The difference between a budget and a cash flow forecast can sometimes be confusing in the beginning. They can seem to show similar information, yet both are very different and have different uses. Both are essential for the accurate financial management of your organisation.

 

What is a budget?

A budget details what you plan to do with your finances for the relevant period of time. This is usually over 12 months and focuses on profit. In addition:

  • Accruals and other non-cash adjustments such as depreciation are often included.
  • A budget also reflects the planned objectives of what the organisation is trying to achieve and is linked to the strategic and business plans of the organisation.
  • A budget also provides a benchmark to then monitor performance. After each month you can compare what actually occurred against what was budgeted or planned to occur.
  • Usually the full year budget is broken down into months.

A budget is NOT used to monitor the amount of cash in the bank accounts. That is where the cash flow forecast comes in.

 

 

What is a Cash flow forecast?

A cash flow forecast details when the actual receipts and payments are likely to occur.

  • A cash flow forecast reflects when the actual income and expenditure is transacted from the actual bank account.
  • It is not based on accrual accounting and adjustments such as depreciation are excluded.
  • Large capital purchases not reflected in a profit and loss budget will be included in a cash flow forecast.
  • The full year cash flow forecast Is mostly broken down into a month by month basis. But in some instances, it can be further broken down into fortnightly or even week by week depending on the circumstances.

The main difference between a budget and a cash flow forecast is based on:

  1. The type of the transaction and;
  2. The timing when receipts and payments will occur.

 

As a simple example: a budget will record the income when you have sent out the invoice whereas your cash flow will record it when you actually receive the amount in your bank account. One particular point worth mentioning is not to assume that debtors will pay the following month. Often it may be later which is why it is important to know your Average Debtor Days which may show that payment occurs typically 64 days after sending out the invoice.

This also highlights the value of knowing some important Key Performance Indicators (KPIs) such as:

  • Debtor days
  • Creditor days
  • Inventory turnover days
  • Working capital ratio

So you are starting to see the difference between Budgeting and Cash Flow Forecasting. Needless to say, both are essential for the good financial management of any organisation.

 

Understand the difference between a budget and a cash flow forecast and you’ll be well on the way to managing your finances.

 

 

How to Use a Budget

With a well-prepared budget you should know the basis for each figure, how it was calculated and any key assumptions for each amount used. Then, at the end of each month you can compare the actual figure with the budget and understand where and why the variations have occurred. The article Budget Planning for NFPs is Critical discusses this in more detail.

 

 

Managing Solvency

As the cash flow forecast is linked to your bank account it also predicts the solvency of your organisation. Often your budget and the actual performance for a period of time may show a significant profit and indicate your organisation is quite healthy but the bank account doesn’t reflect this and in some instances you may in fact face a solvency issue.

So why can this occur? The main reasons for this difference are timing of payments and receipts and movements in balance sheet accounts. Timing differences can occur when there are delays between invoicing and payment. You could have a problem this month because you won’t receive income for another couple of months or because you have to pay out this month for expenses incurred in the past.

For many organisations the most likely balance sheet accounts to cause cash flow issues are tax and payroll liabilities. It’s the amounts you owe to the tax office and employees’ superannuation and pension funds.  These accumulate over time until paid and require careful planning to manage.

The benefits of managing your cash flow are covered in our article titled 5 Reasons you need a Cash Flow Projection which also highlights why having good cash flow projections makes for good business.

 

 

Practical Steps to Budgeting & Forecasting

Preparing a Budget

The budget should be prepared first and cover the relevant period of time, usually twelve months. Here are some key steps to follow:

  1. Prepare a profit and loss budget. While there are different techniques for preparing a budget, you can use the previous 12 months as a guide and Calxa’s Budget Factory can help you with this.
  2. Prepare a balance sheet budget. The importance of the balance sheet budget is that it relates to debtors, creditors, assets, capital purchases, investments, loans and income received in advance. While this may at first appear to be hard, the Calxa software handles some of these calculations making your life easier.
  3. For each figure be clear about how it is calculated and any key assumptions and allocate it for each month.
  4. Factor in any issues from the strategic and business plans that may have an impact in this upcoming period.

