I was recently asked by one of my clients, who is new to using the Cash Flow Mojo® software, to explain cash flow management budgeting basics so he could understand it better. Here is how I answered that request.
When it comes to creating a budget, you are actually doing three different things in that process inside the software:
1 – You are working out your spending plan for the coming year, and you are making it as accurate as possible because you are also planning your savings for future needs.
2 – You are finding out what your Income Planning Target is so you know exactly how much cash you need to bring into the business on a weekly basis to do better than break even.
3 – You are finding out where your weekly income is in comparison to where it needs to be so, if you are making less income than needed, you can plan out how much more of what products or services you need to sell each week to make up the shortfall, or, if you are making better than break even, you can plan out how to save the extra funds to make more money and also plan for the future needs of the business so you can expand and grow.
A working budget is very effective in making sure your business has adequate cash flow and in ensuring financial success. Once you have worked out a budget, then actual income amounts can be compared to budgeted spending amounts. If actual income falls short of budgeted income/spending, expenses must be cut back to below actual income.
It’s essential to plan out your spending as accurately and realistically as possible, and to avoid common errors in budgeting. Here are some of the errors commonly made by small businesses, and some tips for avoiding them.
Underestimating Costs. Every business has secondary costs that don’t always make it into the budget. An example of this is planning to buy a new software program or piece of equipment and then not budgeting for the costs of training staff on the new software or equipment, or for equipment repairs and maintenance after the warranty runs out. Certainly the increase costs associated with the new National Health Care Insurance plan needs to be part of a U.S. based business’ budget in 2014 and beyond is you have more than 10 employees.
Failing to Update Your Budget. Things are always changing in your business, and you need to update your planned spending on a regular basis – once a quarter or once every 4 months. This gives you the opportunity compare your planned budget against the amount you actually spent, and then adjust your budget accordingly, including planning for future spending you have decided on since the last update – like buying a piece of equipment.
Not Setting Spending Priorities. It’s almost impossible to set goals for your business without also setting spending priorities to accomplish those goals. Getting in more customers may require an increase in spending on advertising and promotion in addition to trying new things like internet marketing tactics that are constantly being developed. Faster delivery may require saving up for and buying a new piece of equipment or adding more personnel. It’s important to identify, in detail, your business and financial goals and what you want to achieve in your business and then plan out how to pay the costs of reaching those goals.
Blowing Your Budget. This is a common mistake that is due to a number of factors:
1 – Not budgeting for future needs, like for unexpected financial emergencies or predictable repairs and maintenance on equipment. (Or not budgeting at all.)
2 – Not knowing, or under-estimating your spending plan for different things. For example under-estimating what your advertising and promotional costs will be and then having to react to a slowdown in sales or to something your top competitors do that can steal business from you, or ignoring the need to plan for adding personnel to increase your production of sales.
3 – Violating your spending plan by not being able to say “No” to pressures to spend on something that you didn’t plan for and that doesn’t necessarily increase sales and production of more income.
4 – Buying on credit because you didn’t plan on this purchase and you don’t have the cash to make the purchase, thereby creating yet another bill that has to be paid.
5 – Not planning on and paying yourself an adequate salary, so you have to draw cash out of the business than you planned on spending on something else.
Those are the primary cash flow management budgeting basics that are very important to understand, and very easy to follow when you are using the Cash Flow Mojo software to manage cash flow.
Business Cash Flow Management Budgeting Basics