Forecasting and budgeting when times are tight Featured

7:00pm EDT December 26, 2010

The economy remains tough for most industries, so heading into 2011 is uncertain for many business owners when it comes to forecasting and budgeting. Do you expect strong profitability? What else can possibly be cut to reduce expenses? How can you pay the bills? These questions, plus many more, form the foundation of concerns for numerous business owners in these uncertain times.

“A couple of useful financial tools to help calm nerves and gain a handle on finances are preparing an annual budget and projecting cash flow. Cash flow management is the process of planning, budgeting, measuring and controlling the money that flows into and out of your business,” says Jeff Hipshman, partner at HMWC CPAs & Business Advisors in Tustin. “Since high operating costs and low profit margins, coupled with tight credit and a shaky economy, can mean poor cash flow for many companies, a firm grasp of cash flow can be critical to your business success.”

Smart Business spoke with Hipshman about how he helps clients with their annual forecasting and budgeting process.

How should I use our financial statements in budgeting?

The balance sheet provides a picture of your company’s assets and liabilities, measuring a single point in time. This is only a partial picture of the company, since it only tells part of the story. For example, it may indicate significant accounts receivable, but, if payment is running far behind, the company can face a cash flow issue soon.

The income statement indicates the business’s profitability during a certain period, which can be misleading for some business owners, especially under the accrual method of accounting if they don’t fully understand it. Further, the income statement contains many arbitrary noncash allocations, such as pension contributions and depreciation and amortization.

The cash flow statement, however, connects the balance sheet and income statement to provide a more comprehensive view of your finances. For example, when analyzing your company’s liquidity, cash flow information is more telling. A cash flow statement reconciles and records the changes in the other statements and nets out the bookkeeping, showing the amounts and sources of profits and losses for any given period. The cash flow statement also maintains records of your company’s fiscal transactions.

So how can I best forecast income and expenses?

Among the most valuable tools in this effort is the annual cash flow projection. With it, you can set realistic profitability goals, measure your progress toward those goals and head off trouble before it gets too serious.

To get started on an annual cash flow projection, use your general ledger’s income and expense account categories to budget cash inflows and outflows. You’ll be able to easily predict many routine, fixed expenses, such as facility rent due at the beginning of each month or semiannual insurance installments. Compare previous years’ figures to your current projection to ensure reasonableness. Your CFO or CPA should be able to prepare the projection, along with your guidance on specific projected changes in income and expenses.

My business is losing money. What quick fixes can I do to solve money problems?

In response to dire times, many business owners may look for quick fixes to tide them over until the economy recovers or at least until the next big customer or project comes along. Yet this thought process can be extremely dangerous — particularly when full economic recovery remains nowhere in sight.

Each situation is different. A business that is only recently losing money might be able to proactively make moves that will stop the bleeding, such as reducing employee hours, changing inventory purchase practices and reducing various variable costs. On the other hand, a business that is on the brink of closing its doors may need to downsize by moving or renegotiating its lease, selling assets, laying off employees and asking for extended terms with creditors, etc.

You should work with your financial team (CFO, controller and outside CPA firm) to identify reasonable approaches to improve accounts receivable collections and reduce fixed and variable costs. Since a CPA typically has experience with many companies in similar situations, he will likely provide some very viable solutions that you may not otherwise have considered.

Ultimately, you need to give serious thought to your business strategy when facing tough financial decisions. Although quick fixes may be tempting, they’re detrimental without a well-thought-out plan to back them up.

Why is long-term thinking important in a recession?

When faced with less-than-desirable financial circumstances, you must think long term. While knee-jerk downsizing and cost-cutting may be your first instinct, they often aren’t the best options. Specifically, you must identify the driving forces of your business by asking questions such as:

  • What are your company’s strengths and weaknesses?
  • What is the economic state and forecast for your industry and market area?
  • What variables affect your business?
  • Where do you want to be in 10 years?

Through strategic analyses such as these, you may find, for example, that talented employees and technological innovations are invaluable to your company and are areas in which you must invest — even when money is tight. These analyses may also identify areas that are less of a priority where you can make effective cuts.

Jeff Hipshman is a partner at HMWC CPAs & Business Advisors in Tustin. Reach him at (714) 505-9000 or