Cash Flow Budgeting and Forecasting

In this article, cash flow budgeting and forecasting will take center stage, with a spotlight on why this particular planning process is helpful to CFOs and companies in today’s business culture.

This blog has covered different aspects of financial planning for different enterprise resource planning (ERP) systems and different industries.  Cash flow budgeting and forecasting are a couple of processes that zoom in on your actual cash money, specifically in terms of payments going out for payroll and debtors and the cash coming in from customers.  In other words, a cash flow budget showcases a company’s monthly capital requirement.  And unlike the more traditional operational and transactional budgeting, cash flow budgets are a little bit more complex because there are more unknown figures to calculate and analyze.  This article will zoom in on the process, so you can understand more about the ins and outs, as well as the benefits for your company.

Cash comes in and goes out from various sources.  For example, investments, loan proceeds, sale of assets and general sales bring cash in for your company.  Direct expenses, principal debt service, and purchasing assets require company cash output.  Cash flow budgets are typically utilized to evaluate whether you have adequate cash to perform regular operations, as well as ensuring that cash isn’t being allocated to unproductive or ineffective areas.  Among many benefits, a cash flow budget empowers a company with the knowledge of how much credit it can extend to customers before beginning to have liquidity problems.  And this specific type of budget has particular aspects that speak to the future by evaluating the company’s past performance.

Cash flow budgets are comprised of a set of elements.  In particular, capital requirements, cost of goods, development expenses, operating expenses, and sales and revenue are all highlighted by a cash flow budget.  And like every other quality budget, your cash flow projections rely on past performance data.  In order to forecast your cash flow, you will begin by looking at your estimated sales for the next year, related to the percentage of business volume produced monthly.  You’ll divide each month’s sales by cash and credit sales.  Your cash sales can be recorded in the cash flow report in the same month they’re generated.  As for your credit sales, they are not credit card sales that are treated as cash, but instead, they are invoiced sales with agreed-upon terms.  Therefore, you will want to look at your AR (accounts receivable) records and figure out your typical collection period.  You won’t be able to log your credit sales as cash until 5-10 days after the period ends because you are waiting on another bank to receive payment.

Next up is other income.  More specifically, the next line item on a cash flow statement is the revenue you get from investments, interest accrued on loans that have been extended, and liquidating any assets.  The sum of cash sales, receivables and other income is your total income.  In your first month of cash flow budgeting, it will typically be comprised of cash sales, other income, and any receivables from the previous budget that have matured to a collection point during the first month of the current budget.

You are also going to need to consider your cost of goods (COGs) and direct labor, if you are producing a product.  Once you have broken down the sales by month, you need to figure out the cost of materials and labor needed to manifest those sales.  You should already have a good idea of COGs, but you’ll need to determine how much direct labor will be requisite for the year to put out your product.  Divide this number by the percentage breakdown of your sales.  You can log direct labor into your cash flow during the same month in which it is accrued.  COGs are a little different though.

With material costs, you will need to utilize a time frame that enables you to convert the COGs in cash flow into your finished goods for sale.  For example, if it takes you 60 days to develop your raw materials into finished goods, and your payable period is 30 days after the product is delivered, then you will enter the COGs under material in cash flow 30 days before you log your sales.  You’ll also want to consider your operational expenses.

You can determine your working capital from your operating expenses because your personnel and overhead costs are tied to sales.  You can divide your administrative and general, marketing and sales, and overhead expenses by your total operating expenses projection.  Then, divide that total by the percentage breakdown of sales for each month and plug that number into the appropriate line items in your cash flow statement.  Capital equipment costs are another aspect of cash flow budgeting.

Under the capital heading, you can include capital equipment costs.  If you can handle added debt or purchase your equipment from operating expenses, then you should purchase and install your equipment at the beginning of the business year or quarter closest to when you’ll need that equipment.  If your cash flow is tighter, then it might be better to wait to purchase and install your equipment when the expenditure makes more sense because of additional volume.  This way, you are ensuring that you have adequate cash flow to handle the added debt service or purchasing the equipment outright.  You’ll want to also include your long-term debt and your tax obligations in your cash flow budget.

Once all of these costs are input into your cash flow budget, the sum is your total expenses.  Subtract your total expenses from your total income, and you have your cash flow.  If it is a deficit, you will want to determine the minimum cash balance you would like to maintain.  Then, calculate the difference between your minimum and the deficit.  This is the amount required for financing purposes.

The good news is that the best modern budgeting and forecasting tools can help you achieve your cash flow planning process goals in streamlined, powerful, and dynamic ways.  There are a couple of different ways to accomplish cash flow budgeting.  First, you can budget the income statement and the balance sheet, and the cash flow comes from these inputs.  This is how the actual reporting would work.  In this case, there is no input directly to cash, and it is simply running a report.  Additionally, you can create a cash flow budget form.  This would give the ability to input assumptions, pull data from other forms, and calculate a cash flow.  Solver offers an Excel- and Web-based budgeting module stand-alone and as part of the comprehensive suite of BI modules and would be happy to answer questions and generally review BI360’s easy-to-use Planning solution for collaborative, streamlined cash flow decision-making capabilities.

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