What it means
A profit budget can balance perfectly and the business still run out of money in March. The cash flow budget is the check.
It converts the profit budget's sales and costs into the cash they will produce, adds the cash items the profit budget ignores, and lays them out month by month so that the balance is visible at every point. Building it starts from the sales budget, translated into receipts by applying the expected collection pattern: if 20% of customers pay in the month of sale, 60% the month after and 20% two months after, January sales produce cash in January, February and March in those proportions.
Sales tax collected is added where applicable. Then purchases are translated into payments by the supplier terms; wages are timed to the pay dates, with employer taxes a month later; rent, insurance and other overheads on their actual payment dates (quarterly in advance for rent, annually for insurance); tax payments on the statutory dates; capital expenditure when the invoices will be paid; loan repayments and interest on the schedule; dividends when declared.
Opening cash plus receipts less payments gives closing cash, which becomes next month's opening balance. The result typically shows a profile: cash dipping in months when large payments cluster (a quarter's rent plus a tax instalment plus a capital purchase), and rising when receipts from a strong sales month arrive.
The lowest point is the figure that matters, because it determines the facility the business needs. A budget that shows a negative balance in June is not a forecast of failure; it is a warning to arrange an overdraft, defer the capital purchase, accelerate collections, or renegotiate the tax timing before June.
The cash flow budget tests plans that the profit budget cannot. A growth plan that looks profitable may show, in cash terms, months of negative balance as receivables and inventory build ahead of receipts; the cash budget quantifies the funding the growth needs.
A capital programme's timing can be adjusted to the cash profile. A dividend can be set at a level the cash supports.
During the year, actual cash flows are compared with the budget monthly, and variances are explained: receipts below budget because customers paid slower, payments above because a supplier was paid early. Many businesses also maintain a rolling short-term cash forecast (13 weeks, updated weekly) alongside the annual cash budget; the budget sets the plan and facilities, the forecast manages the detail.
The cash flow budget is the document lenders most want to see when a business asks for a facility, because it shows when the money will be needed and when it will be repaid. A business that can present one, with its assumptions, is usually treated as a better credit than one that cannot.
In practice
Real-world examples.
Example
A seasonal toy business budgets a cash deficit of $800,000 in September as it builds Christmas stock and arranges a facility that is repaid in January.
Example
A start-up's cash flow budget shows its funding running out in month 14 and sets the date by which the next round must close.
Example
A school budgets fee receipts in three termly lumps against monthly salary costs and holds a reserve to cover the gaps.
Think of it
“A cash flow budget is your financial game plan-mapping out exactly when money should arrive and leave.
Formula
Calculation
Closing Cash (month) = Opening cash + Receipts minus Payments
Receipts (month) = Sum over prior months of (Sales x Proportion collected in this month) + Other receipts
Peak Funding Requirement = Lowest closing cash balance across the period (negative figure) plus Safety margin
Worked example. A furniture maker prepares a cash flow budget for the first six months of the year. Sales budget: Jan $200,000; Feb $220,000; Mar $260,000; Apr $300,000; May $320,000; Jun $340,000. December's sales were $240,000 and November's $210,000. Collection pattern: 30% in the month of sale, 50% the following month, 20% the second month.
Receipts:
- Jan: 30% x $200,000 + 50% x $240,000 + 20% x $210,000 = $60,000 + $120,000 + $42,000 = $222,000
- Feb: 30% x $220,000 + 50% x $200,000 + 20% x $240,000 = $66,000 + $100,000 + $48,000 = $214,000
- Mar: 30% x $260,000 + 50% x $220,000 + 20% x $200,000 = $78,000 + $110,000 + $40,000 = $228,000
- Apr: 30% x $300,000 + 50% x $260,000 + 20% x $220,000 = $90,000 + $130,000 + $44,000 = $264,000
- May: 30% x $320,000 + 50% x $300,000 + 20% x $260,000 = $96,000 + $150,000 + $52,000 = $298,000
- Jun: 30% x $340,000 + 50% x $320,000 + 20% x $300,000 = $102,000 + $160,000 + $60,000 = $322,000
Payments: materials at 40% of the following month's sales, paid one month after purchase (so January pays for December's purchase of 40% x Jan sales = $80,000; February pays 40% x Feb sales $88,000; and so on, using next month's sales for each purchase month); wages $70,000 a month; overheads $30,000 a month; rent $36,000 quarterly in January and April; a new machine $150,000 in March; a tax payment $45,000 in April; loan repayment $12,000 a month.
