To keep track of your business’s finances and liquidity, it’s essential to establish some solid budgets. Therefore, you should have both an income budget and a liquidity budget. In this article, we will explain how you can set up this.
How to prepare a budget for a company
One of the most crucial actions you can take for your business is budgeting. Budgets are excellent management tools, revealing where adjustments are needed. This way, you’ll know when and where to make changes to keep your business running, identify areas of surplus for potential investments, and facilitate growth.
In this article, we’ll guide you on setting up the most central budgets.
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Liquidity budget and income budget
You should prioritize creating an income budget, also known as an operating budget, and a liquidity budget. The income budget shows the final results after a period, while the liquidity budget helps you determine if you’ll have funds to cover upcoming expenses. By having control over both income and liquidity, you’ll have a solid foundation for sustaining your business in the long run.
A well-maintained financial record is a good starting point for a clear and accurate budget. If you’ve been in business for a while, last year’s figures can be a good starting point. For new businesses, you can create budgets based on the costs of producing your goods or services, estimate expenses for things and services you need, and determine the pricing strategy.
It pays to be realistic when setting up a budget. For budgets to effectively guide your business in the right direction, they cannot be based on hopes and dreams. Budgeting with higher costs and lower income than expected increases the chances of avoiding unpleasant surprises.
What is an income budget?
When setting up an income budget, you compare expenses against income. The result shows whether your business is profitable and provides an idea of how much you should pay in taxes. It indicates whether you’ll have a surplus or deficit in a given period, serving as a measure of your business’s value creation.
It’s most common to set up an income budget for a calendar year, but you can also create budgets for shorter periods. Start with an income budget because the figures can be used to set up a liquidity budget later. It’s also a good idea to place the budgets side by side for the best possible overview.
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How to set up an income budget
You can calculate the income budget like this:
Income = revenue – costs
Under income, list everything you expect to earn in the given period, while under costs, list everything you expect to spend. Note that income and costs in an income budget should be listed in the month they are invoiced, not the month they are paid. For example, if you purchase a new printer for your business in January but don’t pay the invoice until February, the printer’s cost should still be recorded in January.You can easily set up an income budget in a spreadsheet and input your own items.
In the example below, we’ve used a small sole proprietorship with one part-time employee as a basis for a six-month income budget:
Income budget explained
The «Cash Sales» show what you expect to receive in cash, while «Credit Sales» show what you expect to invoice with payment deadlines of 15 and 30 days. «Total Income» shows the total expected income each month.
Under «Costs», fill in relevant items for your business. Common items may include the cost of goods (what it costs to buy and produce items needed for your business), wages, employer’s contributions, and vacation pay. If you also rent a location or have other significant fixed costs, include those. Small expenses like mobile subscriptions can go under «Other Costs.”
«Result» shows income minus costs, regardless of whether you’ve received payment from customers or paid suppliers. «Total Result» shows the overall result at the end of the budget period. In this case, the sole proprietorship will have a surplus of 14 550 Dollar at the end of June.
What is a liquidity budget?
The simplest way to determine whether your business has enough money to pay bills every month is by setting up a liquidity budget.
The liquidity budget provides an overview of planned receipts and payments in a future period, showing how much money you’ll have compared to what you need to pay. It reflects your business’s liquidity and payment capacity.
You can set up a liquidity budget for as long or short a period as you want, depending on your business plans. If, for example, you plan to invest in new equipment for your business in the next three months, you can create a budget to find out when you can afford to make the purchase. It may also be wise to set up a liquidity budget for the first year of your business. This way, you can easily determine whether you’ll manage with the expected funds and income or if you should find more ways to make money.
The advantage of a liquidity budget is that you can easily see periods when you’ll have a surplus and periods when you may have too little money. Once you have this overview, you can plan your expenses better and postpone larger purchases to periods with better liquidity.
Banks may also want to see a liquidity budget if you’re applying for a loan or seeking a credit line. Having good liquidity increases your chances of getting a loan and a credit line.
How to set up a liquidity budget
You can calculate liquidity reserves in this way:
Liquidity Reserves = estimated receipts – estimated payments
While the income budget shows planned income and costs, the liquidity budget shows estimated receipts and estimated payments—when money actually comes in and goes out of the account. This makes it easier to see periods of surplus and periods when you should cut expenses.
Let’s use the income budget from the earlier example of the small sole proprietorship as a basis for creating a liquidity budget:
Cash flow budget explained
The «liquidity Reserve» indicates how much money you lack or have in surplus each month. It’s important to monitor this aspect to determine where you might consider moving expenses or exploring new financing methods.
If you see that you have more expenses some months, you might want to consider cutting product costs or taking on more projects in the preceding months to enhance your cash reserve.
«In the Account at the start» shows what you expect to have in your account at the beginning of the month, and the «In account at the end» shows what you expect to have at the end of the month.
Another way to figure out if your business has good liquidity is by finding the liquidity ratio.
