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This article is to explain the necessity of small business owners and managers to have and maintain a sound control over their cash flows.

If you are a small business owner/manager and you do not have a cash budget and don’t have money collection procedures than I that case there is a great probability that your business have cash flow problems and you are probably in position of ‘robbing Peter to pay Paul’.

Having cash flow problems does not mean that your business is not profitable and feasible. You may have a really good profitable business, however you have to understand that profit and cash is not the same. There is a paradox where small business owners who are chasing and monitoring profitability have actually lower profitability and higher costs of capital than the businesses which give more emphasis to cash and cash collection.

Example cash vs. profits

The problems with cash flows arise where e.g. you business has purchased inventory for cash for $1,000 and sold it for $2,000 your profit from this transaction is $1,000 or 100% however your cash flow if you have not collected money from your buyer is sitting at       -$1,000. In the worst case scenario if this transaction turns into bad debt you will actually have loss of $1,000.

Another example is that your profit and loss statement shows non cash items such as depreciation and amortization, does not take into account timing differences between the point of sales and when the cash is collected and it also excludes capital purchases and capital component of loan and other debt repayments.

All of this reasons combined together provide that your profit and loss statement can not be a good tool for cash management and cannot provide any future projections, this is the reason to have a cash budget. Another reason is that if you are trading under company structure you should maintain liquidity of your business at all times which means that you should have enough cash to meet your current commitments. Planning your cash flows will enable your business to be liquid and profitable in the same time.

Budget as a planning tool

By having a cash budget you will be able to estimate your bank balance and the approximate amount of cash on hand which will enable you to e.g. plan purchases of mayor assets or other mayor expenses. This alone will help you to make sound management decisions such as when and how much money to borrow to finance purchase of business assets.

Just setting up cash budget is not the end of the process, you have to monitor you cash flow planning and to analyze any variances. I you have planned to e.g. collect $10,000 from your sales and you have collected only $5,000 you have to find out why this has had happened and this may indicate some weaknesses of your collection procedures.

You will finally be able to see and monitor do your customers obey your credit terms and policies. It is very important to communicate your budgeting plans to your staff and the all should know what plans are and what they can do to achieve what was planned. It is actually highly recommended to plan your budget together with your key staff as this will be additional motivational tool for your business.

Some of your key stakeholder may be interested in your cash budget and this could save you some money in the long run such as banks may offer you lower rates if you show the that you maintain your cash budget on regular basis as the risk of business failure is actually lower for businesses with cash flow budgets.

Read our article: ‘How to setup your cash budget’

Download simple Excel template for cash budget