How to create a cash budget
Earlier this morning, I went out cycling with my good friend Julie. Julie is
a prospective entrepreneur and considering opening an online sports equipment
retailing site.
As we rode along in the fresh air and sunshine of a beautiful North
Carolinian Fall morning, we discussed a pitfall common among new business
owners. In short, while many pre-launch business plans develop into lengthy
tomes covering a vast array of planned operations, they often fail in one
critical respect. And that failure has been the thorn in the paw of more than a
few lions of enterprise, who might otherwise be kings of their respective
jungles.
What is this great weakness?
Despite a preponderance of data and reams of financial analysis, the simple
truth is that many business plans neglect adequate planning for cash positions.
Sure, the plans have carefully-constructed pro-forma statements of profit and
loss, and balance sheets for the foreseeable future. On the scale of a year of
operations - the critical first year, in particular - a business may seem to
make money. When projected revenues exceed projected expenses, it is easy for an
anxious entrepreneur to think that everything is going to go well. The problem
is that cash provided from operations is often not adequate to carry the
business through the build-up period and into the zone of self-sufficiency.
To avoid surprises such as this, construct a cash budget.
A cash budget is simply a systematic projection of a business's cash flow,
taking revenue collections and cash expenses into consideration. There are
typically four budgets that come before and drive the cash budget: sales, cash
receipts, selling expenses, and general & administrative expenses. With these
forecasts established, the computation of a company's cash position for any
given period is a matter of simple arithmetic.
The math is straightforward:
| |
Beginning cash
balance |
|
+ |
Cash receipts
(from cash receipts budget) |
|
- |
Selling
expenses (from selling expenses budget) |
|
- |
General & administrative expenses (from G & A budget) |
|
= |
Ending cash balance |
A more sophisticated cash budget model would also take into consideration
short-term loans and repayments, as well as interest expense from such
borrowings.
The most valuable aspect of a cash budget is being able to see in advance all
of the points where the ending balance goes negative. To avoid that, business
planners may choose to alter plans to decrease expenses, generate more cash
earlier on, or secure additional financing. Of course, not all of these options
are possible, in all circumstances.
In any event, the foresight created by a well-prepared cash budget can help
entrepreneurs avoid making costly mistakes. My friend Julie will be prepared to
include a cash budget in her business plan, and will therefore be in a better
position to make a thorough critical analysis of her business plan and avoid
costly mistakes, before passing the point of no return.
How about you?
For a sample cash budget created in Microsoft Excel (provided at no charge),
simply
send me an e-mail to request it.
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