What is a cash budget? – An insight into its Need

A cash budget plays an important role in ensuring the efficient working of a company. Every business must know whether it will have enough cash in hand to cope up with its upcoming business liabilities. In case it predicts to have a shortfall of cash, the business can look for ways to finance money at the earliest. By predicting the future cash position, a business can take wise steps today to avoid facing any likely challenge in the future.

What is a cash budget?

A cash budget is an estimation of cash inflows and outflows of an individual or a business over a given period. It shows the amount of cash that will be available to a business in the future. It is extremely important to gauge the balance of cash because a lack of its availability can put a halt to business activities.

Cash budgets establish control over the cash position of a business. They are used as a tool through which cash can be managed and coordinated to the requirements of overall working capital, investment in revenue, and debt. The requirements of cash can be matched with its availability so that appropriate measures can be taken well in advance to combat any cash deficiency likely to arise in the future. Similarly, efficient allocation of cash can be made where there is a surplus.

Although cash budgets can be made for a short period or even for a long duration, people usually plan such budgets in monthly intervals, over a period of 1-2 years.

When we talk of cash budgets, the term 'cash' refers to the total of absolute liquid reserves allocated to a business to use at any given time. These shall comprise bank balances, bank account deposits, and more.

Need for a cash budget

It is very significant to have a cash budget, especially for smaller companies. (source) The importance of preparing cash budgets on a regular basis can be validated from the following points:

  • Cash budgets are usually used to determine whether or not a company has enough cash to support daily operations. (source)
  • It can also be useful in determining whether an organization invests too much of its cash in unproductive ways.
  • Through a cash budget, a business can establish summaries of expected sales, operating expenditures, the selling and purchase of properties, and the admission or settlement of debts.
  • It makes it easier to determine the situations when more cash resources are required, and where there is likely to be surplus cash availability. This helps to plan for short-term borrowings in advance to meet the cash shortage or to make premature investments in times of surplus cash.
  • Managers normally use a cash budget to administer a company’s cash flows. They must ensure that the company has sufficient cash to pay off its bills when due. Payroll, for example, must be paid every two weeks, and service facilities are payable every month. The cash budget helps managers to foresee shortfalls in cash flows of the company and address the issues before payments are due.
  • Similarly, it is not desirable for businesses to have huge sums of cash lying unused in bank accounts. It should rather be used for the expansion and development of new operations. This money must, at the very least, be invested to earn a decent amount of interest. With a view to preventing the locking up of idle cash, a cash budget enables the management to predict, alter, and optimize the cash levels as necessary.
  • By preparing a cash budget, any probable effect on the organization’s cash position is revealed from the details of sudden and seasonal requirements, large stocks, delay in collecting receipts, etc.
  • A cash budget helps a company to assess the volume of credit it may lend to consumers without causing liquidity issues.
  • A proper cash budget helps prevent a cash crunch during times where a business faces an outlay of a significant amount of expenditure. A carefully designed cash budget would account for such provisions beforehand.
  • If your business is unable to pay expenses because of a cash deficit, then this issue must be resolved immediately by bringing in more revenue, postponing or eliminating some of your costs, or getting your bank’s approval for a larger loan. Since these solutions are complex, time-consuming, and not guaranteed, so it is wise to prepare ahead of time for higher costs, if possible. The cash budget serves this purpose.

Two major components of the cash budget

Cash budget

The cash budget typically consists of two sections, which include precise estimates of (i) cash receipts and (ii) cash disbursements.

Cash receipt forecasts are usually calculated on a monthly basis and are based on expected cash sales, debtor transactions, and projected receipts from other sources such as asset sales, borrowings, etc.

On the other hand, cash disbursement forecasts are based on estimated cash purchases, creditor payments, employee remuneration, bonuses, supplier advances, budgeted capital expenditure for expansion, etc.

Is a cash budget influenced by other budgets?

A cash budget is one of the most critical components of an annual budget. It is influenced by details generated from various operating budgets, such as revenue budget, budget for direct material purchases, and budget for manufacturing and administrative expenses. Additionally, the budget set for capital expenditure, dividend strategies, and equity or long-term debt funding strategies also impact the cash budget. (source)

In fact, the management of a company usually creates a cash budget after the estimates for revenue, acquisitions, and capital investments have already been made. The budgets for all these have to be made in advance of the cash budget so as to accurately estimate how cash will be affected during the budget period. For instance, the management has to have an estimation of sales revenue so it can forecast how much cash will be collected over the year.

When to prepare a cash budget?

The cash position can be ascertained more frequently, say every month, to hold track of a company’s performance. But the need for preparing a cash forecast could vary from company to company. For example, in the case of enterprises that face seasonal fluctuations in demand, the cash budget might be created for short periods of time, say weekly or monthly. On the other hand, an enterprise can go for a longer period budget, perhaps even a year, if its cash flows are relatively stable with very few variations.

