Understanding Business Budgets and Cashflow
Budgets and cashflow analysis are important management tools to allow businesses to properly manage their performance; allowing them to plan ahead and make informed decisions relating to aspects such as planning, resource allocations and funding requirements.
Preparing budgets and cashflow forecast can give you a more realistic measure of where your business is heading and can help you to avoid problems before they occur. They also provide:
A measure, to compare with actual performance over time, to help a business stay on-track with its objectives
Provide a means to compare past history with future expectations, for strategic planning
- Useful mechanism when seeking finance, as it shows lenders you have the capacity to pay them back.
A budget is effectively a forecast (based on history or on assumptions on changing conditions, or both), to provide a benchmark against which actual performance can be compared.
A Budget provides business owners with greater control over their business activities, as it allows them to set goals, forward plan and make appropriate decisions relating to their business, with the benefits of being able to compare actual performance of the business with the expectations and assumptions used in setting the budgets.
Budgets help business owners to allocate funds for specific purposes and can also assist businesses to obtain finance by supporting expectations of future profits and cashflow.
When preparing a budget the starting point is to determine the time frame that it relates to; which could be on a monthly, quarterly or annual basis, depending on the needs of your business.
There are a number of things you'll need to know to put a budget in place: These include:
Most ongoing expenses are paid out of the income that is generated out of a business; although in a start-up phase there may be insufficient income to cover cost, requiring adequate funding to be in-place, compared to established businesses where the timing of income may be more predictable. Income may be received by a business on a regular or inconsistent (eg. seasonal) basis, which needs to be panned and mapped out over the budget period.
There are certain costs that are fixed in a business; often these types of costs are incurred on a regular or constant basis. Often fixed costs represent a high proportion of the operating costs of a business. Examples of fixed costs include wages, rent, insurances, equipment leases, telephone, bank fees and interest.
- Variable costs
There are certain costs which vary, both in terms of when they occur and the expenditure amounts that are to be paid. .Examples of variable costs include cost of materials required to generate sales, rates, utilities (such as electricity, gas, water) legal and professional fees, marketing and advertising, motor vehicle expenses, repairs & maintenance, membership & licenses.
The expected profit of a business is its income less expenses required to run the business.
After establishing a budget, to predict the profits that can be generated from the business, the next important stage is to compare the actual income and expenses against the expectations embedded in the budget; comparing the difference between the two. This analysis is crucial, as it allows the owner or management of a business to track how their business is preforming and make necessary changes where required.
Comparing actual results to budgets can assist in identifying whether corrective action is required, if there are variances between the performance of the business and its forecasts.
Cashflow forecasting is an effective way to prepare for cash expectations and requirements of a business, in advance.
Businesses can be profitable but still get into trouble because they simply do not have enough cash to pay their expenses when they are due; i.e. they become insolvent. It is therefore crucial to monitor the cashflow of a business, including the expected timing of receipts and payments, to understand how much money the business is receiving and how much it will need in the future.
A cashflow forecast needs to relate to a specific period of time; usually not more than a period of 12 months. Longer-term cashflow forecasts, spread over a period of years, are predominantly for strategic planning purposes or for planning capital investments (such as equipment, property and infrastructure decisions).
The primary purpose of the cashflow forecast is to provide the status of the business' cash position at any point of time over that period, to support decisions during that time by identifying when there may be projected or expected shortages of cash so that payments can be managed and prioritised. So, in its simplest form, a cashflow forecast predicts whether a business will have sufficient working capital to operate during a specified period of time.
The forecast dsn't necessarily be too complex, and can be changed if circumstances change over the period.
To calculate a cashflow forecast, you will need to look at the estimated cash-inflows and out-flows over the period; which is usually based on historical trends and results as well as predictions based on assumptions for the future. When preparing a cashflow forecast, regular cash inflow and outflows will need to be considered along with seasonal and cyclical variations. If the expected sources of cash are higher than the expected outgoing of cash, then the business will be cashflow positive. In inverse applies if it is the other way around, to be cash negative. In either situation, you will be in a better position to analyse your cashflow needs, to better plan your cash usage, allocation of funds and potentially help identify sources and timing that will be able to assist.
H&R Block can assist with your budgets and cashflow forecast for your business.