A cash budget is a budget or plan of expected cash receipts and disbursements during the period. These cash inflows and outflows include revenues collected, expenses paid, and loans receipts and payments. In other words, a cash budget is an estimated projection of the company's cash position in the future.
Management usually develops the cash budget after the sales, purchases, and capital expenditures budgets are already made. These budgets need to be made before the cash budget in order to accurately estimate how cash will be affected during the period. For example, management needs to know a sales estimate before it can predict how much cash will be collected during the period. Management uses the cash budget to manage the cash flows of a company. In other words, management must make sure the company has enough cash to pay its bills when they come due.
Chartered Institute of Management Accountant (CIMA) defines cash budgets as a short-term fiscal plan expressed in money which is prepared in advance. It helps to determine the cash-inflow and cash-outflow of the business.
Features of Cash Budget
a) The cash-budget period is broken down into periods, mainly in months.
b) The cash-budget is always in columnar form i.e. column showing each month.
c) Payments and receipts of cash are identified in different heading and showing total for each month.
d) The surplus of total cash payment over receipts or of receipts over payment for each month is shown.
e) The running balances of cash, which would be determined by taken the balance at the end of the previous month and adjusting it for either deficit or surplus of receipts over payments for current month, is identified.
Importance of Cash Budget
Cash budget is an important tool in the hands of financial management for the planning and control of the working capital to ensure the solvency of the firm. The importance of cash budget may be summarised as follow:
(1) Helpful in Planning. Cash budget helps planning for the most efficient use of cash. It points out cash surplus or deficiency at selected point of time and enables the management to arrange for the deficiency before time or to plan for investing the surplus money as profitable as possible without any threat to the liquidity.
(2) Forecasting the Future needs. Cash budget forecasts the future needs of funds, its time and the amount well in advance. It, thus, helps planning for raising the funds through the most profitable sources at reasonable terms and costs.
(3) Maintenance of Ample cash Balance. Cash is the basis of liquidity of the enterprise. Cash budget helps in maintaining the liquidity. It suggests adequate cash balance for expected requirements and a fair margin for the contingencies.
(4) Controlling Cash Expenditure. Cash budget acts as a controlling device. The expenses of various departments in the firm can best be controlled so as not to exceed the budgeted limit.
(5) Evaluation of Performance. Cash budget acts as a standard for evaluating the financial performance.
(6) Testing the Influence of proposed Expansion Programme. Cash budget forecasts the inflows from a proposed expansion or investment programme and testify its impact on cash position.
(7) Sound Dividend Policy. Cash budget plans for cash dividend to shareholders, consistent with the liquid position of the firm. It helps in following a sound consistent dividend policy.
(8) Basis of Long-term Planning and Co-ordination. Cash budget helps in co-coordinating the various finance functions, such as sales, credit, investment, working capital etc. it is an important basis of long term financial planning and helpful in the study of long term financing with respect to probable amount, timing, forms of security and methods of repayment.
Methods of Preparation of Cash Budget
(1) Receipts and Payments Method
(2) Adjusted Profit and Loss Method or Adjusted Earnings Method or Cash Flow Method.
(3) Balance-Sheet Method.
The above methods of preparing cash budget represent different approaches.
(1) Receipts and Payments Method: It is the most simple and popular method of preparing cash budget. The method is most commonly used in forecasting the short term cash position. It is just like receipts and payment method in technique. It shows yearly cash position with proper breakups by quarters and months. For the purpose of preparing cash budget under this method, cash information’s are collected from other budgets such as sales budget, salary and wages budget, overhead budgets, material budget etc.
Under this method cash budget is divided into two parts. One part shows the timing and the amount of cash receipts and other part shows the timing and the amount of cash disbursements. Cash receipts and cash disbursements are estimated as under:
(i) Estimation of Cash Receipts: The amount of cash receipts can be estimated from the following items:
(a) Cash receipts arising from Operations. It includes advances form customers, estimated cash receipts from sales, debtors and collection of bills receivables. In estimating the amount of cash sales, cash-discount policy of the firm should be taken into account. Forecasting the receipts from credit sales, i.e., receipts from customers, B/R etc. Credit policy, terms of sales, position of customers, customers of the trade, any time lag between sale and collection should be considered.
(b) Non-operating Cash Receipts. It includes revenue receipts of non-operating nature and includes receipts from interest, dividend, rent, commission, royalty, sale of scrap, refund of tax etc.
(ii) Estimation of Cash Disbursements. The amount of cash disbursement can be estimated from the following items:
(a) Disbursement for operations Such as disbursements for cash purchases, wages and overheads, payment to creditors, bonus and other remunerations such as gratuities, pensions etc. and advances to suppliers. Terms of purchases, discounts receivable and time lag between the time of purchase and payment are taken into consideration.
(b) Disbursement for non-operating functions. It includes financial expenses on non operative functions such as interest, rent, dividend, donations, income tax and other taxes etc.
(c) Disbursement for capital transactions. Such as expenditure for expansion, payment of loans and overdrafts, redemption of debentures and preference capital etc.
In preparing cash budget, total budgeted cash receipts are added to the opening balance of cash and then the total budgeted disbursements are deducted there from to know the closing balance of cash. If opening cash balance and estimated total cash receipts are much larger than the estimated payments, there will be cash balance at close and management should take the necessary steps, to invest surplus funds for short period. On the other hand, if there is cash shortage, the management must plan the borrowings for short period to manage the deficiency.
(2) Adjusted Profit and Loss Method or Adjusted Earnings Method or Cash Flow Method: The method is suitable for preparing the long term estimates of cash inflows and outflows. It is also called cash-flow statement. Under this method, profit and loss account is adjusted to know the cash estimates. This method is useful in budgetary control technique.
Under this method, closing cash balance can be known by adding profits for the period to the opening cash balance because the theory is based on the elementary assumption that profits of a business are equal to cash. Thus if we assume that there are no credit transactions, capital transactions, accruals, provisions, stock fluctuations, or appropriations of profit, the balance of profit as shown by the profit and loss account should b equal to the cash balance in the case book. However, such a situation will never exist in actual practice, the assumption needs adjustments. In preparing the cash forecasts, one proceeds with the budgeted profit for the period and then adjusts this figure by the items mentioned below-
Items to be Added
(i) All non-cash items shown in the debit side of profit and loss account should be added to the budgeted profit because these items do not involve any cash outflows-depreciation, deferred revenue expenditure, writing off of intangible assets, prepaid expenses etc.
(ii) Changes in working capital which results in inflow of cash balances such as increase in closing stock, debtors and decrease in sundry creditors and other liabilities, redemption of preference shares and debentures, payment of dividend, purchase capital assets, investment etc.
(3) Balance-Sheet Method: This method is similar to that of profit and loss adjustment method, a budgeted balance sheet is prepared for the next period showing all items of assets and liabilities except cash balance which is found out as the balancing figure of the two sides of balance sheet.
If the asst side exceeds the liability side the balance shall reveal the bank over-draft and if the liability side is heavier than the asset side, the difference represents the bank balance.