Cash Budget

Businesses need to manage their cash flow to enable them to operate effectively. It is important to be able to interpret a cash budget and justify suitable solutions to cash flow problems.

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 could be for a weekly, monthly, quarterly, or annual budget. This budget is used to assess whether the entity has sufficient cash to continue operating over the given time frame. The cash budget provides a company insight into its cash needs (and any surplus) and helps to determine an efficient allocation of cash.

A cash budget is a document produced to help a business manage their cash flow. A cash budget is prepared in advance and shows all the planned monthly cash incomings (receipts) and any planned cash outgoings (payments).

Preparing a cash budget has a number of benefits:

  • It can identify any times where there may be a shortage of cash. This will allow the business to plan ahead and arrange extra funding such as a bank overdraft.
  • It can help to regulate expenses. Any months where expenses are high will be highlighted by a cash budget.
  • It will clearly show where a business has more cash than expected (surplus) or less cash than expected (deficit). This will allow a business to plan more effectively and make better decisions.

What Does Cash Budget Mean?

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, management must find additional funding sources.

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 materials 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.

How is the Cash Budget Prepared?

A cash budget takes shape after the preparation of other budgets like sales, purchases, etc. These budgets give a clear picture of the cash drivers in the company and by how much. This budget mainly comprises of three parts:

Cash Inflow Forecast

This budget takes into account all the probable sources from where the company can earn cash over the budget period. These sources include cash sales, cash to be received against accounts receivables, 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, or any other similar source. The cash balance at the beginning of the budget period will add up to the total cash inflow to give the total cash with the company over the period.

Cash Outflow Forecast

Preparing the budget will take into consideration all the probable cash outflows during the budget period. These outflows will include all the 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, etc.

Cash Balance Forecast

The cash balance forecast is done by deduction of the total cash outflows from the cash inflows over a period of time, maybe a week or a month, as the management feels appropriate. If the budget foresees a high surplus of cash balance, the management may use it appropriately by preparing a financing budget. It becomes the basis for deciding suitable investments for the company. The management may decide to invest in land, plant, and machinery, invest in some other fixed asset, or may allocate the surplus funds to other functions within the organization as per need.

In case the cash balance thus calculated seems to be marginal or deficient of the actual cash requirement of the company, the management may take actions accordingly. They will have to look for other sources of raising capital. Or they may have to increase the borrowings from the bank, or cut down on unnecessary expenditure or delay it.

Example of a Cash Budget

Here is an example of the cash budget, showing the sources and uses of cash by week:

Everson Manufacturing
Cash Budget

Week 1Week 2Week 3Week 4
Beginning cash$25,000$55,000-$24,000-$63,000
Sources of Cash
 + Cash sales +10,000 +12,000+15,000+18,000
 + Accounts receivable collected +180,000+185,000+180,000+192,000
 + Asset sales +30,0000+10,000+25,000
 = Total cash available $245,000$252,000$181,000$172,000
Uses of Cash
– Direct materials-$87,000-$91,000-$99,000-$107,000
– Direct labor-19,000-20,000-23,000-25,000
– Manufacturing overhead-29,000-30,000-34,000-37,000
– Selling & administrative-35,000-35,000-38,000-38,000
– Asset purchases-20,0000-50,0000
– Dividend payments0-100,00000
= Total uses of cash-$190,000-$276,000-$244,000-$207,000
Net Cash Position$55,000-$24,000-$63,000-$35,000

The example shows that an inordinately large dividend payment in the second week of the cash budget, coupled with a large asset purchase in the following week, places the company in a negative cash position. Paying out such a large dividend can be a problem for lenders, who do not like to issue loans so that companies can use the funds to pay their shareholders and thereby weaken their ability to pay back the loans. Thus, it may be wiser for the company to consider a small dividend payment and avoid a negative cash position.

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.

Why Are Cash Budgets Important?

Cash budgets are important for a myriad of reasons. For most organizations, cash is a critical component to daily operations. There are business models that are not cash intensive, but even they benefit from diligent cash budgeting practices.

One reason cash budgets are so important is that they highlight and provide useful insight into potential cash deficits.

This helps business leaders to plan accordingly and adjust costs so that cash balances do not run too low.

In the same vein, cash projections can be used to identify periods of time where excess cash balances are generated, thereby allowing financial planners to make effective use of the capital.

