There are many different types of budgets that can be used and are certainly beneficial for a small business. Therefore, there are many questions to be asked and answered. Should a static or fixed budget, a rolling budget, or a flexible budget be used? Should separate departmental or divisional budgets be prepared that will eventually roll into one main master budget? Is a capital expenditures budget necessary? The best budget or budgets, of course, are those that are easily understood by management and continuously reviewed to ensure that the business is on track to meet predetermined goals.
Cash Flow Budget
A cash flow budget (or simply called a cash budget) is a must budget for any small business to ensure sufficient cash available to meet current obligations to operate such as rent, payroll, utilities, insurance, etc. Depending on the type of business, inventory, materials, and supplies might need to be purchased in addition to the possibility of servicing outstanding debt (principal and interest payments).
A cash flow budget is a summary by category of expected cash inflows and outflows. This is different than projected profit or losses for a business especially if it is on the accrual basis of accounting that recognizes revenue when it is earned and not when the cash is received, and recognizes expenses when they are incurred and not when actually paid.
Businesses will have cash inflows and outflows from various sources:
• Cash sales
• Receipt of receivables
• Payment of expenses
• Receipt of loan funds
• Repayment of loans
• Purchase of equipment for cash
Basically, all cash inflows and outflows must be projected when preparing a cash flow budget.
Will Numbers Be Exact?
Since a cash flow budget predicts future cash inflows and outflows, the numbers most likely will not be exact, so what is the purpose then of preparing this projection? A cash flow budget gives a business a direction regarding future cash because the relevant question that all small businesses must ask is, “Will sufficient cash be available to meet current obligations?”
Cash Flow Budget vs. Master Budget
A cash flow budget is not the same as a master budget prepared on the accrual basis of accounting for various reasons:
• The business might have credit sales
• Receivables will not all be collected immediately
• Expenses can be charged on a credit card or billed
• Payables might have different payment terms
• Inventory and materials might not be paid at the time of purchase
• There might be equipment purchases for cash or extended payments
Therefore, a cash flow budget must take into consideration all cash inflow and outflow items whereas a master budget prepared on the accrual basis of accounting will take into account only projected items of revenue and expenses (not necessarily when cash is received or paid out).
Preparing in Advance
Businesses must prepare in advance if additional funds will be needed to operate and whether those additional funds will be borrowed or come from owners and outside investors. Preparing in advance means that each component affecting cash flow must be analyzed and estimated:
• When cash will be received
• When cash will be paid
Although it is difficult to pinpoint exactly when cash will be received and paid, projecting these amounts and dates with a cash flow budget provides a guide for the business regarding future cash flow.
Estimating the Right Way
Preparing a cash flow budget with a certain degree of accuracy means estimating by month the cash inflows and outflows of the business. Therefore, in addition to cash sales, cash received from receivables must be estimated by month based on a business’s previous history of credit collections knowing all receivables most likely will not be received the following month after-sales. Other cash inflows also have to be estimated such as loan proceeds, additional investments, sale of equipment, etc.
Cash disbursements need to be estimated by month for normal operating expenses in which cash will pay and possibly debt servicing payments, cash purchase or downpayments for equipment, etc.
Calculating monthly cash inflows and outflows for 3-6 months in advance will reveal either a cash surplus or cash deficit for each month when added to or subtracted from the beginning cash balance (or deficit). Management can then make decisions regarding (as examples):
• The need for additional cash
• Reduction of expenses
• Increase in expenses
• Purchase of equipment
Planning in Advance
Planning in advance is a key to operating an efficient and profitable small business. Preparing a cash flow budget is an important aspect of the planning process.
