Budgeting and cash flow forecasting

Understanding the basics of budgeting and cash flow forecasting is essential for small business owners. Budgeting and cash flow forecasting are vital financial tools that help businesses take control of their finances. Linking budgeting and cash flow forecasting helps business owners make informed decisions to achieve long-term business growth.

Budget – the plan

A budget is a financial plan of how a business will use its cash. It outlines the expected income and expenditure of a business for a defined period, usually a year. It enables businesses to track and monitor their progress in achieving their goals.

Cash flow forecast

A cash flow forecast shows how much cash a business anticipates generating and spending over a specified period. It estimates the timings of cash that will flow into and out of a business over a specified period. A cash flow forecast helps a business identify potential cash shortages and surpluses. It helps ensure a business can meet its cash obligations.

Accruals basis of accounting

Most companies prepare their financial accounts on an accruals basis, in accordance with accounting principles. With the accruals basis of accounting income and expenditure are recognised when they are earned or incurred.

Timing differences

The key difference between a budget and a cash flow forecast is timing differences. Budgets are based on the accruals basis, recognising income and expenses when they are earned or incurred, regardless of when the physical cash is received or paid. Cash flow forecasting focuses on the timings of the actual movement of cash.

Integrated approach

Whilst budgeting and cash flow forecasting differ in timings, there is an inherent link between them. By linking budgeting and cash flow forecasting, businesses can identify differences and timing links between their accrual based income and expenses and their actual cash inflows and outflows.

Common timing differences

Here are some of the more common timing differences between a budget and a cash flow forecast:

Sales

Sales are recognised within the budget in the month of the expected sale. Businesses frequently offer payment terms of 30 days on their sales, resulting in a delay in cash receipts. Consequently, the actual receipt of cash appears in the following month in the cash flow forecast. As an example, a £1,000 sale in May, will appear under May in the budget and show as a cash inflow of £1,000 in June, in the cash flow forecast.

Purchases

Likewise, purchases are included under the month of purchase in the budget. For purchases made on credit, the physical cash outflow appears under the month of physical payment in the cash flow forecast.

Payroll

In the budget, the full salary amount plus employers’ national insurance will appear for a month. e.g., May. In the cash flow forecast, the net pay appears under May. Payroll deductions and national insurance are payable to HMRC in the subsequent month. The payment to HMRC for May’s payroll deductions and national insurance will appear under June in the cash flow forecast.

Depreciation

Depreciation is the allocation or amortisation of the capital costs of assets over their useful life. As an example, equipment with a useful working life of 5 years must be accounted for as an expense over the 5 years. This matches the cost of the equipment to the income that it generates over the 5 years. Depreciation is included in a budget but is not included in cash flow forecasts. It is usual to have a section in the cash flow forecast for new capital expenditure. This allows a business to make sure it has sufficient cash resources to purchase new equipment in the future.

Tax and VAT timings

Various taxes are payable at different times of the year. Corporation tax is payable annually, and VAT is usually payable quarterly. Budgets should include a monthly estimate of the VAT and tax liability. The cash flow forecast will show the actual timings of the tax and VAT payments using the budget estimates. To ensure a business has the cash resources to pay its tax liabilities when they become due, it is prudent to have a monthly cash transfer to a tax savings pot.

Examples

Below are excerpts of an example budget and associated cash flow for three months. This provides a basic overview of some of the timing differences between a budget and cash flow forecast.

Variance analysis

It is important to review the budget and compare the budgeted figures against the actual figures from the accounts. This process is variance analysis and allows a business to see where they have deviated from the budgeted plan. This helps the business to highlight and investigate the reasons for any deviations and make any necessary changes. This helps put the business back on track to achieving its business plan.

Cash flow forecast versus actual cash movements

Comparing the cash flow forecast against the timings of actual cash inflows and outflows in the bank accounts is a vital exercise. This allows a business to check the accuracy of its forecasting, identify trends and issues, and prevent cash flow shortages.

Benefits of budgeting and cash flow forecasting:

• Improved financial control – Better control over the finances preventing overspending.
• Informed decision-making – financial decisions are based on accurate data and projections.
• Improved liquidity – businesses can plan for future cash needs, avoid cash flow disruptions, and ensure they can meet financial obligations when due.

Cash flow forecasting with cloud accounting software

There are a number of inexpensive cloud based accounting software packages that offer cash flow forecasting functionality. Read more in our post about cloud accounting.

Budgeting resources:

Visit our shop for some useful budgeting resources: