Cash Budget

From CEOpedia | Management online

A cash budget is a budget or plan of expected cash receipts and disbursements during the period. These cash inflows and outflows include revenues collected, expenses paid, and loans receipts and payments. In other words, a cash budget is an estimated projection of the company's cash position in the future and ascertain whether company operations and other activities will provide a sufficient amount of cash to meet projected cash requirements. If not, management must find additional funding sources.

The need for preparing the cash budget

A cash budget is important for a variety of reasons. For one, it allows to make management decisions regarding your cash position (or cash reserve). Without the type of monitoring imposed by the budgeting process, you may be unaware of the cycle of cash through the business. At the end of a year or a business cycle, a series of monthly cash budgets will show just how much cash is coming into the company and the way it is being used. Seasonal fluctuations will be made clear. A cash budget also allows to evaluate and plan for the capital needs. The cash budget will help assess whether there are periods during the operations cycle when it might need short-term borrowing. It will also help to assess any long-term borrowing needs. Basically, a cash budget is a planning tool for management decisions (J. A. Turnes, 2013).

Types of cash budgets

A cash budget details a company's cash inflow and outflow during a specified budget period, such as a month, quarter or year. We can list several types of budgets (A. Mungal, H. L. Garbharran, 2014):

  • Short-term cash budgets aim to solve cash requirements on a weekly or monthly basis. These budgets help forecast the payments that need immediate fund allocation and identify sources that can help offset this requirement. Short-term budgets also help determine short-term investments that can earn interest while the fund is not being used.
  • Interim-Term Budgets are typically meant for 12-month periods. These are usually created at the end of the year for the succeeding period based on the current year's transactions. When preparing the budget, management takes into account aspects such as seasonal variations in business and cyclical changes that change the dynamics of the budget, apart from considering the routine income and expenses. Based on these estimations, they make decisions regarding annual borrowing requirements and accumulated accounts receivable plans. Interim budgets also provide for annual increments to employees, principal loan payouts and insurance payments.
  • Long-term cash flow budgets are predominantly spread over several years. These budgets aid strategic decision-making such as capital investments in machinery and infrastructure, business diversity plans and manpower projections costing. Based on the long-range forecast, the company builds sustainable cash reserves that help in the execution of the plans. Management creates long-range budgets from which various interim and short-term budgets are derived for the respective time periods.

How to prepare a cash budget

There are three main components necessary for creating a cash budget. They are (J. A. Turnes, 2013):

  • Time period
  • Desired cash position
  • Estimated sales and expenses

Time period.

The first decision to make when preparing a cash budget is to decide the period of time for which the budget will apply.

Desired cash position.

The amount of cash that wish to keep on hand will depend on the nature of your business, the predictability of accounts receivable and the probability of fast-happening opportunities (or unfortunate occurrences) that may require to have a significant reserve of cash. It is good to consider the cash reserve in terms of a certain number of days' sales. The budgeting process will help to determine if, at the end of the period, there is an adequate cash reserve.

Estimated sales and expenses The fundamental concept of a cash budget is estimating all future cash receipts and cash expenditures that will take place during the time period. The most important estimate you will make, however, is an estimate of sales. Once this is decided, the rest of the cash budget can fall into place. Each type of expense (as shown on your income statement) must be evaluated for its potential to increase or decrease. The estimates should be based on the experience running the business and on the goals for the business over the time frame for which the budget is being created. At a minimum, the following categories of expected cash receipts and expected cash payments should be considered:

Cash balance:

  • Expected cash receipts
  • Cash sales
  • Collections of accounts receivable
  • Other income

Expected cash expenses:

  • Raw material (inventory)
  • Payroll

Other direct expenses:

  • Advertising
  • Selling expenses
  • Administrative expense
  • Plant and equipment expenditures
  • Other payments

Examples of Cash Budget

  • A business can create a cash budget to estimate their future cash flows, expenses, and revenues. This budget can be used to identify potential shortfalls or surpluses, and to plan for any necessary cash flow adjustments.
  • An individual may create a cash budget to estimate their future expenses and income. This budget can be used to identify where they can save money and how to plan for future financial goals.
  • A nonprofit organization may create a cash budget to estimate their future expenses, revenue, and donations. This budget can be used to identify areas of need and how to plan for future fundraising goals.
  • A government agency may create a cash budget to estimate their future expenditures and revenue. This budget can be used to identify areas of need and to plan for any necessary cash flow adjustments.

Advantages of Cash Budget

A cash budget can provide a number of advantages. It can help a business:

  • Identify shortfalls in liquidity and provide solutions to address them in a timely manner.
  • Improve cash flow management by providing detailed information on expected cash flows.
  • Allocate resources in an efficient manner, helping the business prioritize their expenditures.
  • Create financial projections and help the business make strategic decisions.
  • Monitor cash inflows and outflows, helping the business identify potential sources of cash and improve their budgeting process.
  • Assess the impact of potential changes in the business environment and make appropriate adjustments.

Limitations of Cash Budget

A cash budget is a useful tool for businesses to plan for their future cash flows, however, it does have some limitations. These include:

  • Cash budgets do not include non-cash transactions such as depreciation and amortisation, which can have a significant impact on a company's financial position.
  • Cash budgets are based on estimates and forecasts, which may not be accurate. Therefore, the budget may not be an accurate reflection of actual cash flows.
  • Cash budgets are only as good as the assumptions and estimates used in creating them. This means that if the assumptions and estimates are not accurate, then the budget itself will also be inaccurate.
  • Cash budgets do not account for unexpected events, such as a sudden increase in demand for a product or service, which could lead to a difference between the expected and actual cash flows.
  • Cash budgets do not take into account inflation, which can have a significant impact on cash flows.
  • Cash budgets also do not account for taxes, which can have a significant impact on a company's cash position.

Other approaches related to Cash Budget

A cash budget is an essential tool for any business, as it provides a forecast of the expected cash inflows and outflows over a given period. There are several other approaches that can help businesses better manage their cash flows, such as:

  • Setting up a Cash Reserve: A cash reserve is a pool of funds that can be used to cover unexpected expenses or cash shortages. This helps businesses stay afloat during difficult times and can also be used to invest in new opportunities.
  • Analyzing Cash Flow: Analyzing cash flow allows businesses to identify patterns of cash flows and pinpoint any areas of potential improvement. This can help businesses identify areas of potential savings, such as reducing inventory or renegotiating payment terms with suppliers.
  • Negotiating Payment Terms: Negotiating payment terms with customers and suppliers can help businesses manage their cash flows more effectively. For example, businesses can ask customers to pay earlier or offer discounts for early payments.
  • Investing Excess Cash: Investing excess cash can help businesses earn returns and grow their business. Businesses can invest in short-term investments, such as treasury bills, or longer-term investments, such as stocks and bonds.

In conclusion, a cash budget is an important tool for managing cash flows, but there are other approaches that can help businesses better manage their cash flows. Setting up a cash reserve, analyzing cash flow, negotiating payment terms, and investing excess cash can all help businesses manage their cash flows more effectively.


Cash Budget — recommended articles
Total expenditure — Functional budget — Future cash flow — Committed cost — Master budget — Time period concept — Operating cycle — Aged debt — Normal cost

References

Author: Katarzyna Górna

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