A liquidity budget is a schematic representation of all the cash flows that your company earns and emits in a certain period. That budget gives you insight into your future financial situation.
Cash is essential
Every company needs money in order to function smoothly. You have to be able to pay the standard invoices, such as those of the energy bill and of the purchased products or services. There will also be occasional unexpected expenses that need to be taken care of. It is therefore important that as a company you always have sufficient liquid assets that are immediately due and payable.
Think of a bank account, cash or assets that can be easily and quickly converted into cash such as shares. Only if this is the case, you can make payments run smoothly and keep your business running. Partners and suppliers do not like to have to wait a long time for their money. Therefore, propose a liquidity budget on. On this basis you can see whether it is wise to take measures that increase your liquidity.
Costs and returns vs. expenses and income
The first step towards the liquidity budget is to understand an important difference. In accounting terms, costs are not the same as expenses and revenues are not the same as income, even though they are often used as synonyms in the vernacular. You may need a handy calculator as Costs and revenues are simply the money used in the profit and loss account to calculate the operating result. Expenses and income are the cash flows that a company actually enters and exits. Costs and expenses do not have to be equal to each other. The liquidity budget is drawn up with expenses and income, i.e. the actual cash flows.
Determine the period
The liquidity budget is reviewed by the company over a predetermined period. For example, the income and expenditure over the coming month or over the coming year can be examined. For the preparation of the budget, determine which period is important for you. The more small budgets you make, from months instead of a year, for example, the better you get an idea of your company's financial situation.
What does the liquidity budget look like?
There are several ways to draw up this budget, but a common form uses three different types of income and expenditure. For example, cash (read money) from normal business activities, cash from investments and cash from financing are distinguished from each other.
The first type of cash flow is the result of daily business activities such as purchasing and received sales revenue. The second type stems from the investments that a company has made, such as investments in company housing or equipment. The sale of this can, for example, generate money. The last form comes from financing activities. These include the cash flows from and to creditors (think of loans) and the share capital. By adding up all expected cash flows you can see how your cash position is expected to change.
Knowledge is control
After compiling the liquidity budget, compare the net increase in cash with your current cash position. So you can see how liquid you are expected to be in the future and whether it is wise to take measures. As an entrepreneur, try to regularly draw up a liquidity budget. The more often you do it, the greater your knowledge about your company and the sooner you can take action if the situation seems to get out of hand. Compare lastly also the budgeted figures for a certain period with the actual net increase in cash in that period in order to be able to adjust any expectations for the future. This way you can see whether expectations were realistic and then make even more precise estimates.
Tips
When you create a liquidity budget, there are a number of things you need to take into account:
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