business budget cash flow

Having a budget for 2015 is fine, and if you already have one developed, great! The income statement operating budget is a great first step. However, to have any real insight and impact on improving your cash operating results, your business requires a complete set of projected financial statements. If all you have is a budget, then all you’ve done is project out the income statement. 

Does that help you answer the three questions that keep many business owners awake at night? 

  1. How much cash is my business going to need
  2. When will we need it
  3. Where will it come from

In our opinion, the most important result of financial planning is cash flow management and cash flow improvement. This cannot be accomplished by only focusing on top line revenues and bottom line net income.

The only way to plan for cash flow improvement is by forecasting out the income statement, and the balance sheet and the cash flow statement.  Each of the three financial reports is tied to the other, and going through the projections process will help you understand how they are tied together. It will also show you why managing cash flow is more difficult than simply meeting sales goals and managing expenses!

Here’s how to create your own cash flow plan:

1. Income Statement Forecast

The income statement forecast is the first step and its purpose is to help you manage and improve profits. Think in terms of detail goal setting. Let’s assume you have growth goals (if you’re an entrepreneur, you do). So come up with what your growth goals are for the coming year and then break that down into monthly increments. Look at your history to determine any monthly seasonality and of course factor in any major initiatives you have planned. Now analyze your historic gross profit margins – commonly referred to as revenue, less cost-of-goods-sold (maybe more easily understood as sales minus direct costs of producing the product or service).

Gross profit is a key area that has a huge impact on your company so it’s important to really dig in and understand the direct costs associated with each and every sale – it will probably provide some real insight into how you can improve profit margins. Break it down into revenue and direct variable costs for each type of sale – by product, by service type, by customer type, by location, whatever makes the most sense for your business. This means you will need to break your revenue goals into the different types, analyze your costs, and forecast out the next twelve months.  Now fill in the rest of the Profit and Loss forecast by analyzing every single overhead expense line item. Each overhead expense should be justified by either improving your customers experience or improving your team’s experience and their ability to deliver exceptional service to your customers. 

2. Projecting the Balance Sheet

Now for the hard part, projecting out the balance sheet. The best advice here is that you will need some business budgeting software. This process is simply too complex and there’s too much room for error trying to build this with formulas in excel. We use Plan Guru.

In order to project how balance sheet accounts are going to impact cash flow, you’ll need some historical information on accounts receivable average aging days (# of days sales in receivables), inventory turnover, and accounts payable average aging. You’ll also want to factor in notes payable, principal pay down, and your goals for paying down any lines of credit, credit card balances, or any other debt. All line items on the balance sheet need to be factored in as each can potentially impact cash flow, such as major equipment purchases, or changes in ownership capital. The software will then allow you to view a forecasted statement of cash flows, which should be reviewed in detail and in tandem with the forecasted income statement and balance sheet to ensure no surprises.

Remember, the objective of business financial planning is to help you visualize the financial impact of your profit and cash flow goals. You will probably want the help of your CPA to put some of this together and help you conceptualize how all three statements tie together.

In business, you should be monitoring and comparing actual financial results against forecasted results on a monthly basis. We believe that forecasting out monthly for twelve months is enough detail for most business owners. Beyond the next twelve months, you may want to forecast out annual results up to three years to give you some broad range perspective on long term goals but for detailed monthly planning and comparing actual to planned results, twelve months is enough. And remember, the real value of planning is to return to it every month comparing actual to plan. Then roll forward at least once a quarter so you’re always refreshing your twelve-month view, continually adapting to unforeseen curves in the road.

You must first understand where you are today, and decide where you want to be. There’s value in the planning, but the real value is in measuring against the plan. You have to continually monitor progress and adapt along the way.

Financial Optics serves business owners and entrepreneurs with remote web and cloud-based finance applications. Let our professional accountants run your daily, weekly, or monthly bookkeeping and accounting, so you can run your business. Contact us by phone at (913) 649-1040 or click here to visit our Contact page.