The Importance of Creating a Budget and Managing Cash Flow

These important financial documents will help you plan and manage your business more effectively

BY MICHELE WILLIAMS

Many of us are feeling the current hiccups in the supply chain and other disruptions that are making it difficult to complete jobs on time. And with these disruptions, we are not getting paid in a timely manner. The trickledown from this is a cash-flow crunch.

Even in a year of healthy supply chains, cash flow can be an issue if not managed closely. That’s why I believe it’s vital to monitor not just a cash-flow statement but a budget that will help you create the most accurate cash-flow statement possible. What is cash flow? Simply put, it is the cash coming in and out of your business at any given time. We usually manage cash flow by looking to see what is in our bank accounts.

Before each year begins, create a budget for your company. This budget will show how much revenue you expect to come into the company and what income sources are most likely to deliver the funds. In addition to income, note the estimated cost of goods and gross profit derived from this. Then, list each expense category with the estimated amount that will be spent on that item throughout the year. Think of this as a glimpse of what you are expecting your profit and loss statement to look like at the end of the year in summary form. Now, to create a statement of cash flows, we will look at what is actually coming in and out of your bank accounts at any given time that are working toward this budget you have created. It may be that January is a heavy-expense month, and for someone else, July is their heavy-expense month. A future statement of cash flows allows you to estimate monthly (or whatever time frame you are working with) what will come in and out (flow) through your firm. Knowing this gives you much-needed information on how much money needs to be on hand at any given time for expenses such as payroll and extra money on hand.

Managing to the budget and cash-flow statements each month creates a healthy view of your current financial status. A statement of cash flows is usually managed against your bank account and is created in a spreadsheet format. At the end of each month, after reconciliation, the cash in and out is compared to the estimated in and out for that month.

It is good form to update the cash-flow document each month with the actuals and then adjust the future months for anything that needs to be taken into consideration. This adjustment could be higher profits because you sold more than you thought in the time frame, or it could be reduced profits because there were expenses you did not plan on that month. Either way, you are forecasting forward to see what is happening in your business so that you can make decisions with the most current financial information and plans in mind.

Why does cash flow seem to be crunching more now than ever? Because our clients are often holding on to the final payments until the installs are completed—and we can’t complete them. This is money that we may have planned to come in for the month of July and now it won’t come in until October. You can start to see the domino effect when these payments pile up and the only way to bring in more money is to take on more work now with upfront payments.

One of the first things I do with my clients is look at their cash-flow cycle. How much are they getting up front in a new sale? When are payments due and based on what work product? How much in accounts receivable are they OK with? How do we go about reducing accounts receivable so that we have more money to pay ourselves, our employees and our contractors, and to run the company?

Knowing your cash-flow needs each month is also very important. How much available cash do you need on hand to meet the monthly obligations of the firm? Every business owner should know this number. This indicator informs our marketing, sales process and delivery follow-through. To be able to confidently make decisions about your company, and to know how making a purchase affects the business going forward, create a yearly budget and statement of cash flows, then manage to them monthly. Your understanding of where every dollar goes in your firm will be enlightening and allow you to really manage the finances with ease. V

Michele Williams is the owner of Scarlet Thread Consulting, an advisory and coaching firm focused on profitability for the interior design industry. She works with designers to scale and grow their firms with ease so that they can reclaim their time and be paid a consistent salary. She is also the host of the popular podcast “Profit is a Choice.” Learn more about her online class, including Master Your Profit, on her website.