Whether you’re an individual or a business owner looking to stay on top of your finances, it’s important to plan out your budget and overall cash flow. Cash flow planning means different things in different contexts. For an individual, it’s about sticking to a budget so you’re able to save money. For business owners, it’s about balancing costs and earnings. In the context of insurance, a cash flow plan offers the chance for policyholders to pay premiums in small increments based on their overall cash flow.
What Is Cash Flow Planning?
In simple terms, “cash flow” refers to all forms of cash and assets that come and go from anyone. Companies value cash flow because it offers a clear distinction between what they owe and what they’re earning. It can also be particularly beneficial for individuals, especially when planning a budget.
When it comes to this type of financial planning, a cash flow plan can come in two basic variations: business and personal. Although things work similarly in each context, the end goal is often different. These differences are rooted in the fact that businesses are aiming to gain profits, whereas individuals are usually looking to make ends meet and have some leftover money for their savings.
Personal Cash Flow Planning
Individuals and families should create a cash flow plan to ensure that they can properly support their spending needs on a regular basis, in addition to creating an emergency fund. Those who don’t have an effective cash flow plan in place risk going into debt to cover their life expenses. Cash flow plans can help people figure out how to best allocate income between savings and spending.
Assume the Smith Family has a monthly income of $6,000. Between mortgage and car payments and groceries and other daily costs, the family usually spends around $2,500, giving them a positive cash flow of $3,500. However, the family’s oldest daughter will need $10,000 to pay for her semester at college next month. Therefore, a cash flow plan can help the family determine what their financial situation will look like over the upcoming months.
Business Cash Flow Planning
Many businesses have a cash flow plan in place to ensure that they’re properly balancing costs and earnings. These might include operating expenses like salaries, rent, taxes, loan payments, equipment purchases, raw materials, business permits and more. But when you make a sale to a customer, that money creates a positive impact on your profit and loss (P&L) statement.
Without a proper cash flow plan, a company may not be able to sustain its business model. This could have dire consequences, as it then may be forced to raise expensive short-term capital, get a loan or even shut down completely.
To create an adequate cash flow plan, a business should note how much it plans to spend and earn in a given period of time. This can be done by subtracting the company’s accounts payable by its accounts receivable. Here’s a breakdown of each:
- Accounts Receivable – This account tracks the assets coming into the business. In most cases, this is the money earned from goods and services you provide.
- Accounts Payable – A company’s liabilities are tracked in this account, including payroll, loans and more.
For example, assume that Company A expects to sell 500 units a month at a price of $100 each. Altogether, expenses and employee wages for that same month are expected to be $40,000. However, because the company has a loan to its name, it owes the bank $5,000 this month. In the end, that leaves Company A with a positive cash flow of $5,000. It can use that money to help further pay off its loan or the funds can be reinvested back into the company for some other purpose.
Just because the previous calculation is positive doesn’t necessarily mean the company has a positive cash flow. This is because a business could theoretically make more money than it has paid out, but those incoming funds may still be pending in accounts receivable. As a result, the money won’t actually show in the company’s account, making its cash flow lower than its profitability.
Cash Flow Plans in Insurance
Personal and business cash flow plans are relatively similar in nature, but insurance cash flow plans differ significantly. In this context, an insurance policyholder can use a cash flow plan to pay for an insurance policy by dividing insurance premiums into smaller intervals. As a result, the size of these payments varies based on the policyholder’s incoming cash flow.
This type of cash flow plan allows policyholders to benefit from holding onto their cash reserves for longer. It also has potential benefits for insurance providers, as its income sources will be vastly more spread out. This arrangement is typically more affordable, decreasing the likelihood that the policyholder defaults.
Cash Flow Planning & Budgeting
As you might expect, cash flow planning and budgeting often go hand in hand. Whether you’re a business, an individual or a family planning out how your cash flow is going to match your spending needs, is in direct correlation with an effective budget. Whereas a cash flow plan focuses on long-term finances, a budget is much more helpful on a micro scale. Budgets also lend themselves to the formulation of a plan for finding where you can save for the future and retirement.
Budgeting involves being prepared for what lies ahead. On the other hand, spending money recklessly without the guidance of a budget could quickly put you and your family in a bad spot. While cash flow is worth calculating monthly, both Company A and the Smith Family should be fully aware of their financial limitations more regularly. In either example, the introduction of a major purchase would be unlikely to fit into a cash flow plan. However, through budgeting and other similar tactics, these goals could eventually become attainable.
Cash flow plans for both businesses and individuals are an important step in ensuring financial stability and longevity. They also go along with budgeting as a way to help people and businesses stay on top of their finances in both the short and long term. Don’t confuse either of these situation with an insurance cash flow plan, though. This differs in that it’s a way for policyholders to pay for insurance more affordably. In all three scenarios, a substantial budget should be in place as well.
Tips for Creating a Budget
- Whether you’re creating a budget for your family or your business, professional guidance might be helpful. That’s where a financial advisor can come in handy. Finding the right financial advisor that fits your needs doesn’t have to be hard, though. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
- Creating a budget might feel intimidating, but it’s an important step towards maintaining your financial health. SmartAsset created a budget calculator to help make things easier for you. Plug in your income, location, family size and expenses to see how you’re doing.
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