Smoothing out cash flow is a huge issue for most small businesses. It doesn't matter what type of business you run, you must do what it takes to ensure you have enough cash in your business to not only survive the lean times, but to make informed decisions about sales campaigns, rolling out new products or services, client projects and operational purchases.
To better track and predict your cash flow, you need to create a 12-month cash flow budget. The information will help you be proactive and give you the time needed to address the issue before it becomes critical.
The most important thing to remember about a cash flow budget is that it’s not just numbers. It tells the story of your business and can help you decide when situations are high, medium or low risk to your company’s survival.
How to Create a Cash Flow Budget
Your cash flow budget should contain six data points. (You can pick up a copy of the free cash flow budget worksheet template to help you understand and set up the structure for your business.)
- Total Sales
- Total Expenses
- Cash Flow Surplus/Deficit
- Opening Cash Balance
- Closing Cash Balance
- Minimum Cash Target
You’ll first need to add up sales and expenses detail to get the totals needed for your monthly calculations. Total Sales minus Total Expenses will show your Cash Flow Surplus or Deficit for any given month. That amount added to your Opening Cash Balance will provide your Closing Cash Balance. The result will indicate whether your business will be cash flow positive or negative for any given month.
You also want to include a Minimum Cash Target. This is the amount of cash you want to keep on hand in your business for emergency situations. A good rule of thumb is an amount equal to three to six months of expenses.
A Cash Flow Budget in Action
Lots of small businesses think a contract with a big company will be the answer to their dreams. But that’s not necessarily the case. It could be the catalyst that puts your company out of business.
Sounds pretty counterintuitive, huh? Here’s an example.
John runs a Web services company with five employees which provides online presentation services to a broad sector of the small to medium business market. Each client that comes on board is assigned an account executive to take care of their business requests from concept to completion.
The company keeps several prospects in the sales pipeline so he has a steady flow of work for the team and manages to keep the cash flow in balance. They’re not flush with cash, and have come close to going negative on occasion, but they’ve managed to squeak through and maintain a positive bottom line.
An opportunity has come up to do business with a Fortune 500 company. The monthly contract payments will be more than all of the combined payments John’s company receives today from a variety of clients. The project is expected to last for one year with annual renewal options.
John is ready to sign the contract now. But that would be a big mistake.
Taking on this big contract will require use of all the company’s current resources, leaving no one to service the tried and true customers who have kept them in business over the years and could very well put the company out of business, since large companies typically take much longer to pay their bills.
Here are two charts. The first is what the cash flow budget looks like currently; the second is what it could look like if they take on the corporate client. Notice how the corporate contract would impact Month 2 and 3.
Current Cash Flow Budget
| Month 1 | Month 2 | Month 3 | Month 4 | Month 5 | Month 6 |
Sales | $ 35,085 | $ 41,305 | $ 33,405 | $ 34,925 | $ 32,905 | $ 38,645 |
Expenses | $ 32,875 | $ 32,875 | $ 32,875 | $ 32,875 | $ 32,875 | $ 32,875 |
Cash Surplus/Deficit | $ 2,210 | $ 8,430 | $ 530 | $ 2,050 | $ 30 | $ 5,770 |
Cash Flow Budget With Corporate Client
| Month 1 | Month 2 | Month 3 | Month 4 | Month 5 | Month 6 |
Sales | $ 35,085 | $ 0 | $ 0 | $ 42,000 | $ 42,000 | $ 42,000 |
Expenses | $ 32,875 | $ 32,875 | $ 32,875 | $ 32,875 | $ 32,875 | $ 32,875 |
Cash Surplus/Deficit | $ 2,210 | ($ 32,875) | ($ 32,875) | $ 9,125 | $ 9,125 | $ 9,125 |
Knowing how accepting the new client project will affect cash flow allows John to make an informed decision about what action he will take before he’s faced with a critical situation.
An Invaluable Decision-Making Tool
A cash flow budget can be used to determine the risk and impact of most company decisions and can give you an opportunity to develop your options for addressing each issue. A good rule of thumb is to take about 30 minutes a week to review your budget, update the numbers if needed, and look at what’s going to happen in the next three to six months.
Wouldn’t you rather be running your company from an informed position? Start today by sitting down and creating your cash flow budget so you have a clear picture of your business situation.
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