What is a Cash Budget?
A cash budget is an estimation of the cash flows of a business over a specific period of time. This timeframe could span a week, month, quarter, or year. The purpose of a cash budget is to assess whether the entity has sufficient cash to continue its operations over the given time frame. It provides insights into a company’s cash needs and surpluses, facilitating efficient cash allocation.
Key Takeaways
- A cash budget estimates cash inflows and outflows over designated periods such as weeks, months, quarters, or years.
- It helps a company determine if it has sufficient cash to sustain operations within the projected timeframe.
- The budget reveals cash needs and surpluses, assisting in effective cash utilization.
- Cash budgets can focus on short-term needs (weeks to months) or long-term requirements (years).
- Effective sales and expense management is crucial for optimal cash flow.
Understanding How a Cash Budget Works
Companies utilize sales and production forecasts to ascertain necessary spending and accounts receivable collections while creating a cash budget. This process ensures a company has enough liquidity to sustain operations. A company lacking sufficient liquidity may need to raise capital via stock issuance or acquiring debt.
A cash roll forward computes monthly cash inflows and outflows, using the ending balance as the starting point for the subsequent month. This method enables a company to forecast cash needs and revise the roll forward to adjust future cash balances.
Differentiating Short-Term and Long-Term Cash Budgets
Cash budgets are typically categorized as short-term or long-term. Short-term cash budgets address immediate cash needs for the upcoming week or months, focusing on utility bills, rent, payroll, supplier payments, operating expenses, and investments. Conversely, long-term cash budgets, spanning a year or more, examine larger expenses such as quarterly and annual taxes, capital expenditure projects, and other long-term investments. These budgets often require comprehensive strategic planning and analysis.
Special Considerations for Managing a Cash Budget
Managing a cash budget heavily relies on balancing business growth. For instance, while increasing sales is advantageous, it must be done sustainably. An example would involve leveraging a marketing strategy to boost product demand. However, without adequate machinery, workforce, or suppliers to meet such demand, a business may face customer dissatisfaction despite the increased demand.
Thus, it is essential to harmonize sales and expenses to ensure optimal cash flow.
Example of a Cash Budget: ABC Clothing
Suppose ABC Clothing, a shoe manufacturer, estimates $300,000 in sales for June, July, and August at a retail price of $60 per pair. Predicted sales amount to 5,000 pairs of shoes per month. ABC forecasts that 80% of these sales will be collected in the following month and the remaining 20% two months post-sale.
Starting with a cash balance of $20,000 in July, ABC expects to collect 80% of June sales in July, totaling $240,000. With $100,000 expected from earlier sales, total cash inflows for July are $360,000. Considering production costs of $50 per pair and needing to produce 4,000 pairs in July, the cost is $200,000. Alongside $60,000 in non-production expenses, total outflows are $260,000. The resulting cash balance for July would be $100,000.
Steps to Creating a Cash Budget
- Establish Reliable Forecasts: Predict cash inflows and outflows, accounting for varying expenses like rent and payroll, and unpredictable numbers such as sales figures.
- Account for All Inflows/Outflows: Prepare a budget incorporating all anticipated cash movements.
Expenses in a Cash Budget
A comprehensive cash budget considers all expected cash flows including revenue and operational outflows (returns, payroll, rent, utilities, supplies, etc.).
Preparing a Cash Budget
The preparation of a cash budget varies by duration: short-term budgets consider operational expenses spanning days to weeks, while longer-term budgets account for larger expenses like equipment, investments, and taxes. Any cash surplus from one budget period will serve as the base for the next.
Related Terms: financial statements, capital expenditure, liquidity, cash management, accounts receivable.
References
- OpenStax. “Principles of Accounting, Volume 2”, Page 366 of PDF.
