways, for example, you might budget $1,000/month for online costs, whereas in the cash flow you’d enter the actual amount (maybe $987 one month, $1,134 the next).
Because they are so close, often a cash flow and budget are on the same spreadsheet or similar in accounting software.
A budget and cash flow forecast can help you:
One of the most useful functions is tracking expenses to highlight any costs that have increased or decreased abnormally, allowing you to take timely action. The other function is to check sales levels and signal any red flags if some area of your business is underperforming.
Allow at least two or three months to prepare for your annual budget and prepare 12-month forecasts on an on-going basis. Update your budget each month based on what happened in your cash flow.
Often the hardest piece to get right is the sales forecast, which typically is based on a combination of your sales history, current market conditions and your marketing campaigns. But if you’ve never been in business before, look at separate forecasts for different products or geographical areas and any seasonal patterns of your business and industry
Remember that sales variations may reflect any changes to price, what competitors are doing, the launch of new products or possible economic (down or up) conditions.
Common reasons for getting your budget or cash flow forecast incorrect are:
Forecasting when you will be paid for sales will also be affected by the credit terms your offer, the effectiveness of your debt collection and whether people pay on time. Be sure to include items that don’t relate to sales or operating expenses in your cash flow forecast such as loan repayments, tax and shareholder dividends or drawings.
Conducting sensitivity or ‘what if’ scenarios can show you how different outcomes affect performance. Typically, you might work with optimistic, pessimistic and most-likely scenarios to review the effects of any changes to revenue or costs. You can also check the impact of any other significant risks to your business. For example, if thirty percent of your turnover comes from one customer, what would happen if they stopped buying from you?
Comparing your actual expenditure against your budget helps you improve your ability to predict future costs accurately. Some fixed costs may increase as the business grows, while variable costs per unit may even be lower.
Reasons for changes in the relationship between costs and turnover could be:
Each month look at your budget and compare it to your actual cash flow, and then amend it as you go. Each month as more business information comes in, you will get more and more accurate at completing these forecasts.
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.