A precise statement that shows projected forecasts of the cash revenues and payments for a given period is known as a cash budget. It is an operating budget that is helpful for an organization’s financial management.
A cash budget, often known as the “Nervous System of Budgetary Control,” is crucial for businesses. Additionally, it goes by the name “Cash Flow Plans.” It primarily relies on cash receipts and payments to function. These elements are determined by examining the flow of funds within and beyond the company.
What is Cash Budget?
A cash budget forecasts a business’s cash flows over a specific period. The budget could cover a week, month, quarter, or year. The entity’s ability to maintain operations for the given period is assessed using this budget. It also helps determine an optimal cash allocation (and any surplus) by providing a company with information about its financial requirements.
Cash budgets are typically evaluated in either the short or long term. Short-term cash budgets concentrate on cash requirements for the next week or months, while long-term cash budgets concentrate on cash requirements for the next year to several years.
Objectives of the Cash Budget
- The main goal of the cash budget is to forecast a company’s future cash position so that management can determine when additional funding will be needed to ensure smooth business operations.
- It is also prepared to assess whether there is any available surplus cash; if so, it must invest it wisely to maximize its benefits to the business.
- Moreover, they are equipped to forecast the cash surplus and deficit for the given time frame.
Cash Budget Format
There are four sections in the cash budget format:
- It lists all cash inflows, excluding money received for financing, under “Cash Receipts.”
- All cash payments, excluding principal and interest payments, are referred to as cash disbursements.
- It determines whether the company will need to borrow money or whether it will be able to return money that has already been borrowed.
- The financing section describes the estimated borrowings and repayments throughout the budget period.
budget period.
A cash budget example
Consider XYZ Clothing, a shoe manufacturer, which projects $200,000 in sales for June, July, and August. The company predicts monthly sales of 5,000 pairs of shoes at a retail price of $60 per pair. According to XYZ, 70% of the money from these sales will be paid out in the month that follows the sale, while the remaining 20% will be paid out two months later.
The beginning cash balance for July is anticipated to be $20,000, and the cash budget anticipates collecting $140,000 (70% of $200,000), or 70% of the sales from June. XYZ also anticipates receiving $200,000 in cash from earlier-year sales.
XYZ also needs to figure out the production expenses necessary to make the shoes and satisfy client demand on the expense side. Five thousand pairs of shoes must be produced in July to meet the company’s expectations.
If the manufacturing cost is $50 per pair, XYZ will incur $250,000 ($50 x 5,000) in July. In addition, the company anticipates spending $60,000 on expenses like insurance that is not directly connected to manufacturing.
XYZ calculates the cash inflows by adding the receivables collected in July to the starting amount, which is $360,000 ($20,000 for the beginning of July plus $140,000 from June sales collected in July plus $200,000 from previous sales).
The business then subtracts the money required to cover production costs and other outlays. $310,000 is the total ($250,000 for the cost of goods sold and $60,000 for additional expenses). The final cash balance for XYZ for July was $50,000, meaning $360,000 in cash inflows less $310,000 in cash outflows.
The Method of Preparing Cash Budgeting
A cash budget is prepared in three ways. Cash budget methods are explained below:
Receipts and Payment Method
Utilizing receipts and payments is the most popular and simple method for developing a cash budget, particularly a short-term budget. The receipts and payment mechanism add all anticipated receipts to the opening cash sum.
After completing the preceding computations, the expected receipts and any balance represent the closing cash balance. All projected cash payments then reduce the total opening cash balance.
Adjusted Profit & Loss Method
The basis for preparation under this system is the profit and loss account. This model assumes that each gain and reduction in the cash balance represents a profit or loss for the company.
When creating a profit and loss statement, losses on asset sales, depreciation, goodwill write-offs, and other costs that don’t involve actual cash transfers are subtracted from the business’s income. It is added to other earnings, such as the profit from the sale of fixed assets, to arrive at the company’s net profit.
Moreover, to create a cash budget using this method, all non-cash expenses are added to the net profit, and all non-cash incomes are subtracted. The sum is multiplied by the opening cash balance to arrive at the cash balance. Then adjustments are made to capital receipts and payments, working capital changes, and financing-related flow changes.
Balance Sheet Method
A budgeted balance sheet is prepared under this method, which includes all assets and obligations except the cash balance. The balancing figure is thought to reflect the monetary balance. If the liabilities exceed the assets, the balance is a conventional cash balance; if the assets exceed the liabilities, the balance is assumed to be a bank overdraft.
Conclusion
The most significant of all operating budgets is the cash budget. However, it is prepared after completing all other functional budgets. The cash budget summarizes the expected cash revenues and payments for a certain period, and it assists management in making cash arrangements if sufficient cash is not available at the end of each month.
The company can cover all operating expenses and other obligations in this manner. On the other hand, if surplus capital is available at any moment, management can make appropriate arrangements for investments outside the organization.
References
- https://www.wallstreetmojo.com/cash-budget/
- https://theinvestorsbook.com/cash-budget.html
- https://www.investopedia.com/terms/c/cashbudget.asp#:~: text=A%20cash%20budget%20is%20an,over%20the%20given%20 time%20frame.
- https://www.investopedia.com/terms/c/cashbudget.asp#:~: text=A%20cash%20budget%20is%20an,over%20the%20given%20 time%20frame.
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