Improve Your Cash Flow with Proper Budgeting
Preparing the annual budget for a business is often thought of as being a standalone exercise, and it is possibly one of the least popular tasks for business owners.
But budgeting and forecasting is an integral part of the business planning process. Your budget will tell you if you can afford the equipment you plan to buy. It is your budget that will guide your purchasing decisions in the coming twelve months, and your budgeted figures will provide the data that you need to prepare your cash flow forecast.
Some people believe that a budget should be like a road map, and then they lose faith in the budgeting process when they see that the figures that took so long to prepare look nothing like the actual results. But a budget should not be viewed as the route your business must follow. A business budget is an estimate and a guide to the general direction you expect the company to travel.
So, taking last year’s actuals and adding ten percent for good measure is not the way to prepare your annual budget. You need to take a slightly more scientific approach than that. Here are ten tips to help you get more out of your budgeting and forecasting.
1. Start with Your Strategic Plan
It would be advisable to set your overall business goals before you sit down and begin the number-crunching budgeting exercise. Your business goals might be to increase sales by 20% or take on more employees in the coming year. You might have plans to move to new premises, release a new product, or invest in new technology. These are the high-level goals that you will now go on to quantify in your budget.
2. Involve the Team
You will get a more realistic budget if you involve members of your team in the budgeting process, and a team that has been involved in the preparation of any target will be more committed to achieving the forecast result. You may wish to set high-level objectives yourself, but it would be better to delegate the detailed budgeting to the heads of departments.
3. Where to Begin
Do you begin the budgeting process with your forecast income? Or do you forecast your expenses first and then calculate the sales you will need to meet those costs? The truth is that when you are preparing a budget for a small business, it will be a combination of these two approaches. Preparing a budget inevitably becomes a what-if modeling exercise. You can begin the process with your strategic plan and your historical data, but then you will need to “juggle” the numbers to work out what is realistically feasible.
4. Forecasting Sales
Forecasting sales income is the trickiest part of budgeting, because sales are something you have little control over. However, you can use historical data to help you predict future sales. You can start by looking at the trends in your sales figures over the past few years. If you have experienced steady growth in sales of 10%, that could be the basis for forecasting sales for the next twelve months. You can also use the peaks and troughs in historical sales to improve the accuracy of your forecast. Is there a seasonal fluctuation in sales, for example? Did a particular marketing campaign increase sales significantly? Was there a sharp increase in sales when you employed a new salesperson?
5. Forecasting Expenditure
Forecasting expenditure is more straightforward than predicting income. You can begin budgeting expenses by listing your known fixed costs, such as office rent, professional fees, and interest payments on loans. Historical expenditure will provide the basis for future spending on items like office supplies, utilities, and other general overheads. You will then have your variable costs, which are the items of expense that vary with sales volumes. Variable costs include things like raw materials, goods purchased for resale, and packaging and delivery costs.
6. Consider Limiting Factors
When you prepare your budget, you will need to consider the knock-on effects of changes to your forecasted figures. An increase in sales, for example, might mean that you exceed your production capacity and lead to the need for investment in new machinery. If you provide professional services, you will need to consider the number of productive hours your team currently has available. An increase in sales volume can also have a knock-on effect on administrative functions, such as customer services or your finance team.
7. Consider External Factors
You cannot plan for all eventualities, but it would be advisable to evaluate the impact that external factors could have on your budget. The effect of external factors is one reason why you should be flexible in your approach to budgeting. External factors, such as a recession or a pandemic, are tricky to predict. However, you could create a worst-possible budget that would show you how badly a significant drop in sales would impact your bottom line. Having a worst-possible scenario budget will allow you to plan for such an eventuality.
8. Forecast Profit and Cash
It is essential to remember that a cash flow forecast not the same as a budget. Once you have completed your budgeted figures, you will need to prepare a separate cash flow forecast. A cash flow forecast will differ from a financial budget because it is based on when cash is received or paid rather than when invoices are raised or received. Capital expenditure will appear in your budgeted figures as an increase in the depreciation charge. But it will show in your cash flow forecast as a one-off payment for the asset’s full cost unless you have leased the item.
9. Take Your Time to Get it Right
Spending a day or more working on your budget may not be your idea of fun. Even so, an accurate budget and cash flow forecast will help you manage your business throughout the year. Whether you use an Excel spreadsheet or a budgeting software package, the more time you spend setting up your budget, the more helpful it will be to you later. The budgeting process can sometimes also yield some unexpected benefits because it focuses your mind on planning for your business’s future.
10. Maintain a Rolling Budget
Short-term predictions will always be more accurate than long-term forecasts. So, update your budget and cash flow forecast as you progress through the year. Most budgeted figures can be considered obsolete within four to six months. So, it would be advisable to maintain a rolling budget that you update at least every quarter. The initial figures that you estimated at the beginning of the year are your yardstick. The rolling budget that you update frequently is your management tool.
The Bottom Line
Take your time preparing your budget and forecasts, and you will have a valuable management tool at your disposal. And remember to involve your team in the budgeting process and to consider the limiting and external factors. But don’t expect your original budget to be the only budget you prepare. You will need to update that first forecast to reflect changes that occur during the year.
About Universal Funding
Universal Funding is a privately-owned funding source that has funded thousands of businesses and more than $2 billion since 1998. We turn your accounts receivable into the funding you need through invoice factoring and can have cash in your hands in a matter of days.