5 Steps for Effective Cash Flow Budget Planning

5 Steps for Effective Cash Flow Budget Planning
5 Steps for Effective Cash Flow Budget Planning

Forecasting cash flows and cash flow reporting utilizing actual results are two critical activities that go hand in hand. Cash flow forecasting, also known as cash flow budgeting, forms the core of the financial process of any business.

A cash flow budget guides you to take the right decisions to ensure comfortable liquidity for the business. An accurate and detailed cash flow forecast would help organizations anticipate cash flow issues and resolve them on time.

It must be noted that constant review of this forecast with actual cash flow is crucial for keeping the company afloat. An annual cash flow forecast should be continually adjusted for the timing of actual receipt and disbursement of cash.

A number of steps are required to create a cash flow budget and for controlling cash flow. There are two key factors that go into the preparation of cash flow budgeting: one is the cash inflow (receipts) and the other is the cash outflow. In order to accurately forecast these figures, you might have to make a number of assumptions about how your business will be operating. Read on to find out the steps involved in preparing a cash flow budget.

Steps Involving a Cash Flow Budget

  1. Determining Cash Inflows:

    • The first step is to take your P&L statement and predict future cash receipts based on the sales figures. The best place to start would be by looking at sales in previous years. This would help identify trends and patterns in sales.
    • One can then identify internal (e.g. changing product pricing) and external (e.g. industry pricing changes) factors that might have an impact on the current period. When it comes to price changes, look at the timing and quantum of price changes. You might also need to factor in the impact of seasonality when predicting sales. For instance, a business selling air conditioners cannot expect the same kind of sales in summer and winter.
    • Once you predict realistic sales for the period, it needs to be broken down into cash receipts (i.e. when would the cash from customers come in).
    • Next is to identify the pattern in debtor remittances. To facilitate this, you could prepare an ‘aged’ list of your receivables. This would show the actual payment terms being taken. For example, you might see that sale happens in one month while the total cash is received only the next month. This is because sale might involve cash as well as credit sales and the credit could be for 30, 60 or even 90 days. For instance, you might receive 60%on sale, 20% within a month and the rest within another fortnight.
    • Furthermore, start considering cash receipts other than those from sale of goods and services. These could include deposits or part payments on contracts, supplier rebates, insurance claims, new loans or cash from shareholders.
  1. Determining Cash Outflows:

    By forecasting your expenses, you could get an estimate of your total outflows for the year. The selling price of your products or services has to include an amount that would cover these expenses, if you want to make profits. Usually, there are three types of cash outflows to consider, although they may vary from one business to another:

  2. Overhead Expenses:  

    These are also known as fixed costs because they do not vary much with the level or volume of sales or they have no correlation to sales. These expenses are usually paid on a monthly basis and include items such as salaries, electricity, stationery, rent and phone bills.  Even though expenses might change during unusual periods, they generally remain within a range. For instance, utility bills might go up during particular seasons.

  3. Variable Expenses:

    These expenses change along with the sales volume or the inventory levels. Variable expenses might include raw materials, direct labor and other such costs. These costs should be forecast as a percentage of sales. For example, assume your cost of goods sold (COGS) is 60% of your selling price and you decide to keep a quarter’s supply of goods on hand. Suppose you forecast $200,000 of sales in the first quarter, you would need $120,000 worth of goods (at cost) as part of inventory, before the quarter begins. However, this does not take into account the cash paid for such inventory. Costs associated with inventory are several and might not be paid at the same time. For instance, direct labor, if you run a manufacturing firm, would have to be paid early, while raw materials can be obtained on credit ranging from a week to 90 days or more.

  4. Other Expenses:

    Some other expenses might require you to pay cash. However, they might not be incurred regularly or could be a one-time expense. These would include expenses like purchase of machinery or equipment, dividends, insurance premiums or training programs. These also need to be taken into account for accurate cash forecasting.

  • Preparing the Cash Flow Budget:

    • It is best to prepare cash flow forecast for a minimum of 13 weeks into the future. This is because most organizations do not have enough financial strength to survive even a short-term cash flow crisis. For large or complex organizations, monthly forecast could be prepared for a minimum of six months. Only for very large organizations, annual cash flow statements could be looked at.
    • Start with the simplest of forecasts. You could scale as you gain control. If you prepare the budget in the right way, forecasting should not be too tough. Once you have a cash flow forecast, you must share it with key staff members. This would help you achieve your goals on time.
    • Engage talented Finance and Accounting (F&A) professionals internally or outsource to a specialist F&A services company for accuracy of cash flow forecasting and updating on a periodic basis.

It is evident that an organization’s success lies in finding a successful balance between producing profits and effectively managing its cash flows. Cash flow management is the core of any successful business and effective cash flow management depends on forecasting with accuracy.

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