What Is Cash Budget?
Definition: A cash budget is a record potential cash inflows and outflows for a period, so management can predict future cash flow needs.
Every project or business must use a cash project, which serves as one of the primary determinants for success. The cash budget offers an evaluation of cash inflows and outflows within a set period, say a year, a quarter, or a month. It also defines the financial status, especially of large companies.
When and How the Cash Budget Used?
Many companies or entities set out a one year cash period. For ease of analysis, the one year is then broken into shorter periods, weeks, or monthly periods depending on its objective. The short periods of cash budgets may be used to offset immediate cash requirements. In contrast, a long term cash budget is suitable for capital investment on machinery, infrastructure, or workforce projections.
More often than not, the cash budget is developed after budgets relating to purchases, sales, and capital expenditures. It is because they outline the estimated cash plus the predictions of how it will be collected within its required period.
The following are the primary objectives of a cash budget: –
- It helps in making critical decisions. It ensures any projected shortages are taken care of in advance, perhaps by creating cash reserves.
- Helps in prioritizing and analyzing payments in the budget period. It is also very significant when formulating a dividend policy.
- To assist in maintaining a steady and reliable balance for disbursements, investments, and working capital.
- Determines the best financing cash requirements for a company
- A cash budget outlines when the cash is required; hence it plays a vital role in planning, especially advance bank loans will be necessary.
Cash Budget Template Example
Done’s company estimates to make $400,000 in sales of its clothing fabrics in January, February, and March 2020. With a selling price of $50 per 6yards of cloth, the company will sell 6,000 pieces of material each month. Done estimates a60% cash collection in the first month before the sale; however, 40% will come within the two months after the purchase.
January’s predictions of the start-off cash balance are $30,000, and rememberthe 60% assumption of sales in December, which will be collected in January. It translates to $240,000. The company has a new prediction of $120,000 cash inflows received from last year’s sales.
Done have also calculated the expected expenses that include the production costs of the fabrics. The projection is to have 5,000 pieces in January, and if each fabric costs $50, the company will spend $250,000 in January. It is commonly referred to as the cost of goods. Other administrative costs related to production will cost $80,000.
In its cash inflow, Done will have the receivables of $30,000+ $240,000+ $120,000 = $390,000
The outflows will be the $250,000+$80,000 = $330,000.
In summary, Done’s cash balance for the three months will be $60,000.
Cash Budget Cautions
Every so often, the planning of a cash budget is easier for existing companies because they have previous histories they can borrow from. New companies are vulnerable to challenges, given that they do not have any such records. Nonetheless, it is still doable and with a significant amount of caution.
Meanwhile, some variables are easy to plan while others are not. Take, for example, employee salaries, petty cash, or supplier’s payouts; these are routine; hence they are easy to budget, especially for small companies.
On the other hand, inconsistency or reduced sales could spark cash inflows while increased sales result in unplanned expenditure.
Lack of a cash budget is likely to derail the operations of a company leading to a reduced outcome. The company will not meet its obligations and will lose credit opportunities from the banks. A majority of financial institutions decline to work with companies that do not have good financial management practices. Additionally, the company risks having to deal with higher interest rates on its loans.