Another useful byproduct of cash budgets is that they help to regulate expenses by identifying time periods where expenses run higher than others.

By helping to identify these time periods, financial analysts can review and explore ways to reduce expenses overall or create plans to spread the burden of the expenses out over a longer period of time, reducing cash demand.

Because cash budgets are designed using receipts for income and expenses, it creates a useful map of sources and uses of cash.

These sources and uses can be used to create efficiencies in processes. For example, if revenue is high for the period, but cash collections are low, then it alerts business leaders to address collection cycles and manage receivables better.

Finally, a result of creating a cash budget is that it reinforces the principles of adhering to a financial plan.

By highlighting the sources and uses of cash and identifying potential times where cash balances might run low, it helps to steer the organization to adhere to more fiscally responsible practices.

What is the Purpose of Cash Budgets?

The primary purpose of a cash budget is to assess the financial stability of a business. Understanding the positive or negative cash flow at a company allows you to determine its operational stability. Although a positive cash budget is generally preferable, the specific interpretation of a company’s cash budget can vary based on the company’s circumstances.

A positive calculation in a cash budget means that the company expects to earn more money than it spends in that period. This means that the company is turning a profit, which can then be used increase compensation, pay out stakeholders or increase the company’s cash reserves for future projects. Excessive profits can also indicate an opportunity to safely increase spending on growth initiatives while still maintaining financial stability.

A negative calculation shows the company projects to lose money over a given period. While this is a potential warning sign, there are many circumstances where a company may plan to lose money for a period. For example, new companies commonly need to spend more than they bring in when getting started in order to find the new customers needed to build a stable and sustainable company. Similarly, a company may take on short-term losses to expand manufacturing or increase marketing with the goal of benefiting from the spending over a longer span of time.

How to Make a Cash Budget

Before beginning a cash budget, it is important to point out that a cash budget differs from an overall financial budget in that it is strictly concerned with cash receipts and outflows.

This means that revenue assumptions for the period must be converted to cash receipts for the same period, and the same for expenses.

In some cases, accounting software can help to identify sources and uses of cash from a bank account; however, it is possible that poor record keeping can have an impact on the availability of information.

To avoid this, it is important to manage cash reconciliations along with keeping tight controls over accounting journal entries.

Here are the steps needed to create a cash budget.

Identify a Beginning Balance

First, it is important to identify the beginning balance that will be used to roll the projected cash balance. If the cash budget is for one quarter, then the beginning balance should equal the ending balance of the previous quarter.

This works for any given time period. Always be sure to tie the beginning cash balance to a source like a bank statement.

Identify the Time Period

Cash budgets can be built weekly, monthly, quarterly, and annually. They can even be made daily if the organization is cash intensive.

Be sure to choose an appropriate timeframe that will help manage daily cash balances while giving enough future insight to detect any potential issues.

Identify All Sources and Uses of Cash

Identify every source and use of cash over the time period and group them in an itemized list. Cash inflows are positive, and cash outflows are negative.

Net Sources and Uses Against Beginning Cash Balance

Add all of the sources of cash to the beginning cash balance for the period and then reduce it by the amount of expenses to determine your net cash position

Identify Deficits and Surpluses and Create a Plan

Once you have rolled your beginning balance for the time period, it will highlight cash surpluses and deficits.

Assess the drivers of the balances. If it is a deficit, work to identify ways to reduce expenses or increase cash receipts. If it is a surplus, identify potential uses of the cash that is in line with the organization’s goals.

Short-Term Cash Budget vs. Long-Term Cash Budget

Cash budgets are usually viewed in either the short-term or the long-term. Short-term cash budgets focus on the cash requirements needed for the next week or months whereas long-term cash budget focuses on cash needs for the next year to several years.

Short-term cash budgets will look at items such as utility bills, rent, payroll, payments to suppliers, other operating expenses, and investments. Long-term cash budgets focus on quarterly and annual tax payments, capital expenditure projects, and long-term investments. Long-term cash budgets usually require more strategic planning and detailed analysis as they require cash to be tied up for a longer period of time.

It’s also prudent to budget cash requirements for any emergencies or unexpected needs for cash that may arise, particularly if the business is new and all aspects of operations are not fully realized.

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