The Dr. is In: Financial Planning Guide for 2011: Part II
When you create your operating budget, you set a goal for your expected revenue and expenses. This budget mirrors your Profit and Loss (P&L) Statement and helps you create your Gross Profit and Net Profit goals.
The next step is to create a Cash Flow Budget. Cash flow does not equal net profit. While net profit is the difference between revenue and expenses, cash flow includes all cash inflows (money in) and cash outflows (money out), not just those items that appear on the P&L.
Typically, the biggest source of money in is sales and the collection of receivables. However, your company can also increase cash by borrowing money, selling assets and earning investment income. Cost of goods sold (COGS) and overhead expenses are typically the largest sources of cash outflow, but money also flows out of your company when you repay loans, purchase asset such as vehicles, build up your showroom or display area, or pay taxes. Therefore, it is important to create a cash-flow budget as well as an operating budget to help you manage your business.
Differentiate Cash Out
There are three types of cash outflows: variable, recurring and infrequent. Variable cash outflows are specifically related to the volume of sales. Equipment costs are a good example of variable costs. For example, if you sell more equipment, your money in from equipment goes up as well as your money out for that equipment purchase. A 10 percent increase in equipment sales will typically result in a 10 percent increase in equipment costs. Other examples of variable expenses are credit card fees and sales commissions.
Recurring cash outflows are any costs that are the same (or similar) each month, such as rent, utilities, benefits and vehicle lease payments. What makes a cash flow statement significantly different than a P&L is that labor, in our industry, is typically a recurring cost. If your technicians and designers are salary, the cash out for this expense is fixed, not specifically tied to your revenue for the month. Therefore, while these costs appear in your COGS section of your P&L, on a cash flow projection, they should be entered in the recurring cash out section.