There's nothing more important to your business than cash. The way cash moves your business is called "cash flow," and cash flow can be the difference between staying in business and throwing in the towel.
A cash budget determines the patterns of how you collect and pay over a specific period of time, such as a month, quarter, or year. Your goal is to maintain sufficient cash for operations and liabilities without leaving too much cash idle or unproductive.
While you cannot predict exactly how your cash will flow in any given month, the process of creating a budget based on previous years' cash flow will help you to manage shortfalls and plan for appropriate use of excess funds.
Short-Term Financial Planning
The cash budget is one of the primary tools used in short-term financial planning for cash flow. It is often developed on a month-by-month basis. A good cash budget allows the owner to see short-term financial needs and develop opportunities for the business.
For example, one month the firm may have extra cash and be able to save some money in a money market fund. Another month, the firm may have a shortfall and have to withdraw some money from savings or apply for a short-term bank loan to cover its needs.
Many owners state their expected cash inflows (sales revenues) and outflows (expenditures) on a month-by-month basis to calculate their excess cash or cash shortage at the end of each month. It is a helpful short-term planning tool for the small business owner.
Three Main Components
There are three components to the process of developing a cash budget:
- Time period—the amount of time for which you are developing the budget
- Desired cash position—the amount of cash you want to keep on hand based on the nature of your business, the flow of accounts receivable, and the possibility of drastic change, such as an immediate opportunity or unforeseen expenditure
- Estimated sales and expenses—during the selected time period
Because sales and expenses are estimated, your cash budget will never be completely accurate, but over time you'll become more adept at forecasting expected sales and expenses for a given time of year.
Once the cash budget is prepared, you'll compare it to your company's real-world performance. Comparing your budget to outcomes will provide you with possible differences in the outcomes you predicted and actual outcomes.
This comparison will give you the information needed to adjust the cash budget for this period and refine your budgeting for the next period. You'll almost certainly need to tweak the budget as changes occur based on unexpected expenses.
Small business owners should pay close attention to their cash position, cash flow, and the accuracy of their cash budget.
Without these tools, there's a very good chance that you will either find your organization cash poor or end up with cash that could be invested improve the bottom line.