How to Budget for Cash in Small Business

The concept of cash budgeting, or cash flow forecasting as it is otherwise known, is not new. Many large companies have been using the technique as a tool of management for many years. It is, perhaps, only during the past five or ten years that cash flow forecasting in smaller businesses has gained some momentum-However, there still exists more than a measure of resistance to its use and its validity in the context of operating a small busi­ness is often denied. This is unfortunate. Company success and, in some cases, survival is dependent on the achievement of a mix of two main factors, namely profitability and liquidity. Although profitability is obviously a vital ingredient, it is equally important that liquidity is maintained. The most common reason for the demise of a business is that it is unable to meet its commitments as they fall due. Obviously, many factors can con­tribute to the onset of such a crisis, but liquidation or bankruptcy inevitably follows when the business runs out of cash.

Small Business

A cash flow forecast is based on a set of well-defined assump­tions and inevitably the ‘actual’ cash flows will not always corre­late precisely with the original projection. This discrepancy occurs because the cash plan is developed from the various budgets for sales, cost of sales, overheads and profit, which are themselves based on assumptions and the views of the manage­ment as to the future. However, given that a case is made for business planning in order that the corporate objectives can be achieved by maximising the use of the available resources, it follows that the planning process should incorporate the manage­ment of cash, arguably the scarcest of resources.

A cash flow forecast should enable the businessman to answer the following questions:

1. Can the plans which I have for my business for, say, the next six or twelve months, be achieved within the available cash resources?

2. What effect will any planned capital expenditure have on the cash position?

3. At what time will further finance be required from the bank and what type of facilities will be needed?

The technique of cash flow forecasting, used intelligently and updated regularly, can, together with the other planning ‘tools’, provide information vital to the effective management and con­trol of a business.

The formulation of a cash flow forecast is, for most businesses, a relatively simple operation, provided that ade­quate base information – the various operating and capital expenditure budgets – is available. Some businessmen attempt to produce cash flow forecasts without preparing these two original budgets, but this method has the inherent risk of inaccuracies. The cash flow forecast is, therefore, a restatement in cash terms of the original budgets, taking in account the timing differences and excluding the non-cash items of revenue and expenditure.

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About the Author: Marie Mayle is a contributor to the MegaHowTo team, writer, and entrepreneur based in California USA. She holds a degree in Business Administration. She loves to write about business and finance issues and how to tackle them.

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