 

 

Preparing the Cash Flow Forecast

Once the budget has been finalised then the cash flow forecast can be prepared. The budget gives the framework when certain events and activities are planned to occur that now can be translated into when actual payments and receipts will occur.  Here are some key steps to follow:

  1. Review previous cash flow reports and be clear about the timing of payments and receipts. As noted earlier, don’t always assume that debtors will pay the following month. Calxa’s default method estimates this for you from statistical analysis of your average outstanding debtor and creditor days. This is by far the simplest and most reliable method for most businesses.
  2. If you have previously received grants, ask if you expect to receive them again for the following year. If so, are they paid to you in full, monthly, quarterly or in stages? Ensure you accurately track these linked funds and manage the unspent components.
  3. If you run fundraising events be clear about when they will occur and how money will be received and don’t assume all funds will be received and banked during the same month. Cash donations will usually be banked immediately but pledges may not be received until later. If you have sponsors, they are likely to pay prior to the event.

For more information refer to our Step-by-Step Cash Flow Projections to assist with the preparation of the cash flow forecast.

 

 

Presenting Your Budget and Forecast

Once the figures have been finalised then it is best to present the budget and cash flow forecast on a month-by-month basis that show the full year budget, the year-to-date budget as well as the actual amount. At the end of each month review actuals to budget.

Use a Calxa report such as the Budget Summary or Budget Analysis which can show variations in dollar terms or as a percentage and whether it is under or over the budget.

 

 

Understanding the End Result

Now, let’s focus more on the review and analysis of your reports and understanding the end result.

At its simplest, the review of a budget comes down to comparing your predicted result. Essentially, it’s the budget compared to what really happened, the actuals. There are, however, many ways to make that analysis more complex!

 

 

Getting the Timing Right

The first issue we have is timing; over what period should we compare budgets to actuals? Sometimes it’s the current month that’s important. Or, more commonly, the month that just completed. How well did we do this month? Focusing on one month is important when you need to be close to the detail of what’s happening and on the lookout for changes. It enables you to identify and react quickly to falls in revenue or increases in costs.

 

 

Long-term and Year-to-Date Comparison

At the CEO or Board level the focus is more on the longer-term and this is when year-to-date comparisons become much more useful. This eliminates the monthly fluctuations and enables you to pay attention to the big picture. You may have budgeted for a major expense in February, for example, but if it was delayed and didn’t happen till March. This wouldn’t affect the year-to-date results.

 

 

Re-forecast Unspent Budgets

In many Not-for-Profits there is often a requirement to focus on the full annual budget. And, sometimes an even longer period. This is especially true when a project is grant-funded. The funding provider may have strict rules on what can and can’t be done with surplus funds or what happens if there is a deficit. Calxa’s Unspent Budget with Current & YTD Variance report is a convenient way to compare budgets for the month, year-to-date and the full year. It is conveniently viewable on one page. In contrast, the P&L Reforecast Unspent to Meet Budget will recalculate what can be spent each month in order to meet the full year’s budget.

 

 

Comparing Budgets to Actuals

Comparing budgets to actuals should be done as a learning tool. It’s not (usually) a good tool for berating staff for excessive expenditure, there are better ways of managing that. What it will do is alert you to problems with your budgeting process or to changes in the business. If your electricity expenses are constantly over budget is this because of some problem with a change in usage? Maybe this should be investigated and fixed. Or, is it because of inaccurate estimates or incomplete knowledge in the original budget? If the latter, maybe your current forecast should be adjusted in light of the new, improved information so you’re not reporting the same variances each month.

 

 

Monthly Cash Flow Forecasts

Your bank balance at the end of each month is the best measure of accuracy for your cash flow forecast. However, remember that one of the uses of a cash flow forecast is to encourage you to modify your behaviour so that a negative outcome is avoided. If I’m forecasting a deficit in three months’ time, I’ll change what I do in my business now. For example:

  • Work to increase revenue
  • Reduce or defer costs
  • Worst case scenario, bring in additional funds

The end result will be a better outcome than the projected forecast.

 

 

Comparing Actuals to Forecast Cash Flow

One way compare your forecast bank balance to actuals in Calxa is to use the Cash Balance KPI. Simply add that to one of the KPI charts. The budget will display what was forecast at the beginning of the financial year. This way you can see how well you have improved on that.

Alternately, consider the Bank Movement (12 month) report. This starts with your Opening Bank, shows the movements on your Profit and Loss and then Balance Sheet accounts, finishing with the Closing Bank. You can include Actuals for the past months, budgets for the rest of the year.

 

 

In Conclusion

Use your budgets and cash flow forecasts wisely, review them regularly and you’ll improve your knowledge and understanding of your organisation to achieve a positive outcome.

To give you some ideas, check out some of the reports you can create with Calxa.