Budgeting - Forecasting Profit and Cashflow For A Future Period

By: Mark Bailey Click author's name for more of his/her articles

Perhaps one of the most important tools for small business success is the financial budget. This is a forecast of the expected income and expenditure that will be generated by the operations of the business for a period into the future. The time period extends from several months to a year or more ahead of the present time. The financial budget also encompasses the cash flow forecast for the same time period.

Critical Features of a Budget

Many small business owners are stumped when requested to develop a budget of their business activity. Yet this document is crucial for better appreciation of the long term viability of a business. And it is most often the primary information that bankers will revert to in the business plan when deciding your request for a loan to fund your business activities.

Although budgets can be prepared for almost any area of business, such operational areas like purchasing and inventory, financial budgets provide the most meaningful information for your overall decision making. The financial budget is a crucial component of your business' financial planning. It involves a detailed breakdown of the various categories of revenue and expenditure that are likely to impinge upon the long term profitability and liquidity of your business.

Normally prepared as a corollary to the year end financial statements, budgets are usually more appropriate as monthly, quarterly or yearly forecasts of profit and cash flow. Monthly budgets reveal the anticipated revenue that the business will likely earn from its business activities and the predicted corresponding expenditure. This powerful tool assists you in keeping abreast of the financial condition of your business. It enables you to make pertinent decisions that affect business operations such as when to curtail expenditure on non essential services to leverage debt when sales are sluggish.

Each month's anticipated sales will be matched against an estimate of the expenses your business will incur in relation to the sales. Expenses will include book figures for depreciation and an estimate of possible bad debts. The cost of sales will be knocked off against the sales to arrive at the forecast gross profit. The forecast gross and net profits in the budget are what your business would ideally be able to achieve given the level of sales anticipated.

What Budgets Reveal

Your bookkeeper prepares a budget of your profit and loss account and balance sheet based on certain assumptions. These would include the percentage at which turnover will increase month to month and the cost increases for purchases. The growth of your business is revealed primarily by the growth in sales. Your budget will identify if the pricing structure of your products is too stiff and how this impacts your gross profits. You will know what it will cost to stock the required inventory for the anticipated future sales and the corresponding cost of purchases. The budgeted expenses provide you with a fair idea of your expenditure in the forthcoming months. You can even determine if your payroll should be trimmed as payroll costs are fixed and payable regardless of the level of sales.

From an analysis of your budget your bookkeeper will be able to advise on the impact of any new equipment purchases you may be thinking of purchasing such as a new van or forklift. If you intended to borrow funds to expand your premises, the budget will reveal impact of this mode of financing on the profits through the payment of interest or repayment of capital. You will also know how much you can borrow before you the business profitability is affected.

Forecasting Cash Flow

Once your budgeted financial statements have been prepared, your accounting services will then prepare the forecast cash flow for the same time period covered by the financial statements. The cash flow forecast is a statement of the inflow and outflow of cash from business operations. It reveals the liquidity of the business.
The cash flow forecast takes account of the anticipated receipts from customers of sales made and potential payment to creditors for purchases done. Interest and capital repayments of debt are also factored in as are purchases of inventory. The net result of the inflow and outflow could be a net inflow of cash into the business or a net outflow of cash outside of the business.

When your business experiences a net inflow of cash, this signals that your operation is liquid and financially sound. A net outflow of cash, especially if forecasted to extend for months, will throw the continued viability of the business into question. An illiquid business is a prime target for bankruptcy as banks foreclose on outstanding debts and creditors initiate actions to recoup their losses.

An entity may be highly profitable. However, if it lacks sufficient liquidity, the business will not be able to service debts as they fall due. Eventually the working capital cycle will be drastically affected and this may spell potential business failure.

Having a budget and cash flow forecast gives you a very good idea of whether or not your business will remain a profitable venture. Your budget serves as a benchmark against which actual income and expenditure can be compared. It's a vital tool for controlling your business and essential for knowing the direction your operations is heading. Without a budget you may not know if your sales will be sufficient to cover the corresponding expenses. You will not be able to determine your profits for future periods and cannot make realistic plans for the expansion or curtailment of operations.

The cash flow forecast indicates the amount of money your business will make and its liquidity level in the coming months. A net inflow of cash augurs well for the success of the business.
Bookkeeping Central (http://www.bookkeepingcentral.com.au) has the capability of doing exemplary budgets for small businesses, providing forecasts of profits and cash flow that will assist business owners to better control their operations. Highly experienced and qualified bookkeepers handle the entire budgeting and cash flow forecasting process based on a thorough understanding of the unique intricacies of your business.