Preparing a budget and cash flow forecast is one of things which most business people have heard about, few (particular smaller) businesses actually do and even fewer know what to do with when they have it.
What is a budget?
A budget is a document, normally prepared each year which sets out, usually in monetary terms, what the expected financial results of the organisation for the budget period are expected to be. This will then set the benchmark for the forthcoming financial year. It will normally cover significant areas such as:
- sales (both in terms of volume and dollars)
- margins (what is left over after an item or service has been sold?)
- payroll (how much are my staff going to cost me in the forthcoming year?)
- marketing (what marketing activity am I going to undertake this year, when will I do it and how much will it cost?)
- operating expenses (what will it cost me to operate the business this year)
What is a cash flow forecast?
A cash flow forecast is different from a budget in that it looks at the movement in your cash balances as opposed to simply looking at income and expenses. There are some key differences here:
- a business which sells on credit to customers does not receive the cash at the same time as it makes a sale
- a business which purchases on credit does not pay the bills at the same time as it make the purchase
- asset purchases – if you need to purchase assets for your business (eg. machinery or vehicles), the costs of these will not necessarily be borne from your operating budget
- GST payments – despite common belief to the contrary, GST is not a business expense. Any cash flow forecast will need to build in the cash outgoing associated with GST payments to the ATO
- Other tax payments – like GST payments, these will have to be factored in to your cash flow forecast
Why prepare a budget and a cash flow forecast?
Anyone who was a boy scout or girl guide as a child will remember the motto, “Be Prepared”. A well drawn up budget and cash flow forecast will highlight periods when cash will likely become tight (as well as periods when cash may be more readily available).
Imagine this scenario:
XYZ Pty Ltd has drawn up cash flow forecasts for the following year and identified significant cash shortfalls in February and May. This has been done before factoring in BAS payments. The business has also identified that they will need to find $16,000 to payout a lease on a motor vehicle the following May. When these payments are factored in, there will be significant shortfalls in cash which may require additional short-term borrowings to be made. Now that XYZ has identified a need for additional cash, they may be able to approach their bank for those funds well in advance – this is much more likely to gain a favourable response than an urgent call to the bank manager the day before matters hit crisis point.
How to prepare a budget
There are a number of different ways of preparing a budget. These include:
- “Bottom up Budgeting” – start with a required profit and work out what sales will be needed from there (not usually recommended)
- “Last Year Plus Budgeting” – take last year’s actual figures and work from there (this can mean that crucual information is lost as inadequate thought may be put into changes in circumstances since last year)
- “Zero Based Budgeting” – Assumes that everything starts with a clean sheet
In reality, we will work with you to create budgets and cash flows which reflect the realities of life; a minimum acceptable profit, some basis from what has gone on in the past but a justification for the key elements based on sound assumptions which reflect the expectations of the future.
For more information on how we can assist you to put budgets together and prepare meaningful cash flow forecasts, please contact Ian or Leanne. We will be happy to spend an hour or so with you on a no obligation basis to show you what can be done.