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Budgeting: Part 2
Companies Served Since 1981

Budgeting: Part 2

By Gregg Schoenberg Monday, January 14, 2013

In a previous post we discussed the importance of setting an annual budget and introduced readers to the operating budget, which can be used to predict your company’s net income for a one-year period. And while net income represents your firm’s bottom line, you may remember from our series on financial statements that it is neither the most important metric nor the best indicator of company health.


In order to better gauge financial well-being we need to look at cash flows, and in order to properly manage cash flow we need to create a cash-flow budget each year along with our operating budget.


To get started with your cash-flow budget, take the numbers from your operating budget and plug them into the same software you used to create that budget. The next step is to look at all of your receivables and payables and determine when the cash associated with each is likely to be moving into and out of your firm’s coffers.


For example, if customers have 60 days to pay their invoices in full, then January’s income should be represented as March’s cash flow. Of course, the same logic also applies to your expenses; your cash-flow projections for critical things like inventory should be budgeted for the period in which you actually have to pay for them, which can be prior to receipt.


Going through this exercise will highlight the difference between income and cash flow and can help you to identify and plan for times when cash is likely to be tight. Say you need to make a lump-sum payment due in June but won’t have the cash flow to cover it until you collect the invoices that are due in July; if you’ve done your cash-flow budgeting you’ll see this coming months in advance and can make a contingency plan that involves borrowing money for the short term or temporarily cutting back on expenses. But if you don’t have a cash-flow budget it may be too late to do anything about the shortfall once you realize that it’s there.


It’s difficult to overstate the importance of cash flows, and by extension the cash-flow budget, yet many entrepreneurs seem to ignore this critical component and instead focus on revenue and net income. This is a huge mistake, as a business can operate at a loss for an extended period of time, as most start-ups do, but it’s impossible to survive with negative cash flows. And even profitable business can run into life-threatening trouble if they don’t properly manage their cash flows.


So make cash-flow budgeting a core part of your financial due diligence, and review your cash-flow budget on a monthly basis to make sure that your finances are either on track, or that you have time to adjust when things aren’t going according to plan.


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