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A Budget Is Not a Cashflow Projection, but Here’s How to Create One

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A Budget Is Not a Cashflow Projection, but Here’s How to Create One

A budget is defined as: “an estimate, often itemised, of expected income and expense for a given period in the future.” A cashflow projection is defined as: “the movement of money into and out of a business; a prediction of such movement over a given period.” In a simple business where everything is cash, the two are identical.  However, the vast majority of businesses are not run on a pure cash basis.

Most businesses will buy their goods and services on credit, paying for these items, some time after actually taking possession of the items or receiving the service.  Businesses also often will provide their goods or services to their customers or clients, provide them with an invoice and get paid at a time long after the goods were delivered or collected or the services provided.

These types of transactions are what accountants call accrual accounting.  This is defined as: “a charge incurred in one accounting period that has not been paid by the end of it.”

What accountants are aiming to achieve using this method is to match expenses and costs spent with the income in the particular period.  For example, consider the situation where a business sells B2B and provides 30-day credit terms to all their clients.  The clients pay 30 days or more after they receive the invoice.  So in the month that the work is completed, the business pays the staff their wages and other costs but doesn’t receive any money for the work they’ve actually done that month.  At the end of the month, the business invoices their client for that months’ work and the client pays at the end of the next month or into the following month.

Allocation of Income and Expenses in A 12 Month Budget

This same business needs to have both a budget and a cashflow projection.  The budget will show what the revenue will be month by month, and what the expenses will be that relate to earning the revenue and all the other fixed overhead costs of the business.  A budget will take costs that are paid annually and spread them equally over the 12 months.  Similarly, a budget will take costs that are paid quarterly and spread them evenly over the 3 months in each quarter.

Using the Budget to Create the Cashflow Projection

Having put together the budget, which must be done first, you can then consider creating the cashflow projection. The cashflow projection takes into account the timing of expected receipt of income payments and the expecting timing of payment of expenses and costs.

For example, if our business above received payment of his invoices from his clients on average 60 days after the date of the invoice, the cashflow projection will show a 2-month delay on each month’s income compared to the budget. Expenses which are paid annually and quarterly need to be entered into the relevant months for payment and other costs which are monthly, included each month.

As in the example above on the income side, so too can you have the same situation with the payment of your costs and expenses.  You may well have a 30-day account with your major suppliers, and you may well pay your account later than 30 days’ after the invoice was issued.

In Summary

When preparing a cashflow projection, it is imperative to use the budget as the starting point and then consider every revenue line and each expense line to identify what the timing of receipt of income and payment of expenses will be and then move the amounts from the budget into the correct months for the cashflow projection.

What so often happens is the budget may well look good with a nice profit expected, but when you prepare the cashflow projection, there may be some challenging months where there is not enough cash to pay the bills.  Having the separate cashflow projection in addition to the budget will allow you to identify when you expect to have cashflow issues and use these reports to talk to your bank manager about short-term funding and how you will be able to pay it back.

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