Making a cash budget is an important management task. While some small businesses may be able to survive without budgeting for a while, savvy business owners will recognize its importance. A cash budget can protect a business from being caught off guard by seasonal fluctuations in cash flow or prepare a business to take advantage of unexpected quantity discounts from suppliers. Let’s learn more about cash budget accounting with some calculations and examples.
What is a Cash Budget?
A cash budget represents an organization’s expected future cash flow over a specified time period. It is an estimate of future cash receipts over the budget period, cash expenditures that will incur, and finally, the cash balance with the company at the end of the period.
However, one can determine the cash position more frequently, say once a month, to keep track of the company’s budgetary performance.
#1. Cash Budget for the Short Term
Short-term cash budgets are design is to meet cash needs on a weekly or monthly basis. These budgets assist in forecasting payments that require immediate fund allocation. They also identify sources that can help offset this requirement.
Short-term budgets also aid in the selection of short-term investments that can earn interest while the fund is not in use. For example, if excess income is available for a few weeks, one can invest it in short-term deposits or stocks and shares to earn interim income for future needs.
#2. Interim-Term Cash Budget
Interim budgets are typically cover a 12-month period. These are typically created at the end of the fiscal year for the following period based on the previous year’s transactions. Apart from routine income and expenses, management considers seasonal variations in business and cyclical changes that change the dynamics of the budget when preparing the budget. They make decisions about annual borrowing requirements and accumulated accounts receivable plans based on these estimates.
Interim budgets also include annual raises for employees, principal loan payments, and insurance payments. In terms of inflows, it considers interest accrual, sales revenue carried forward from the previous year, and deposit renewals.
#3. Long-term Cash Budget
Long-term cash flow budgets are typically spread out over several years. These budgets help with strategic decisions such as capital investments in machinery and infrastructure, business diversification plans, and costing manpower projections.
Based on the long-term forecast, the company creates sustainable cash reserves to aid in plan execution. Management develops long-term budgets from which they derive various interim and short-term budgets for various time periods. They then manage it efficiently with the assistance of experts.
Problems with Cash Flow
You must carefully plan your cash budgets, especially if your company is new and previous records that you can refer to are unavailable. Employee salaries, vendor payouts, and petty cash are all routine expenses that can be easily budgeted for. Some variables, however, are difficult to plan for in a growing business.
These variables can include unexpected capital investments in infrastructure, equipment for business expansion, and unanticipated repairs and maintenance. Sales can also be a source of contention. Reduced sales reduce cash inflows, whereas increased sales cause an unprecedented increase in expenditures. These unplanned expenses can result in cash shortages that stifle company growth, making cash budgets even more important.
What Is the Purpose of Creating a Cash Budget?
A cash budget is necessary for several reasons. For starters, it enables you to make management decisions about your cash position (or cash reserve). You may be unaware of the cash cycle in your business if you do not have the type of monitoring imposed by the budgeting process. A series of monthly cash budgets at the end of a year or business cycle will show you exactly how much cash is coming into your company and how it is being used. It’ll reflect seasonal variations.
A cash budget also allows you to assess and plan for your capital requirements. The cash budget will assist you in determining whether there are times during your operations cycle when you may require short-term borrowing. It will also assist you in determining any long-term borrowing requirements. A cash budget is essentially a planning tool for management decisions.
How can one Create the Cash Budget?
A cash budget emerges from the preparation of other budgets such as sales, purchases, and so on. These budgets provide a clear picture of the company’s cash drivers and how much they contribute. This budget is divided into three sections:
#1. Cash Inflow Forecast
This cash budget accounting takes into account all of the possible sources of cash earned by the company during the budget period. Cash sales, cash to be received against accounts receivable, cash to be generated from the sale of a fixed asset over the period, cash to be earned from the sale of stocks and bonds, and any other similar source are examples of these sources. The cash balance at the start of the budget period will be added to the total cash inflow to calculate the total cash with the company over the period.
#2. Cash Outflow Projection
When preparing the budget accounting, all possible cash outflows during the budget period will be considered. All cash payments made for purchases of raw materials, inputs or semi-finished products, consumables, any cash to be paid for the purchase of a fixed asset during the period, provisions for repairs and maintenance, labor payments, selling and administrative expenses, printing and stationery requirements, dividend distribution, and so on will be included in these outflows.
#3. Forecast of Cash Balances
The cash balance forecast is calculated by subtracting the total cash outflows from the total cash inflows over a specified time period, such as a week or a month, as determined by management. If the cash budget accounting predicts a large cash balance surplus, management may use it wisely by preparing a financing budget. It serves as the foundation for determining appropriate investments for the company.
