When thinking of the financial reporting function, many people in business automatically think of their annual accounts or their most recent set of management accounts. While these reports provide important financial information they share one common issue; their scope relates to the past performance of the business.
In the current environment it is essential that all business people, while learning from the business mistakes and successes of the past, adopt a forward thinking approach. It is far more important to look through the front windscreen of your business, than concentrate all your efforts on the rearview mirror.
Two tools that may be used to look forward in a structured, focused, and objective lead manner are:
- Budgeting
- Cash Flow Forecasting
1. Budgeting
Once you have decided what your future plans entail, you will need to decide how these plans are to be funded. Preparation of a budget is an essential tool in ensuring that you stay in control of your costs.
In effect, a budget will assist in the following:
- Controlling Finances
- Confirming that planned activity can in fact be funded
- Making financial decisions in an educated and well informed manner
- Identifying areas of potential difficulty and planning for same
- Measuring performance to date against pre-planned parameters
The quality of information provided by a budget is proportionate to the effort that has been invested in it. An ill informed and badly prepared budget will hamper business decisions just as much as a well-constructed one will assist in decision making.
To be effective the business person will need to:
- Invest sufficient time in preparation of the budget
- Be realistic and honest even when the information is not palatable
- Review the budget at regular intervals or as new information becomes available
A budget if it is to be effective will need to find the balance between factoring in a little slack to allow for unforeseen events, while at the same time identifying areas in which costs can be cut.
2. Cash Flow Forecasting
While budgeting is a useful tool for planning purposes, a Cash Flow Forecast is more predictive by its very nature. It assists the business owner in identifying peaks and troughs in bank finance. A cash flow forecast (again if properly prepared) will assist in identifying the constraints in which growth is to be managed.
The cash flow forecast is indicative in nature, and will assist in shaping future plans by identifying areas such as:
- Funding requirements
- Areas of cost that need to be reviewed
- Supplier terms that need to be renegotiated
It is also an important tool from the point of view that it alerts the business owner to the fact that cash operates in a manner very different from profit. A business that is profitable may in fact be facing cash flow issues.
The lessons learned from a cash flow forecast should be analysed carefully in the context of the individual business. The best answer to a cash flow shortfall is not always a simple cut in costs. A cut in marketing costs for example while providing a more positive cash flow position may lead to a business being at a disadvantage to its competitors.
Similarly it may highlight areas where overtrading is taking place. Winning a significant contract for example while providing a welcome boost to income, may lead to cash flow difficulties when trying to fund an uplift in activity.
Owing to its predictive nature, the cash flow should not be viewed as a pathway to the future. Accuracy can be improved by regular reviews, but it is not a tool by which performance can be measured.
Conclusion
While budgeting and cash flow forecasting are important tools in aiding the business person to make informed and timely decisions, they should not be viewed in isolation from one another.
The cash flow forecast for a business can inform the planning process by identifying times of financial strength and weakness, this in turn feeds the budgeting process.
These tools if used correctly and for the purposes intended can provide vital assistance in the decision making process. They can provide indications of where funding is required, where corrective action is needed, where reward is to be made and where growth is possible.
The strength of these tools is in the effort employed to make the outcome as true a position as possible, and while 100% accuracy can never be achieved in overall terms, knowing where problems are likely to arise, being able to take corrective action as necessary, and being able to measure where the business is in relation to its overall goals is invaluable.
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