The cooler weather, the start of football, it can only mean one thing: budget season! 

Yes, it is very near the time of year when the accountants prepare their crystal balls about the expected sales and expenses for the next calendar year.

As you have heard a thousand times, “Cash is King”. The absence of cash is blamed for the premature death of many great business ideas.

Many budgets simply compare expected revenue for the year as an annual line item.  The budget appears just like the profit and loss (P&L) appears in the financial statements.  While this provides an easy comparison for variance analysis, it does not assist with the timing of the cash and the overall timing of the budget.

Time the Cash

For this reason, every business (and non-profit) needs a management cash flow budget. This is a monthly breakdown of cash income, cash expenses and required debt payments prepared specifically for managing the company.

It is not a method of accounting like Book or Cash Basis, rather a report tracking the lifeblood of the business. This report transitions the business from not only “how much” but also to the question of “when” in determining cash needs.

Here are three steps to creating a management cash flow from a P&L for your business.

1.  Count your cash receipts

​No funny business here. This has nothing to do with GAAP and everything to do with the cash in the bank. When will your clients pay you? How much does cyclicality impact receipts?

If you use a software that can transition between Cash and Accrual, toggle it back for the past 12 months and compare sales to receipts.

How did the timing line up?

How long did it take to collect the funds?

Some industries are more responsive than others. Some governments and international clients take six months or more to pay!

Plan for the lag by using the cash receipts rather than sales.

2. The expenses need to be prepared on the expectation of when the cash is sent

Start with the “Accrual” basis. For the purposes of this budget, the expected bills over the next year need to be included when they are to be paid.

Cyclicality is a factor here with variable expenses. Setting this up monthly allows the management to see the ebb and flow of these costs.  Since this primarily tracks cash, non-cash expenses (i.e. depreciation and inventory adjustments) need to be removed. In addition to those non-cash expenses, remove the interest expense as it will be counted in the debt service below.

3. Track debt payments

This may be the single most confusing part for many small businesses. Many businesses use a P&L budget and omit the principal payment. A long-term loan payment consists of principal and interest, but only the interest is deductible and will show up on an income statement.

This missing portion of the principal is paid by the business but not showing up on the P&L. (It is on the Statement of Cash Flows but that report is so confusing many accountants don’t like it!) This needs to be treated as a fixed expense and deducted to arrive at the cash available for the month.

In addition to term debt, the interest from the operating line or any credit cards needs to be included here too. The outstanding balance of the loan times the interest rate and any required principal should be totaled with the term debt to include all required debt payments. Once all amounts are known, subtract the cash out (cash expenses + debt payments) from the cash in to arrive at the ending monthly balance.

Businesses need to track cash closer than any other account or metric yet many are only using the standard financial statements (or bank balances!) to manage their cash. A management cash flow budget will allow the business to track this all-important number, understand the business better and be better able to communicate to their business partners than the financial statements alone.