Understanding the difference between budgets vs cash flow forecasts is essential for the accurate financial management of any business. This article goes through the essentials of each. You will better understand the difference of budgeting and forecasting.
Budgets vs Cash Flow Forecasts
To appreciate the difference between a budget and a cash flow forecast, we need to define the key financial accounting terms:
- What is a budget?
- What is a cash flow forecast?
It is important to know how to generate accurate financial reports and utilise these effectively. Using the Calxa application you can define your budgets and generate accurate Cash Flow Forecast Reports in Minutes, enabling you to better understand your business (or your client’s business if you are an accountant or bookkeeper).
What is a Budget?
A Budget details what will be done with the actual finances for a specific period of time (usually over 12 months). It includes estimates of revenue and expenses so that you can project your expected profit over this period. In a stable business, the simplest starting point is usually to take the previous year actual results and project these forward.
Add an uplift factor for inflation and expected growth to make this more realistic.
There may be still some lines that want more detailed review.
Budgeting for Revenue
Income is often budgeted for by starting from the units of product or services that are expected to be sold. This is simpler when the business sells a small range of products or services. However, this is much more complex when there is a mix of products. For example, it is likely to be impractical for a supermarket or retailer with an extensive inventory.
Budgeting for Employment Costs
Salaries and wages are a major expense for many organisations. So, to construct the budget, review staff numbers and salaries. It should include any expected increases. Then, build the budget in blocks to reach the total salary and wages expense. From there, it’s usually simple to add in other on-costs such as superannuation, pension costs and insurances.
The Budgeting Process
The budgeting process is commonly an iterative one. You create the first draft, discuss it with other members of your team.
Do a good review of the expected profit, consider how well it fits the business plan.
Lastly, revise and create the next draft based on the feedback you’ve collected.
Eventually you’ll produce a final version that everyone can agree and sign off on. Lock that in place so you can measure your performance for the year. Be prepared to create a copy and modify it as circumstances change during the year.
Preparing a Good Budget
So, a good budget will:
- Link to both the strategic and business plans
- Include performance benchmarks that can be monitored
- Focus predominantly on profit
However, a Budget is NOT used to monitor the amount of cash in the bank accounts. That is where the Cash flow Forecast comes in. The picture here shows you how to put a budget into action and comparing it to your actuals.
What is a Cash Flow Forecast?
Simply put, a cash flow forecast is a projection, detailing when the receipts and payments are likely to occur. Unless the business runs completely on a cash basis, there will always be differences in timing between the budget and the cash flow forecast. But this is very rare given the obligations to remit certain taxes to government bodies.
Forecasting Income and Expenses
Income and expenses are shown in a cashflow statement in the period when they are expected to be paid. This usually involves some estimate. After all, we are predicting the future.
In traditional spreadsheets, simplistic assumptions were usually made based on everyone paying according to agreed terms.
Modern software applications such as Calxa, can provide more precise estimates based on actual payment activity.
Predicting Balance Sheet Movements
While many businesses keep to just the Profit & Loss for budgeting purposes, a good cash flow forecast requires that the Balance Sheet movements are predicted too.
As well as tax and other government payments, there will be the purchase and disposal of assets, new loans and the repayment of loans to consider. Without these the cash flow forecast is likely to be incomplete and misleading.
Preparing a Good Cash Flow Forecast
A good Cash flow forecast will:
- Reflect the projected payments and receipts from the bank accounts.
- Account for capital purchase and private transactions such as drawings.
- Include balance sheet liability payments.
You can see in this picture how the cash at bank is shown in context to your inflows and outflows.
Understand Budgets vs Cash Flow Forecasts
The main difference between a Budget and a Cash Flow Forecast is based on two things:
- The type of transaction
- And, the timing when receipts and payments will occur.
For example, a Budget will record the income when you have sent out the invoice. In contrast, your Cash Flow Forecast will trace it when you actually receive the amount in your bank account.
Similarly, you can have a read of this blog Budgeting Vs Forecasting.
Difference between Budgets and Cash Flow Forecasts
Budgets are usually created on an accrual or invoice basis to reflect the way transactions are recorded in the accounting system. Revenue, for example, is budgeted based on what is expected to be invoiced each month. This is regardless of when the payment will actually be received. The cash flow forecast will take care of that.
Budget amounts will be shown excluding GST or VAT. It’s really just the same as the Profit & Loss reports in your accounting system. The cash flow forecast however, will show the income and expenses including taxes, with separate tax payments occurring at a later date.
The budget for wages is the gross wages while the cash flow forecast will show the net wages after tax each month and separate entries for tax payments.
Many businesses don’t go to the effort of creating a Balance Sheet budget for normal planning processes. Although though it’s often a good idea!, it’s essential for an accurate cash flow forecast.
Resources to help you Manage your Business
Now you know the difference between budgets vs cash flow forecasts. If you are serious about planning ahead for your business, check out our article on Tax Flow Planning for Business. You can also follow the steps set out in How to Manage your Cash Flow for Growth.