Many small and midsize businesses continue to struggle with managing cash and getting access to much-needed liquidity. That's why it's essential to have a clear picture of incoming and outgoing cash flows, and budget based on that information.

Gregory Gould of the Maine Small Business Development Center in Auburn, Maine says the difficulty in finding financing for small businesses remains a huge issue: 'Without cash, they cannot buy inventory. Without inventory, these companies cannot sell anything, and therefore they cannot turn a profit.'

Budgeting for Cash Flow: Keep Data Up to Date

For companies finding it hard to get access to credit, and in fact for all companies, the goal is to make more efficient use of cash flows in order to minimize their need for, and reliance on, external funding. Having a good cash forecast and budgeting for incoming cash are key to that.

'Cash should always be top of mind for business owners,' says Dale Shintani, senior vice president of small business lines of credit at Wells Fargo. 'Whether using accrual or cash-based accounting, they should budget based on cash to ensure they can cover their expenses.'

A cash-based budget shows when the company will be in a net positive or net negative cash position, which lets the company know when it will need to bridge any shortages and prevent it from incurring unwanted fees--such as overdraft fees or late fees.

There are innumerable packages out there that offer small and medium-sized enterprises budgeting and forecasting solutions, and most accounting software packages also include a forecasting tool. But, notes Gould: 'input equals output. Without putting all the data in, and keeping it up-to-date, you cannot get an accurate forecast.'

Here's a quick rundown of the data you should be tracking and best practices:

  • The cash position report is a snapshot of cash balances and where they are held. It includes bank balances; outgoing checks; outgoing bank transfers; loans and deposits with interest payments coming in or going out; incoming payments that are posted but pending in bank accounts; and incoming payments with specified dates, like post-dated checks and automatic payments. Ideally, the report should be available at any time—so update it as frequently as you can and with as much information as possible being fed in automatically. This is where accounting systems really show their worth, as they can be configured to pull much of that information out of online banking systems with relatively little hassle. Then it's only unusual or post-dated items that must be entered manually.
  • Cash forecasts are generally prepared for up to 90 days out (or the following 90-day period), and should be updated regularly (say, weekly or at the very least monthly). It is a summary of the incoming and outgoing cash—or cash receipts and disbursements. The cash forecast includes expected incoming and outgoing payments from open accounts receivable and payable items; other expected cash transactions appearing on the general ledger; planned payments of salaries and wages; and sales taxes and other taxes payable on A/P and A/R items.

The secret of a good cash forecast is knowing your business: knowing your customers' payment habits and knowing your payments cycle for suppliers. It is a forecast of expected incomings and outgoings, which rarely--if ever--end up coming in or going out exactly when you expect. But the better you know your business and your customers, the more accurate the forecast will be.

Budgeting for Cash Flow: Watch Out for the Vicious Cycle

One big issue exacerbating the cash flow problems faced by many companies is the growing gap between days payables outstanding and days sales outstanding. In part because of the lack of access to funding, and of course as a result of the general state of the economy, companies have looked to extend their working capital cycle—lengthening their payables terms as much as possible.

But this has created a vicious circle. Businesses want to extend their payment terms, but so too do their customers, who are in the same boat. Because there has been such a strain on cash flows, the receivables and payables cycle is being stretched out.

'The longer it takes your customers to repay, the more important it is to do a good job of forecasting inflows and outflows,' says Shintani of Wells Fargo. 'For example, if you need to pay your supplier under net 30 terms but your receivables aren't coming for 90 days, you could be in a situation where you're in a net negative cash position and it's critical to plan for how you're going to bridge that gap.'

Budgeting for Cash Flow: Reduce the Payables/Receivables Gap

Additionally, you'll want to reduce that gap as much as possible. One thing businesses can do that will not only instil greater confidence in banking partners when it comes to negotiating credit lines, but will also reduce the need for a credit line in the first place, is to work on improving the accounts receivable cycle in order to get cash in faster. (Still going to need credit in 2011? Read this guide to improve your chances.)

If the company's average collection period is quite long, it may make sense to offer discounts for early payments—rather than late fees for overdue payments. Not only is this a customer-focused approach—a carrot rather than a stick—but it could also save the company money.

Notes Gould: 'If you offer your customers a 3 percent discount for early payment and they pay in 10 days, it may save you using your credit line to cover expenses--which could be at 8 percent. So you would save quite a bit with the difference.'

In the current environment, companies must have a clear picture of their incoming and outgoing cash flows, budget based on that, and more effectively use the cash they have internally. With credit still quite hard to find, reducing the need for external funding has never been more essential.