What is a cash budget table?
How to Start Preparing Your Cash Budget Table
Entrepreneurs who fail with their first venture almost always put the blame on lack of capital, saying they were undercapitalized. But all too often we hear about entrepreneurs who create wildly optimistic sales projections, to cover their fear of failing, and then go out and spend their money on noncritical capital resources like fancy offices, computer systems, new cars, global-travel, slick brochures, and launch parties.
Every entrepreneur planning a new venture faces the same dilemma. What are the critical capital resources? How much cash is needed? When is it needed? How will the funds be used? How soon will the venture reach profitability? To answer these questions, it is important to first gather all the pieces of the puzzle that are known.
These pieces are related to one of three basic groups: cash coming in, cash going out, and sources of financing.
Cash inflows pertain to payments from customers, and terms for how these customers will pay.
Cash outflows pertain to the critical capital resources needed, precisely when they are needed, from whom, and the terms for how the venture will pay these suppliers.
Financing sources pertain to probable sources, when the money comes in, and repayment obligations.
It is impossible to know exactly all the details, but it is possible to come up with realistic financial estimates based on information, domain expertise, execution intelligence, and sound financial management practices. Financial management has three parts: short-term planning, long-term planning, and financing and capital structuring. We discuss short-term planning in this Article and leave the other two topics for a subsequent Section.
At the heart of short-term financial planning is the preparation of your cash budget table. The cash budget table provides much more detailed information concerning your venture’s future cash flows than do the more common financial statements that you may have seen before. A cash budget table is a forecast of cash funds your venture anticipates receiving and disbursing throughout a specific period of time, and it also projects the anticipated cash position at specific times during the period being projected.
Budgeting is the perfect exercise before venturing into uncharted waters and perhaps the most important activity of your business planning process. Venture capitalists expect entrepreneurs to be able to budget and forecast their operations at least weekly for the next twelve to eighteen months and monthly for the following three to five years. Unfortunately, the practice of preparing a cash budget table is not “taught” anywhere nor found in any popular business literature.
Budgeting deals with information based on data derived from cost estimating and “conjectures of future activities.” The budgeting process forces all members on the venture team to apply comprehensive critical thinking skills and begin considering how to allocate resources for the future. Unfortunately, too many entrepreneurs spend most of their time dealing with daily emergencies, thinking that putting out the daily fires is entrepreneurial management instead of budgeting.
The budgeting process not only provides a means of allocating resources to those activities that will drive value in the venture, but also can help uncover potential bottlenecks before they occur. The budgeting process is a very important formal management practice that coordinates the activities of the entire venture team.
The budget itself provides a clear means of communicating management’s plans throughout the entire organization and ensures that everyone in the venture is pulling in the same direction. And since the cash budget clearly defines goals and objectives that can serve as benchmarks for evaluating subsequent performance metrics, the budgeting process can also help in preparing a financing strategy such as the activities, worksheets, and schedules. These items prepared for the cash budget table can be used to create the pro forma financials required for presentations before investors.
Distinguishing Cash Flow vs. Net Income
It is important to understand the differences between “cash flow” and “net income” or “profit.” Many in the business world do not understand these differences because executives and managers of existing businesses are not used to having to watch or worry about cash flow, and they definitely do not operate their businesses on a cash-in, cash-out, and cash-only basis. For an entrepreneur, when times are good, cash flow is the oil that keeps a venture running smoothly. Even when a venture shows a negative profit but maintains a positive cash flow, life goes on. But cash is like oxygen at the summit of Everest, run out of cash and trouble brews really fast.
Cash is needed to purchase inventories, pay employees, and purchase all the supplies needed to start up the venture. The profit and loss statement indicates profitability of firms, but accounting profits generally do not give a true picture of the firm’s cash flow. Besides, you cannot spend net income. This difference becomes more clear when the firm is beginning to experience rapid growth, has tons of orders coming in, and there is no money in the checking account to meet the payroll at the end of the week.
Nolan Bushnell, founder of Atari game systems and a pioneer in the electronic gaming industry, comments about entrepreneurship and cash flow: “I used to say the difference between an entrepreneur and an employee is how you feel about payday. If you love them, you’re an employee. If you hate them, you’re an employer. And the number of times that it was Wednesday and payday was Friday and there was not enough money in the bank to make the payroll . . . it happened over and over and over again.”
Understanding the Cash Flow Cycle
The cash conversion cycle, or cash flow cycle, is the length of time between the disbursement for the purchase of materials and labor, and the receipt of cash for the sale of goods and services. The shorter the cash flow cycle, the more liquid the venture is said to be. Preparing the cash budget table helps entrepreneurs better understand their cash flow cycle time, which is essentially the length of time cash, including the cash from investors, is “tied-up” in working capital before that money is finally released back into the venture and used to create more value. In essence the shorter the cycle the faster the venture can “re-deploy” its cash and become more valuable.
The longer the cash flow cycle, the more critical cash-flow management becomes. This issue of timing becomes most apparent when the terms for incoming supplies on a “COD-basis,” or cash-on-delivery, and when the targeted marquee customers pay in ninety days. So obviously, the longer the cash cycle the greater the need for cash.
There are three key variables to the cash flow cycle:
1. The inventory-conversion period. This is the average time between the receipt of raw materials or finished goods and the sale of those goods.
2. The receivables-conversion period. This is the average length of time between the sale of goods, materials, or business services, and the receipt of cash for those goods.
3. The accounts-payables period. This pertains to the length of time between the purchase of materials or labor and the payment for them.