Tips on creating detailed Cash Flow Budget

How to get the most out of your cash flow budget

In today’s complex and uncertain global economy, proper cash flow management is critical.  Research tells us that up to 80% of businesses go bankrupt due to a shortage of cash, that’s an alarming statistic. Therefore, it’s not surprising that many financial institutions and investors require companies to provide detailed cash flow budgets.  A detailed cash flow helps the management team be forward-looking and plan for future surpluses or deficits. Unfortunately, some CFOs and Finance Managers avoid creating a cash flow budget based on the assumption it takes tremendous time and resources to make it happen.

While some companies avoid creating cash flow budget altogether, others rely on basic cash flow budgets using few assumptions. For example, it is assumed sales for a given month will generate cash inflow in the following month for all customers. Another common assumption is that sales for the month will generate a cash inflow based on the average payment terms for all customers. This approach is not realistic; most companies tend to have their top 25-50 customers, who generate 60%- 80% of company’s revenue. These customers may have special payment terms which need to be captured to allow for what-if scenario analysis. Using this basic approach lacks the reliability and details required by banks and management teams to make an informed decision.

To generate a more comprehensive cash flow budget use the below tips:

  1. Cash outflow – use actual vendor payment terms for top 25-50 vendors and average payment terms for remaining vendors
  2. Cash inflow – use historical payment patterns for top 25-50 customers and average payment terms for remaining customers
  3. Use what-if scenarios – change payment patterns/terms for your major customers or vendors  to analyze the impact on cash flow

Assuming payment terms for all customers creates a misleading cash inflow projection because many customers have a specific pattern for payment and do not necessarily follow the payment terms on the invoice. For example, customer ABC might have net payment of 30 days but always pays after 45 days. This will impact your cash inflow. It is more accurate to use 45 days as payment terms than 30 days. By using historical payment patterns for your top 25-50 customers and average payment terms for remaining customers, you will have more steady and predictable cash inflow.
Creating what-if scenarios allow managers to understand how different payment terms, will impact future cash flow. For example, by changing the payment terms, one scenario might result in an excess of cash whereas another scenario will lead to a shortage. This level of detail is important for the management team to plan for investment options/future growth or to know when to borrow in case of shortage of cash within next six to twelve months.

Also See: Cash flow planning is king

These types of details and assumptions are hard to maintain in spreadsheets and one of the main reasons why cash flow budget is often overlooked. However, as businesses continues to grow and complexity in global economy increases a detailed cash flow budget becomes imperative. Using CPM software allows CFOs and Finance Managers to create detailed cash flow budget using various assumptions and what-if scenarios.


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