Liquidity Budget and Liquidity Forecast

A Liquidity Budget shows a company's cash position by detailing the cash on hand and the budgeted cash inflows and outflows. A Liquidity Forecast, like the Liquidity Budget, often has a clearer purpose linked to future cash inflows and outflows.

Illustration of Liquidity Budget

What is a Liquidity Budget?

Consider the Liquidity Budget as a budgeted cash account that provides an overview of your company’s liquid assets. It is a tool that shows the current and future cash situation. The Liquidity Budget enables you to plan upcoming cash inflows and outflows.

Practically, it indicates your company's ability to meet its payments within a certain period by measuring planned cash flow. It allows you to pay salaries, taxes, and invoices on time, and serves as support in making decisions about investments and loans.

Sometimes, there is a gap between the money coming into the company and the money going out, a common scenario in growth companies. Liquidity planning helps you to see the need for loans and whether you have tied up too much of your liquid assets in inventory or accounts receivable, for example.

Liquid assets are available funds (in cash or bank accounts) that can be used immediately.
Liquidity is a key ratio used in financial reports and indicates how much money a company has compared to its short-term liabilities. Ideally, you want to have the ability to pay all short-term liabilities at any time (have more than 100 percent liquidity).

Cash liquidity is calculated by comparing current assets (excluding inventory and work-in-progress) to short-term liabilities. Cash Flow Analysis focuses on and shows the change in liquid assets over a certain period (money in and out).

How to Create a Liquidity Budget?

  • Start by compiling all liquid assets from the first day of the period.
  • Add all expected inflows (such as loans, VAT the company will get back, and customer payments).
  • Subtract all expected outflows for the period (such as salaries, taxes, and interests).
  • The total shows how much in liquid assets you are expected to have at the end of the period.

Difference Between Liquidity Budget and Income Budget

The Liquidity Budget accounts for cash inflows and outflows, while the Income Budget accounts for costs and revenues. You want the flow of cash inflows and outflows to align with budgeted costs and revenues.
An Income Budget gives you a long-term view of the company's performance and is usually prepared annually, while a Liquidity Budget provides you with the cash flow for a certain period.

More specific differences between the Liquidity Budget and Income Budget are that you include VAT and exclude depreciation in the Liquidity Budget, but not in the Income Budget. However, the Liquidity Budget includes loans from shareholders, new loans, amortisations, and VAT inflows and outflows.

Difference Between a Liquidity Forecast and a Liquidity Budget

A Liquidity Forecast is a compilation of expected cash inflows and outflows showing the company's future need for liquid assets.

While both the Liquidity Budget and Liquidity Forecast are often done together, there are differences. A Liquidity Budget is prepared for the upcoming year and is often done routinely in combination with an Income Budget.

A Liquidity Forecast may have a clearer purpose and focus solely on providing decision-making support for a CFO, such as recommending shortening the timeframe for receivables. Liquidity Forecasts often differ in the period they cover compared to the Liquidity Budget.

Like the Liquidity Budget, the Liquidity Forecast measures the company's short-term payment ability, but it looks forward (forecasts) to determine the future of your company's liquid assets, although this is also partly done when preparing a budget.

When making a Liquidity Forecast, you usually have a clearer purpose than when making a Liquidity Budget. Perhaps you are concerned about covering payments next year?

Considerations When Making a Liquidity Forecast

If you work for a larger company or have liquidity as a key KPI, it might be a good idea to have a model for how you make Liquidity Forecasts as they can serve as the basis for impactful decisions.

Larger companies also have more stakeholders and data sources that should contribute to the Liquidity Forecast process. Therefore, it is important to make the Liquidity Forecast visible, manageable, transparent, and accessible.

  1. Align the purpose of the Liquidity Forecast with the company’s overarching goals and business objectives. This helps in getting managers, leaders, and investors to work towards the same direction. The time (period) in the Liquidity Forecast can be affected by its purpose (and goals).

  2. Determine the goal of the Liquidity Forecast itself. Will your company manage liquidity day by day? Do you want to reduce debts? Should the Liquidity Forecast be part of your Financial Scenario Planning or Risk Management? Does the company want to free up funds for growth or a tech transformation?

  3. Along with determining the goal of the Liquidity Forecast, it's a good idea to map out what data you have available and what your budget software can handle. You don't want to end up overpromising.

  4. Decide the forecast period and method based on available data, the purpose, and the goal. You can choose between an indirect and direct method. The indirect method is better suited for longer periods, and the direct method for shorter periods. The direct method is more precise but becomes less reliable over longer periods (more than 90 days).

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