Proper planning prevents poor performance. Creating a budget is the first step in business financial planning. Optimizing cash flow is how companies improve financial performance. The two steps work in concert with one another. Optimizing cash flow on a regular basis can help you evolve your budget as business needs and market conditions change. In this article, we’ll explain how budgeting planning works and why it’s important for small business owners.
Creating a business budget
Your budget is a projected profit and loss (P&L) statement for a selected reporting period. Basically, that means you’re adding up projected revenues, subtracting known expenses, and predicting what your profit might be. To get these calculations, you can use numbers from a previous reporting period or estimates based on research.
Here are the steps to create a business budget.
1. Project your revenue
Previous reporting periods are helpful for determining future revenue. Outstanding accounts receivable can offer some insight also. Try to calculate, as accurately as possible, what your revenue will be for this budget period.
2. Subtract fixed costs
Fixed costs might include rent, utilities, debt payments, and payroll. These are known costs, so they’re easy to account for. Add them up and subtract them from your total projected revenue.
3. Subtract variable expenses
Variable expenses are harder to predict. Some increase with sales revenue. Others are dependent on demand. Predict what your variable costs will be based on the current market prices and your projected revenue.
4. Create an emergency fund
This is a step that many small businesses miss. Assume that something unexpected will always come up. Call it ‘Murphy’s Law’ if you like. Set aside an emergency fund to be prepared for the unexpected.
5. Generate a profit and loss statement
Run a basic P&L statement with the numbers from the previous steps. This is not your actual budget, but it will tell you if your budget is going to work. If not, go back to the first step and try again.
6. Finalize your budget
If your profit and loss analysis looks good, finalize your budget. Roll it out to internal partners, accounting, and department heads with ‘sub-accounts’ that may be relevant to your budget planning.
Cash management optimization
Dwight D. Eisenhower once said, “In preparing for battle, I have always found that plans are useless, but planning is indispensable.” He was talking about being adaptive to change. Cash management optimization often reveals that the original budget hypotheses were incorrect. It’s important to be open-minded enough to make changes when that happens.
A good example of this is the loss of a large paying client midway through the budget cycle. That changes the revenue numbers, but fixed costs remain the same. Cash flow slows down. Bills are still due. If you manage your cash properly, you’ll pay those bills on their due dates, not far in advance. That gives your business a bit more runway when revenue is lost or delayed.
Optimizing cash flow can include planning out bill payments or negotiating with vendors for better payment terms. Collect money owed to you as soon as possible and pay out money owed to others only when it becomes due. That keeps cash in the bank longer to ensure that all bills and expenses get covered. This is how you achieve positive cash flow.
Ways to improve cash flow
Revenue isn’t the only way to generate the cash needed to pay your monthly bills. Many businesses use debt financing when cash runs low. That could mean taking out a small business loan, paying bills with a business credit card, or applying for a business line of credit. These can all provide the funds you need to cover overhead and expenses until new revenue comes in.
Taking on debt can be expensive, so review the terms and conditions carefully on any new credit account. Compare interest rates and weigh the pros and cons of a line of credit versus a loan. Typically, business lines of credit are more flexible. They allow you to take and pay for only the amount of money you need. Seasonal businesses often use credit lines to get through the offseason.
How to manage your budget and cash flow over time
The key to successful business budget planning is to reevaluate your plan regularly. Market conditions change, prices go up and down, revenue rises and falls. Optimize your cash flow so you always have enough to cover what comes next and change budget thresholds to adapt when necessary. Budgeting is not something you do once. It should be an integral part of your day-to-day business operations.
