Most small businesses focus their attention on growing sales and reducing costs.
Detailed budgets are often created to set targets for sales and spending. While this level of attention to costs and revenues is crucial, equal attention should be paid to the cash flow situation within the business.
While many small businesses create some form of cash flow budgeting, it often does not get the focus or level of detail that it deserves.
Cash truly is the blood of your company. Without cash flowing through your business, operating efficiently and effectively is impossible. While it is possible to survive with a struggling cash flow situation, it is nearly impossible to maximize your profits if your cash flow situation is not in good standing.
When you create your budgets, either monthly, semi-annually or annually, it is important and necessary to include cash flow budgeting in the process. By budgeting out the cash flow situation, you can understand when your business may need help from outside institutions (loans etc). It can also paint a picture of when major purchases would best be made, by determining when cash will be at its highest and when it makes sense to make major purchases.
By budgeting the cash flow, a small business can anticipate any problems with cash shortages, which could lead to delays in payments to vendors. While we should always strive to pay our vendors in a timely fashion, if we know ahead of time that we may be a few days late in payment, giving our vendors a heads up in advance is almost always acceptable and can eliminate late charges.
When budgeting out the cash flow situation, it is important to recognize that it is not a 'cut and dry' procedure. Just like sales forecasting is not an exact science, cash flow budgeting also has a range of possible outcomes. It is critical that the small business budget various cash flow scenarios to see how different sales and cost situations will affect the cash flow of the business.
Once again, by completing such detailed budgets, the small business will be better prepared to deal with a variety of possible outcomes.
When analyzing the various potential cash flow scenarios it is necessary to understand the implications of running out of cash and requiring a loan. If your business is constantly taking out short term loans to meet its spending needs, your business is not maximizing its retained earnings due to interest paid on these loans. By properly budgeting for cash flow situations, a small business owner can determine in advance when they will have cash needs and take appropriate action.
For example, a sun tan lotion company may have cash needs in the winter months, requiring loans and paying interest. By budgeting out the cash flow scenarios, the sun tan lotion company could shift around spending in order to have enough cash on hand to make their payments during the winter months. Or the company could anticipate the cash shortages and discuss payment options with their vendors that could be significantly less than the interest paid on bank or other loans.
While budgeting cash flow scenarios is not a guarantee that your business will meet all its cash flow needs, it is a solid way to understand where the company stands in terms of meeting their obligations. A business that manages their cash flow well is more likely to succeed to than a business that rides by the seat of their pants. In addition, by budgeting and planning your cash flow you can find ways to maximize your profits and retained earnings.