If someone were to ask you, “What are the most important financial controls for a small business?” what would your answer be? This article looks at the minimum monitors that must be in place in order to protect and preserve the assets of a business.
What you should aim to achieve is to have a system in place that will give warnings when your business is approaching pre-set financial limits that, if exceeded, could do serious harm to your company. I have personally found it quite comforting to have my own watchdog that will give me timely notice if I’m straying from my predetermined financial paths.
My watchdog of choice is the budget. The topic may be boring, but the need for budgeting is indispensable. I will be describing what I think are the two very basic types of budgets — the Cash Flow Budget and the Income and Expense Budget — that will protect and alert you as you are tending to the daily needs of your business.
Believe it or not, there are many businesspeople who have never heard of this type of budget, let alone seen such a rarity. However, I have personally found such a financial device quite comforting. Let me explain.
One of the businesses that I owned had a weekly payroll that at times would exceed US$100,000. Now, we all know that there are some creditors who can be put off for a while — some, perhaps, for quite a while. Your employees can rarely be put off, especially when you have more than a handful.
My worst nightmare was that, come a payroll day, I wouldn’t have the money in our corporate account to pay my employees. To further exacerbate the matter, I had an aggressive union that was just waiting for me to slip up so that they could “rally the troops” for some sort of job action. I, therefore, put into place a rolling Cash-Flow Budget.
This type of budget is really quite easy to put together. The first thing to do is examine your past year’s weekly cash-flow. Figure out how much an average payroll is and how much your other weekly cash expenditures amount to. Be sure to take into account holidays that might substantially increase your weekly payroll expenditure, especially if you must have staff on during the holiday and pay time and a half for those workers.
I would advise that you consult with your office manager, in-house accountant or outside auditor in order to assure that your computations are reasonable. In my case, my office manager would put together a two-month rolling Cash-Flow Budget that I would update at the end of each month. This meant that at the beginning of each new month, I always had a very good sense of where my cash position would be two months hence.
Some of you might say that this process is unrealistic because your cash flow is not steady and tends to go in peaks and valleys. I would answer that you must somehow smooth out the peaks and valleys in order to have a reasonable projection of where you are going and where you will be when it comes to cash in the bank. Think of the alternative to not committing yourself to such an exercise; that alternative might be pandemonium.
One thing that might assist you here is a floating line of credit with your bank. This means you can draw on it during dry times and pay it down when you are flush. A floating line of credit does not eliminate the need for you to know where you are going vis–vis your cash position.
Think about it. Suppose you find yourself unwittingly out of cash and you have to go to your bank to draw down on your line-of-credit. It could very well be that you have exhausted your credit line and there is nothing there for you to draw down. What do you do then?
A little tip — in establishing your Cash-Flow Budget, you have to know where you’ve been in order to know where you are going. Look at the past 12 months to get a good idea of the stream of cash that your company generates. Then look at the drains on this stream: your expenses. This is where you’ve been. Now look forward to where you are going and tweak your past history for your future eventualities. In this fashion, your two-month rolling cash budget will be as accurate as possible.
Income, Expense Budget
The next budget that is a must is the Income and Expense Budget. What you are doing here is essentially drawing up a pro-forma statement of income that looks at the upcoming year. It is, of course, an estimate, but an indispensable one. The fact is, you can more sanely and calmly run your business if you have a good idea about how the highway down which you will be rolling (or careening out of control, if you are among the unfortunate people who don’t plan ahead) looks. Ouch!
What does this budget look like? Well, it’s essentially an annual income statement, with a few exceptions. First of all, it’s an estimate. Secondly, you add an extra column wherein you insert actual results next to your budgeted estimates. Finally, you add a third column called Under & Over.
After you’ve completed your Monthly Income Statement, enter on the appropriate line the element of actual income or expense next to your estimate of that income or expense. Remember, you also have a third column, the so-called “Under or Over Column.” In this column, you subtract the difference between your budgeted line item and your actual line item.
How It Works
Here’s an example.
Suppose that you budgeted a monthly income of $500,000 for January. Then suppose that your actual income for January was $524,000. You would enter the $524,000 in the column that represents your actual results. In the third column, you would enter the amount $24,000 to signify that you have exceeded your estimate of income by that amount. Keep the old accounting axiom in mind while you are budgeting: “anticipate no profits; provide for all losses.” In other words: be conservative!
What about expenses? How should you portray them in your budget? The same principle applies here. You have a column for Budgeted Expenses, another column for Actual Expenses and a third Under or Over column.
For example, suppose you projected that your payroll for January would be $250,000. When you insert the actual results for your January payroll into that line item, you find that your payroll was $256,000. In the Under or Over column, insert $6,000, but put it in brackets to show that you have exceeded your payroll expense for the month.
When you have finished inserting your actual figures, the resulting three columns are tallied.
You have obviously exceeded your budgeted net income by $5,000. This means that you were conservative in your budgeting and that there were no unpleasant surprises for the month of January. This gives you some control over your business life and some sanity and calmness in your everyday business deliberations. It’s a great way to live. Good luck!
Theodore F. di Stefano is a managing partner at Capital Source Partners and can be contacted at firstname.lastname@example.org.
This story was originally published on October 1, 2004, and is brought to you today as part of our Best of ECT News series.