A cash budget is a budgeting method of representing the expected future income or cash flow of an organization throughout a given timeframe. It refers to the estimation of cash receipts expected in the future over the budgeting period, the expenses that are supposed to take place in cash, and lastly the cash balance with the organization toward the end of the accounting period.
All in all, cash budgets are involved in organizing the projected sources as well as cash uses in a future period. They are utilized to find out whether the business operations and other exercises will give an adequate amount of cash to meet projected cash prerequisites. The outcomes of the cash budget are utilized in the funding budgets that are supposed to organize debt, investments, interest income, and interest expense.
What is a Cash Budget?
Definition: A cash budget is the assessment of the cash flows of a business throughout an annual, monthly, or weekly time period. This financial plan is utilized to evaluate whether a business has adequate cash to keep working over the given time period. It gives an organization an understanding of its cash requirements, plus also assists with deciding on an efficient allocation of cash. It involves two key areas-
- Sources of Cash
- Uses of Cash
Here, the Sources of Cash refer to starting cash balance along with the cash receipts from cash sales, sale of assets, and accounts receivable collections. While on the other hand, the Uses of Cash refers to all the planned cash expenditures that come from the direct materials budget as well as the manufacturing overhead budget, direct labor budget, and selling and administrative expense budget. It might likewise include line items for fixed asset purchases and profits to investors or shareholders.
Understanding Cash Budget
A cash budget refers to an organization’s assessment of cash inflows and outflows throughout a given timeframe, and organizations do this for assessing if it has adequate cash to keep working over the given time period.
If a business is confronting seasonal changes in demands, its cash budget plan can be made for weekly or monthly durations. This will assist with accomplishing sensible budgeting objectives. While a business can go for an annual budget in the event that its incomes are comparatively steady with little to no variations.
All in all, the cash budget gives a wide perspective on the organization’s cash needs in the future. In case the cash-budget receipts appear to be missing the mark concerning future needs, the organization can plan to arrange additional cash from different sources. It will assist the business in avoiding the horrendous situation of being short on cash which can impede different business activities.
Why a Cash Budget is Important?
1. Proper Budgeting
It helps the company management in proper budget preparation. It lets management know ahead of time the conceivable cash deficit or surplus in the future. This way it will let the company be ready ahead of time to keep away from unexpected crises or loss of investment opportunities. When there is a consistent surplus budget, it will flag the management to search for other investments. It can likewise choose to raise the size of its own activities.
Then again, a cash shortage can make the management be alert to intelligently manage its expenditures. This will guide the management to arrange funds. The company might stay away from such a circumstance by making a prudent move on time. Subsequently, it will prompt the effective usage of its scant resources.
2. Handling Seasonal Variations
Despite having an overall positive cash budget, it might also show cash shortfalls in specific months or seasons if your business has a seasonal nature. The company can cautiously draft effective plans to handle these occasional variations ahead of time. Some of the proposed cash outflows can be avoided for these periods of low sales. This will for sure assist the company with forestalling cash shortages.
Besides, companies can further know the cash surplus periods ahead of time. They can plan for some investment opportunities using that surplus or they might also plan to repay part of the company’s debt and decrease the interest burden using the cash surplus.
3. Building Brand Value
A cash budget goes about as a tool to accurately time expenditures of the organization according to its cash resources and it further gives the company time to be ready for using cash surplus when accessible.
A cash budget also helps in early repayment of the debt, timely payment for materials to the suppliers, timely salary disbursement, effective streamlining of the production process, and so on. This thusly assists the organization with optimizing brand value and profitability.
How a Cash Budget Works
Businesses opt for sales as well as production forecasts to make a cash budget, alongside some assumptions about the needed spending and accounts receivable collections. A cash budget comes into play for surveying whether an organization will have sufficient cash to proceed with different business tasks. In case a cash budget suggests that an organization needs more liquidity to work, it should raise more capital by taking on more debt or issuing stock.
The cash roll forward is used for computing the cash inflows and outflows for a month, and it considers the ending balance as the beginning cash balance for the next month. This will enable the organization to forecast the cash needs through the year as well as changes to the roll forward for adjusting the cash balances for future time periods.
How is the Cash Budget Prepared?
The cash budgets come to fruition after the readiness of different spending plans associated with purchases, sales, and so on. All such budgets give a proper image of different cash drivers in the organization. They generally have three parts-
1. Cash Inflow Forecast
It considers every one of the likely sources from where the organization can earn cash over the budget period. Such sources can be cash sales, cash to be generated from the sale of a fixed asset over the period, cash to be received against AR or accounts receivables, cash to be procured from the sale of stocks and bonds, etc. In this, the beginning cash balance adds up to the total cash inflow to give the total cash to the organization over the period.