Methods to prepare a cash budget

You can draw up a cash budget by any of the following methods:

1. Receipts and payments method:

Under this method, the cash receipts from various sources and cash payments to different agencies are estimated. For making these estimates, delays in cash receipts and lag in cash payments are taken into consideration. Since this approach is based on the idea of cash accounting, accruals and adjustments naturally do not find a place in budget preparation. The opening cash balance of a budget period and the expected cash receipts are added, and the cumulative expected cash payments are deducted from this to calculate the closing balance of cash. This is the most commonly used method of preparing a cash budget.

2. Adjusted profit and loss account method:

Under this method, the opening balance of cash is adjusted with the expected rise or fall in current assets and liabilities, depreciation allowance, special receipts, and net income for the year before taxes and appropriations. Thereafter, the projected tax and dividends owed, spending on fixed assets, and special payments, if any, are excluded from the combined sum of these. The resultant balance depicts the estimated cash in hand at the end of the budget period.

The main area of distinction between the method of receipts and payments and the method of adjusted Profit and loss is that the former takes into account cash transactions only, while the latter includes non-cash transactions as it reverses all accruals. Moreover, the ‘adjusted profit and loss method’ only offers a general understanding of the cash condition, but the ‘receipts and payments method’ provides as much detail as possible.

3. Balance sheet method:

Under this method of preparing the cash budget, a forecasted balance sheet is prepared, as at the end of the budget period, with all the asset and liability items except the cash balance. Cash balance is then reached as a balancing figure. The magnitude of the two sides of the balance sheet excluding cash balance would determine whether a debit or credit balance (i.e., cash balance at the bank or bank overdraft) would appear on the bank account. This method is rarely used in practice.

Important note

One important thing to be taken into account is that a cash budget includes only the transactions where actual cash will come in or go out. For example, it will not include a credit sale for which cash or payment has not yet been received. Also, it does not include expenses like depreciation or amortization since no exchange of cash takes place.

Let us now see the preparation of the cash budget with the help of an example:

Suppose ABC Limited is a newly started company that wishes to ascertain its cash position for the next six months. On 1st January, it has a cash balance of $10,000 and estimates to have the following expenses and revenue in the future months:

MonthTotal SalesMaterialsProduction overheadsSelling & distribution overheads
January        20,000    20,000                    3,200                                      800
February        22,000    14,000                    3,300                                      900
March        28,000    14,000                    3,400                                      900
April        36,000    22,000                    3,500                                   1,000
May        30,000    20,000                    3,200                                      900
June        40,000    25,000                    3,600                                   1,200

ABC Limited also assumes to acquire new machinery that is to be installed at $20,000 on credit, to be repaid by two equal installments in March and April. Further, the company fixes sales commission @5% on total sales, which it plans to pay within a month following actual sales. ABC Limited has joined hands with M/s Radar Corp., a local supplier, who has agreed to allow a credit period of 2 months for purchases of raw materials. Also, the delay in payment of overheads is 1 month.

On the revenue front, 50% of the total sales are made in cash. For the remaining 50%, ABC Limited expects its customers to pay within a period of 1 month following the month of sales. Dividends from investments amounting to $1,000 are also expected to be received in June.

Cash Budget for 6 Months

Opening Balance10,00020,00036,00025,70028,00040,700
Add: Receipts
Cash Sales (50%)10,00011,00014,00018,00015,00020,000
Collection from debtors10,00011,00014,00018,00015,000
Dividend on investment1,000
Less: Payments
Purchase of materials20,00014,00014,00022,000
Production and selling Overheads4,0004,2004,3004,5004,100
Sales Commission1,0001,1001,4001,8001,500
Installment of Machinery purchase10,00010,000
Total payments5,00035,30029,70020,30027,600
Closing balance of cash20,00036,00025,70028,00040,70049,100

The cash budget of ABC Limited estimates that it will have an ending balance of $49,100 in June. It is not likely to have a cash crunch in any of the months. 

A sample proforma of cash budget

(A) Cash Budget with Receipts and Payments Method

Cash Budget (Receipts and Payments Method)

For six months, July to December 2020

Cash Budget (Receipts and Payments Method)

*It is assumed that the company will maintain a minimum cash balance of Rs. 4,00,000 as at the beginning of the budget period, resorting to borrowing, if necessary. The company could also place substantial amounts in short-term investment deposits, of 15 to 30 days during the first three months.

(B) Cash Budget with Adjusted Profit and loss account Method

Cash Budget (Adjusted Profit and Loss)

(For the Budget period ended 31st December 2020)

Cash Budget (Adjusted Profit and Loss)

Hope the information provided in this blog proves helpful to you!

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Ruchi Gandhi

The author enjoys to write informational content in the domain of company law and allied laws. She takes interest in doing thorough and analytical research on legal topics. She is a CA along with MBA (Fin) and M. Com.

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