Monday, January 16, 2012

Budgeting.....cash flow style

Beth and I are big believers in budgets.  It gives a business goals and benchmarks to guide decision making and can warn of developing problems with enough lead time to make corrections.  When we create a budget, we use a cash flow format rather than a profit & loss format.   Budgeting solely on income and expenses can leave out major pieces of your cash flow: money tied up in accounts receivable and inventory and money spent on fixed asset purchases and making loan payments. 

Last year, one of our clients witnessed first hand the benefits of a cash flow based budget.  The business was experiencing a slight downturn in sales while costs (specifically wages) were up.  The client had a line of credit which was used to cover purchases in their slow period and our budget to actual analysis showed that in a few months, the line would not only be maxed out, but the expenditures were heading in a direction that would require even more money.  Because the budget warned of this trend, the owner was able to quickly make some changes.  She renewed efforts to bring in sales and she cut back on employee hours and thus wages by working a few more hours herself.  As a result, the trend reversed itself and not only did she not hit the upper limit on the line of credit, she actually was able to pay it down to nearly $0.

We recommend all small business owner try to get a line of credit.  Having a line gives a business flexibility during the slow seasons, it also helps during periods of rapid growth.  Having a line of credit requires good cash management because the bank will expect the business to use the line properly.  Proper usage dictates resting the line periodically (paying it down to $0).  All the more reason to have a cash flow based budget and comparing actual results to the budget every month to make sure you will have the money to use your line properly. 

No comments:

Post a Comment