2. Cash Outflow Forecast
The cash budget preparation will think about all the likely cash outflows during the period of a budget. Such outflows will incorporate all the cash payments made for the purchases of the inputs or semi-finished products, raw materials, consumables and other forms of cash to be paid for the purchase of any fixed asset during the same period along with the dividend distribution, labor payments, stationery requirements, provisions for repairs and maintenance, printing, and so forth
3. Cash Balance Forecast
It comes into practice through a process of deducing the total cash outflows from the cash inflows throughout a time frame (perhaps a week or a month) that the company management feels suitable. In the event that the cash budget anticipates a high overflow of surplus cash, the company might utilize it fittingly by setting up a financing budget. It will turn into the reason for choosing appropriate investment opportunities for the company.
In the event that the cash balance is lacking the cash needs of the organization, the company management might make moves appropriately and in the process, they might search for different sources of raising capital.
Short-Term Cash Budget vs. Long-Term Cash Budget
The short-term cash budgets center around the cash needs required for the following week or months. While on the other hand, the long-term cash budgets center around cash needs for the following year to many more years to come.
The short-term cash budgets will pay heed to the things like rents, service bills, payroll, suppliers’ payments, other working costs, and investment while long-term cash budgets pay heed to quarterly and yearly tax payments, long-term investments, capital expenditure projects, etc.
A long-term cash budget typically needs more essential preparation and proper investigation as they need cash to be functional for longer time periods. It’s additionally important to budget cash needs for any crises or unforeseen requirements for cash that might emerge, especially assuming the business is new and all operations are not completely understood.
The usefulness of Cash Budgets
Let us now have a look at the merits of the cash budgets
- Gives details about different sources of cash receipts and the utilization of cash
- Gives details about future probable payments and receipts
- Gives detailed information about excess cash needs and how these can be sorted out
- Helpful in crises when cash balances are not sufficient, and furthermore in showing how this gap can be filled
- Guarantees payments to be made on the due date
- Surplus balances can be invested to optimize profitability
- Empowers planning for short-term repayments and long-term loans
- Ensures a safe cash level to be laid out to actually check uncertain cash outflows
Functions of Cash Budget
Some of the notable functions of cash budgets are
1. Forecasting of cash requirement
It is helpful in telling about the future cash prerequisites for a specific period. This is helpful in arranging cash funds and making investment decisions at a most right time.
2. Cash position
A cash budget is a sign of cash surplus or cash deficit at a particular time for which the firm’s management can plan to invest surplus cash or borrow cash to resolve the deficiency.
3. Controlling cash expenditure
The cash budgets of different departments are not easy to change once they are ready, thus every department attempts to control cash expenditure as per the cash budget predictions.
4. Expansion schemes
Expansion takes place due to surplus resources. The cash budget fills in as a strategy for organizing business expansion programs.
5. Sound dividend policy
The cash budget also channelizes a sound profit or dividend strategy. It is generally connected with the liquidity position of the company. Shareholders and investors always like the cash dividend, and in addition, the higher rate suggests the profitability of a company.
Cash Budget vs Working Capital Budgets
A cash budget is intended to provide budgeting details of all the business needs along with funds for the securing of fixed capital while on the other hand, working capital budgets are used to find out the assessed standards for the seasonal current capital needs of a business.
Example of Cash Budget
Imagine you run a manufacturing company XYZ, so let us have a look at its cash budget for a time of one month. XYZ’s beginning cash balance at the start of the budgeting period is US$ 30,000.
Then the cash inflows estimated throughout the month are Sales adding up to US$20,000. In addition to this, the accounts receivables to the tune of US$85,000 along with a fixed asset sale of US$55,000. Consequently, the total cash with it over the period will be US$ 1,90,000.
Its cash outflows forecast further talks about the payments for materials amounting to US$ 35,000 along with labor payments adding up to US$30,000, printing costs of US$6,000, selling costs of US$20000, fixes and maintenance charges of US$20,000, and finally the asset acquisition of US$40,000. Henceforth, the total outflow forecast will amount to US$ 1,51,000.
In this manner, the cash balance toward the end of the budgeted period will be US$ 39,000 (US$ 1,90,000 – US$1,51,000).
Now, XYZ’s management might choose to use the cash surplus to perform different sorts of proposed activities as per the budget. It might choose to deliver dividends to its investors in the new future or it might simply sit over it to use it later on.
Conclusion!
In the final analysis, it is clear that a cash budget is a financial plan or plan of expected cash receipts and payments during an annual, monthly, or weekly period. All such cash inflows and outflows incorporate revenues gathered, costs paid as well as loans receipts and payments. Hence, as such, a cash budget is a well-assessed projection of the organization’s cash position in a future period of time.
The company management for the most part makes the cash budget after the capital expenditures, selling expenses, general and administrative expenses, and purchases budgets have been made. All such budgets should be made before the cash budget to precisely assess how the cash will perform in the given period. For instance, the company needs to realize a sales estimate before it can foresee how much cash will be gathered during the period.
The company board will utilize cash budgets for effectively managing the cash flows of the company. It helps companies in ensuring that they have sufficient cash to cover their bills when they come due. Now, on the final note, how important do you consider a cash budget for a business? Share your thoughts with us in the comments below.