The management may decide to invest in land, plant, and machinery, or another fixed asset, or to allocate surplus funds to other functions within the organization based on need. If the calculated cash balance appears to be marginal or deficient of the company’s actual cash requirement, management may take appropriate action. They will have to look for alternative sources of funding. Or they may have to increase bank borrowings, cut back on unnecessary spending, or postpone it.
Accounting Examples of a Cash Budget
Assume ABC Clothing manufactures shoes and expects $300,000 in sales for June, July, and August. The company expects to sell 5,000 pairs of shoes per month at a retail price of $60 per pair. ABC anticipates that 80 percent of the cash from these sales will be collected in the month following the sale. Then the remaining 20 percent collected two months later.
The beginning cash balance for July is expected to be $20,000. The cash budget assumes that 80% of June sales will be collected in July, totaling $240,000 (80% of $300,000). ABC also anticipates $100,000 in cash inflows from earlier-year sales. ABC must also calculate the production costs required to manufacture the shoes and meet customer demand.
The company anticipates 1,000 pairs of shoes in the initial inventory. This implies that a minimum of 4,000 pairs must be produced in July. If the production cost is $50 per pair, ABC will spend $200,000 ($50 x 4,000) on the cost of goods sold in July, which is the manufacturing cost. The company also expects to pay $60,000 in non-production costs, such as insurance.
ABC calculates cash inflows by adding the receivables collected in July to the beginning balance, which is $360,000 ($20,000 July beginning balance + $240,000 in June sales collected in July + $100,000 in cash inflows from previous sales). The cash required to pay for production and other expenses is then subtracted.
That comes to a total of $260,000 ($200,000 in cost of goods sold plus $60,000 in other costs). ABC’s cash balance at the end of July is $100,000, or $360,000 in cash inflows minus $260,000 in cash outflows. Read Also: Business Failure: 10 Common Reasons Why Small Businesses Fail and how to avoid it
Benefits of Cash Budget Accounting
#1. Beneficial in Proper Planning
The cash budget assists management in making proper planning decisions. It will be aware of any potential cash surplus or deficit scenario shortly. In both cases, it is possible to plan ahead of time to avoid a crisis or the loss of an investment opportunity.
A consistent surplus budget may indicate to management that it is time to look for other investment opportunities. It may also choose to expand the scope of its own operations. A cash deficit, on the other hand, can serve as a wake-up call to it to watch its spending. It can also arrange funds promptly, whether through equity or debt. Banks are hesitant to make loans on short notice and may charge additional interest.
Management can avoid a situation like this by acting quickly. As a result, its scarce resources will be used more efficiently.
#2. Helpful in Dealing with Seasonal Variations
A cash budget may be beneficial in the long run. However, due to the seasonal nature of businesses, they may still show cash deficits in certain months or periods. Management can carefully plan ahead of time how to deal with seasonal variations. For periods of stress or low sales, proposed cash outflows can be curtailed or avoided promptly. It will aid the company in avoiding a cash shortage.
Furthermore, managers should anticipate times with a cash surplus. Sitting on idle cash will result in the squandering of an investment opportunity. It can result in the company losing out on substantial income. In addition, during periods of cash surplus, management can expect to repay a portion of its debt and minimize its interest burden.
#3. Increasing the Value of Your Brand
A cash budget serves as a guide for properly timing the company’s expenses based on its cash capital. Furthermore, as previously said, it allows management time to plan for the use of surplus cash as it becomes available.
It aids in timely payment of materials to manufacturers, early debt repayment, timely salary disbursement, proper streamlining of production activities to ensure timely delivery to customers, and so on. As a result, the company’s goodwill and brand equity grow. This, in essence, aids the company’s growth and profitability.
Managing a cash budget often entails carefully managing the company’s progress. For example, while all companies want to sell more and expand, they must do so in a sustainable manner.
For example, a company may implement a marketing strategy to increase brand recognition and product sales. The advertising campaign is a success, and demand for the product skyrockets. If the company isn’t prepared to satisfy the increased demand, for example, because it doesn’t have enough equipment to manufacture more products, enough staff to perform quality inspections, or enough suppliers to order the necessary raw materials, it might have a lot of dissatisfied customers.
The company will want to build out all of these aspects to meet demand, but if it lacks the necessary cash or funding, it will be unable to do so. As a result, it is important to balance revenue and expenditures to achieve an optimum level of cash flows.