Cash budget definition
/What is a Cash Budget?
A cash budget itemizes the projected sources and uses of cash in a future period. This budget is used to ascertain whether company operations and other activities will provide a sufficient amount of cash to meet projected cash requirements. If not, the budget can be used to identify exactly when additional cash will be needed, and how much will be required. This document is extremely useful for the treasurer, who is responsible for ensuring that a business always has sufficient cash on hand to conduct its operations. Thus, the cash budget can be used to identify whether additional debt or equity funding will be needed, and the date by which it must be in the company’s bank account.
Contents of a Cash Budget
The inputs to the cash budget come from several other budgets. The results of the cash budget are used in the financing budget, which itemizes investments, debt, and both interest income and interest expense.
The cash budget is comprised of two main areas, which are Sources of Cash and Uses of Cash. The Sources of Cash section contains the beginning cash balance, as well as cash receipts from cash sales, accounts receivable collections, and the sale of assets. The Uses of Cash section contains all planned cash expenditures, which comes from the direct material budget, direct labor budget, manufacturing overhead budget, and selling and administrative expense budget. It may also contain line items for fixed asset purchases and dividends to shareholders.
If there are any unusually large cash balances indicated in the cash budget, these balances are dealt with in the financing budget, where suitable investments are indicated for them. Similarly, if there are any negative balances in the cash budget, the financing budget indicates the timing and amount of any debt or equity needed to offset these balances.
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Example of a Cash Budget
Here is an example of a cash budget, showing the sources and uses of cash by week, and resulting in a net cash position.
The example shows a significant decline in incoming cash flows in the second week, following by a further decline in the third week that will likely require the organization to obtain additional financing. The same problem arises in the fourth week, so management will need to find at least $129,000 of financing before these needs arise. Alternatively, it will have to delay some cash outflows in order to keep from having a negative cash balance.
Benefits of a Cash Budget
There are numerous benefits associated with preparing and updating a cash budget on a regular basis. They are as follows:
Improved Cash Flow Management
A cash budget provides a clear picture of when cash inflows and outflows are expected to occur. This enables management to anticipate periods of cash shortages or surpluses. By forecasting cash movements, the company can schedule expenditures more effectively to avoid liquidity problems. It also helps in planning the timing of investments or loan repayments. Ultimately, better cash flow management ensures that the business remains solvent and financially stable.
Enhanced Decision-Making
Having a cash budget in place equips management with timely financial information necessary for strategic decisions. It allows decision-makers to assess whether sufficient cash will be available for major purchases, expansions, or debt reductions. By basing decisions on forecasted cash availability rather than assumptions, companies can avoid unnecessary financial risks. It also provides a framework for evaluating the potential impact of different scenarios on cash balances. This leads to more informed and confident financial planning.
Early Identification of Financing Needs
The cash budget highlights when and where cash shortfalls may occur well before they become critical. This early warning allows management to arrange for financing in advance, whether through loans, credit lines, or equity injections. By planning ahead, the company can secure better financing terms and avoid emergency borrowing. It also helps maintain good relationships with creditors and investors by showing proactive financial management. Early identification of financing needs is crucial for sustaining long-term business operations.
Increased Operational Efficiency
When a company knows its cash limitations and opportunities, it can operate more efficiently. The cash budget encourages careful planning of expenditures, reducing wasteful or unnecessary spending. Managers are more likely to prioritize critical activities and projects based on available resources. It also supports better coordination across departments, as teams understand the financial constraints they must operate within. Overall, operational activities become more streamlined and aligned with the organization's cash flow capabilities.
Strengthened Financial Control
A cash budget acts as a benchmark against which actual cash performance can be compared. By monitoring variances between budgeted and actual cash flows, management can quickly identify problems and implement corrective actions. This strengthens internal controls over cash management and reduces the likelihood of fraud or mismanagement. Regular use of the cash budget also promotes greater accountability among managers responsible for cash-related activities. Strong financial control ultimately supports the company’s financial health and reputation.
Other Cash Budget Issues
Cash balances may fluctuate considerably within a single accounting period, thereby masking cash shortfalls that can put a company in serious jeopardy. To spot these issues, it is quite common to create and maintain cash forecasts on a weekly basis. Though these short-term budgets are reasonably accurate for perhaps a month, the precision of forecasting declines rapidly thereafter, so many companies then switch to budgeting on a monthly basis. In essence, a weekly cash budget begins to lose its relevance after one month, and is largely inaccurate after two months.
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