- Jan: materials $80,000 + wages $70,000 + overheads $30,000 + rent $36,000 + loan $12,000 = $228,000
- Feb: $88,000 + $70,000 + $30,000 + $12,000 = $200,000
- Mar: $104,000 + $70,000 + $30,000 + machine $150,000 + $12,000 = $366,000
- Apr: $120,000 + $70,000 + $30,000 + rent $36,000 + tax $45,000 + $12,000 = $313,000
- May: $128,000 + $70,000 + $30,000 + $12,000 = $240,000
- Jun: $136,000 + $70,000 + $30,000 + $12,000 = $248,000
Cash balance, opening $60,000:
- Jan: $60,000 + $222,000 minus $228,000 = $54,000
- Feb: $54,000 + $214,000 minus $200,000 = $68,000
- Mar: $68,000 + $228,000 minus $366,000 = minus $70,000
- Apr: minus $70,000 + $264,000 minus $313,000 = minus $119,000
- May: minus $119,000 + $298,000 minus $240,000 = minus $61,000
- Jun: minus $61,000 + $322,000 minus $248,000 = $13,000
The budget shows the business going into deficit in March and staying there until June, with a low point of minus $119,000 in April. The profit budget for the same months shows a profit every month. Options: finance the machine over three years (removing $150,000 from March and adding about $4,500 a month), which keeps every month positive with a low of $31,000 in April; or arrange an overdraft of $150,000 for March to May. The company chooses asset finance and a $50,000 overdraft as a margin, arranged in January, two months before it is needed.Case study
Seen in the real world.
A printing company prepared a detailed profit budget each year and had never prepared a cash flow budget, on the grounds that it was profitable and the bank had always covered the occasional overdraft. One year it planned a $400,000 investment in a new press, a 25% increase in sales with a large new customer on 60-day terms, and a dividend to the owners in April. The profit budget showed a record year.
In May the company could not pay its quarterly tax bill: the press had been paid for in February, the new customer's sales had built receivables of $300,000 that would not turn into cash until June, the dividend had gone out in April, and the overdraft was at its limit. The bank, asked for an emergency increase, asked for a cash flow budget, which the company then had to build in a week. It showed that the plan had been unaffordable from the start: the lowest point, in May, was $350,000 below the facility.
The bank increased the facility against personal guarantees and a delayed dividend. The following year the company prepared the cash flow budget alongside the profit budget, presented both to the bank in November, arranged asset finance for the next capital purchase, and timed the dividend for July when receipts were strongest. The owner's remark was that the company had budgeted its profit to the dollar and its cash not at all, and that the second had nearly undone the first.
Watch out
Common mistakes.
- Assuming receipts follow sales in the same month, or payments follow costs. Timing is the entire point of the cash budget.
- Omitting the items the profit budget does not contain: capital expenditure, loan principal, dividends, tax and sales tax, deposits, and owner drawings.
- Budgeting cash annually without monthly phasing, which hides the low point and the facility needed to cover it.
Questions
People also ask.
What is the difference between a cash flow budget and a cash flow forecast?
The budget is the annual plan, prepared with the profit budget and used to set facilities and targets. The forecast is a rolling, frequently updated projection (often 13 weeks) used to manage cash week by week. Both are needed.
Why does the cash flow budget show a deficit when the profit budget shows a profit?
Because of timing: cash leaves for stock, capital assets, tax and dividends before, or faster than, cash from sales arrives. Growth in particular absorbs cash ahead of profit.
How far ahead should the cash flow budget run?
Twelve months at least, phased monthly, and extended for capital programmes or financing decisions with longer horizons.
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