Why Using 3 Way Budgets Supercharges Cash Flow & Profits [Massively]!

INTRODUCTION:

For years now, many business owners have been well aware of the need to do budgets in order to plan for their business growth.

However, exactly which budget is it? In my experience I sometimes see a profit & loss budget which is meant to be a 'cash' budget. Then I see a cash flow forecast which is meant to be a 'profit & loss' budget.

The issue is that these two budgets are wildly different beasts. Cash flow and profit & loss quite often have little correlation. Getting business owners to understand the difference between the two should be the priority of any small business accountant.

Figure 1: Profit & Cash Flow can be 2 completely different beasts.

1. Understand 3 way budgeting

Three way budgets are great because they automatically tie in the profit & loss assumptions into the cash flow forecasts.

They not only look at what you hope to make as a profit, they have inbuilt formulas which based on assumptions calculate the actual cash flows.

3 way budgets take loan payments, dividends, drawings, asset purchases, GST and time to be paid by your customers and time to pay your suppliers.

At the end, you have a profit & loss budget, a cash budget and a balance sheet budget.

Figure 2: Turning the tap on for profits  so that they turn into cash is key to business success!  Photo courtesy handsonbanking.com

2. What is the process?

Firstly, the job will be made a lot easier if you have 3 way forecasting software. You can buy these off the shelf but most small business accountants Sydney should have access to them. The stronger the software, the more accurate the predictions will be.

We find Castaway software has many powerful forecasting features. There will be others on the market.

JWhether you use your small business accountant or do it yourself, the first thing to do will be to do your profit & loss budget. Within this budget, you will asked to enter in average time to be paid for revenue items and the average time to pay your suppliers and expenses on a line by line basis. This is because revenue and expense items will all have different payment and receipt times.

Then it's time to review your balance sheet and enter things like loan repayments, drawings, dividends and asset purchases.

Once you have entered these in you will have 3 budgets that all reconcile with each other.

3. How to use this process as a business planning tool

The beauty of this whole process is that you can do what-if scenarios so essentially you can then be working out your business plan at the same time.

Go through Point 2 above and see what the results show. Is there enough profit and is there enough cash to fund your business commitments, loans and lifestyle?

If there is not, work out ways to collect cash more quickly and list down what you need to do to make this happen. Maybe you will also need to generate more sales and if so, how are you going to do this? Can you get a better margin on your sales & if so, what are the options to achieve this?

We find as small business advisors that the whole process is quite exciting as you see it is possible to make a real difference and show support to our clients and make them aware that real change can be achieved.

We can also show that by improving certain key performance indicators the small business valuation Sydney will be greatly improved.

Figure 3: Stopping the drain on cash can be examined during the 3 way budget process with your small business accountants. Photo courtesy slideshare.net

CONCLUSION:

These day technology is available to focus in on plans to improve cash and profits but sadly very few are made aware of this. Small business accountants have a duty to help their clients in the best way possible to not only save tax but actually have a more successful business which is in line with their clients' aspirations.

If you're going to do some budgets then why not them do them properly and reap the rewards?