Profit and loss budgets vs. cashflow forecasts

29 November 2017

With January just around the corner, business owners should be looking to the future, and creating both a forecast and a budget for the next year. January can be the perfect month to review what happened last year, and what your new targets should be. In order to properly plan your finances, you’ll need to understand the difference between a P&L budget and a forecast.

What is a profit and loss budget?

Your profit and loss budget (P&L for short) is your financial plan for what you are going to sell, what it will cost, and what overheads you will need to pay, including interest. The P&L budget essentially sets out how much profit or loss the business is planning to make, usually on a monthly basis. It’s important to note that you budget on a profit and loss basis, meaning your income and expenses are accounted for at the point you incur them, regardless of when they're actually paid.

Lenders or investors might request a P&L budget, but it’s a good idea to keep one for your business internally too because it’s a financial roadmap for everyone in the company to work towards. Even if you don’t know exactly what you expect to make and spend, use your best guess based on previous financial history and your plans for the business.

How do I make a P&L budget?

To make a P&L budget you’ll need to really understand your spending and revenue. It’s a good chance to step back and look at all the activities your business has going on, and what those costs are for your budget. If you’ve got a strategy or business plan, you’ll want to think about what you need to do to achieve your targets, and what resources you need to meet them.

It can be really helpful to know what your break-even point is to make sure that your costs don’t outweigh your expected revenues. Depending on your company, you might do a break-even analysis for lots of different products or services, or you might just need to look at the break-even for the whole company.

Make sure your budgets line up with your chart of accounts so you can easily report on your budget versus actuals throughout the year. If you use cloud accounting software such as Xero or QuickBooks Online, you can set up a budget within one of those tools to make this easier. Remember, your P&L budget does not include taxes or repayments of loans or dividends.

What is a cash flow forecast?

A cash flow forecast is a plan of when cash will move in and out of your business. You need to have a cash flow forecast as well as a P&L budget, because your payment terms might mean that your company is profitable, but your bank balance is in the red! A forecast won’t tell you if you’re profitable, but you’ll have a much better understanding of what your bank balance will be and what you can afford to pay for.

It’s crucial that you map this out clearly to anticipate upcoming cash gaps and how you’ll manage them. Once you can see your upcoming peaks and troughs, you can play around with the numbers to work out how to maintain a positive bank balance, or reinvest any surplus cash in the business.

The cash flow also includes items such as tax, repayment of loans and dividends, which aren’t included in the P&L budget — but it doesn’t include things like depreciation expenses. The rule of thumb is if it impacts your bank balance, it’ll be on the cash flow.

How do I make a cash flow forecast?

One of the biggest hurdles when building a cash flow forecast is that you need to start with an accurate opening balance, which can be a moving target. Once you’ve set an opening balance, you then put in forecasts each month for cash in and out based on when and how much customers pay, and when you expect to pay overheads and suppliers.

You can ask your accountant to help you out with doing this manually in Excel, have a go yourself in a manual cash flow template, or use a software tool such as Float to make the process much faster and easier.

Because your P&L budget accounts for income and costs at the point you incur them, it can remain fairly fixed. A cash flow forecast, on the other hand, is at its best when it can stay updated with your accounting transactions as they happen. If a customer misses a payment due date, you need to know how this change affects your bank balance — will you still be able to pay your salaries before the end of the month? With tools like Float this can be easily managed.

The problem with manual cash flow forecasts is that they don’t keep themselves up to date with what’s really happening day-to-day. With Float, your forecast stays up to date automatically, importing data from your accounting software every day to keep you on track.

Which is best?

P&L budgeting helps you remain profitable to make sure your company has a long-term future, and cash flow forecasting helps you make sure you have the right cash on hand to put your plans into action. They are both vital — the two together will help set your business up for success.