Planning for the future is essential for business success. Yet still, none of us has a crystal ball through which we can see what lies ahead. Because of this element of uncertainty forecasting and budgeting remains one of the most under-utilised business tools for clients all over the globe.
Think about it for a second and it is actually not that surprising as most people fear the unknown...so they will rather do nothing than face something they are uncertain about.
To make more confident decisions however, you need to have some sort of sense of what may lie ahead. How are you going to gauge these future events of your business then? Well, through the effective implementation and monthly management of a budget as well as a cash flow forecast.
Understanding the difference between your budget and forecasts however is critical to understand the role each gets to play.
What is a budget?
Your budget is compiled from two sets of data – income and expenses – showing how much profit your business is planning to make. This information is commonly sourced from your Profit & Loss statement.
Accounting principles implies that you will record income and expenses when they are incurred, regardless of when they are paid. This results in a monthly profit/loss figure.
This is the standard way of accounting and lenders such as banks or SARS even, will ask you to submit your financial report in this manner.
As you can imagine, this picture may (in most cases WILL) look vastly different than the one your bank statement transactions would have painted.
How do you compile a budget?
To compile a budget, you’ll need to have a good understanding of the income you’re earning and the expenses you’re incurring. Some good quality record keeping from your accounting records/via your accountant is an awesome place to start.
The best way to budget for future income and expenses is to use actual data. What better place to start than with the actual income and expenses your business incurred in previous years?
Secondly it is critical that you know where your break-even point is. This will highlight how much you need to earn to pay all your expenses or if you may have too many expenses.
Ensure that you use the same account categories your accounting records is set up to use so that you can easily track your budget vs actual figures each month.
"Nothing happens without focus. Don't try to do everything at once. Take it one step at a time"
- Dave Ramsey
What is a cash flow forecast?
A cash flow forecast is a plan of when cash will come into and flow out of your business. A forecast can’t show whether your business is making a profit, but it will clearly show you if you’ll have any money left at the end of the month, after paying all your expenses.
Cash flow forecasts are best used proactively rather than reactively. Ideally, you should be reviewing your cash flow forecast monthly for the month ahead. This will enable you to estimate any cash shortages and how to manage them.
Once you can start to see the future fluctuations of your cash flow, you can start to make operational changes well in advance, to try and compensate for any difficulties you pre-empt.
Remember, if the transaction affects your bank balance, it needs to be included in the forecast.
How do you implement a cash flow forecast?
You can do this the easy way or the hard way...we simply love technology and will always prefer to use the tools at our disposal to do things simpler and faster. If you’re like us, you’d want to access your accounting records and extract the data from there. This will only be doable however if all your bookkeeping is up to date and correctly allocated.
If you’re a sucker for punishment however, you could always go the manual route and allocate each line item directly from your bank statements.
Make sure you have your opening balance inserted as this always forms the starting point of the forecast. You can then put in monthly forecasts for cash in and out based on when and how much customers pay, and when you expect to pay overheads and suppliers.
Two main things that you would need to take in consideration. Because your budget is compiled from income and expenses as they are incurred and not when they are paid, it forms quite a fixed report.
Your cash flow forecast will be a living breathing thing that will change as and when things happen. Late paying customers for instance would impact the time in which you estimate to receive their money and if it will no longer be received in the current month, you’ll need to move it forward on your forecast. The big challenge with this is that clients that use a manual way to compile their forecasts, will constantly need to check that their forecast is still up to date with their accounting records.
Which one do you use then?
A budget will show you whether or not you’re profitable and validate many questions such as: “Am I billing enough?”, “Do we charge enough for our services?” or “Why isn’t there any cash left even though everyone is working at full capacity?”.
A cash flow forecast however is the punch in the tummy that will show you how much cash is available to you. It is imperative that you have both means of forecasting as it paints you a more complete view of your business’s finances. The interaction between is organic in nature and what happens on the one, will invariably impact the other also.
Exactly “HOW” it will be affected is what you’re really keen to find out as this will assist you in better dealing with any challenges headed your way.
If you would like more information on this, you are welcome to grab a copy of our free eBook below.
9 Strategic pitstops to speed up your journey to a more profitable business
Luan van Rhyn is a registered Professional Accountant (SA) and Chief Dreamer and Founder of Calypso Accounting. Luan and his team are passionate about helping SME’s grow and streamline their businesses and are continuously looking for ways to help improve their clients’ bottom line.