Did your New Year’s resolutions include making significant changes, gaining control over, or simply maintaining your business in its current form? If so, putting a plan in place will help you think through the critical aspects of your business and help you to make good decisions in the year ahead. Like a map, a plan can help you to see where you want to go and will help you feel more confident about how to get there. Two effective tools for planning are budgets and cash flow forecasts.
Preparing a budget is a good discipline as it encourages you to look forward and forecast what your expected income and expenditure will be for the upcoming year. This is very important if you are planning for growth as it enables this to be monitored. If a business grows too fast and payments from debtors are not being received in a timely manner, then payment of everyday business expenses may put a strain on a business’s cash flow.
Once the budget is set, regular comparison against actual performance enables you to review variances and take action as necessary. Taking a pro-active approach by planning your cash commitments for the future can help to avoid the risk of spending more money than your business is generating.
However profitable your business may appear to be, cash is still the lifeblood of any organisation. When the cash flowing into your business exceeds the cash flowing out, you can continue to operate. If the opposite is happening, you may eventually run out of money and the business may fail. It is therefore essential that business owners have a forecast of predicted cash flows in the future to ensure the business can survive.
There are five key reasons why a cash flow forecast is important:
- It identifies potential shortfalls in cash balances in advance and enables you to plan accordingly. For example, if your business is seasonal, a forecast will highlight months where you may need to find additional sources of working capital, such as a temporary overdraft.
- It confirms that your business should be able to pay its suppliers and employees on time. Suppliers who don’t get paid will soon stop supplying goods to your business.
- It can highlight problems with timing of debtor payments. It may indicate that your debt management system needs to be reviewed to ensure you have robust systems in place. You may need to introduce measures to encourage debtors to part with their cash earlier, such as early payment discounts or penalty interest for late payments.
- It indicates when it is timely to review your current banking arrangements.
- If you have a business bank loan, the bank may request cash flow forecasts at regular intervals. Producing quality budgets and cash flow forecasts demonstrates to the bank that you have a good grasp on your financial situation.
Once prepared, the budget and forecast should be reviewed on a regular basis to take into account any factors that have arisen since they were set. It is also important to make sure the appropriate members of the organisation have input into the budget and forecast process.
When mapping out the future of your business, you need to be able to see the road ahead if you want to get to where you want to go.