An estimation of cash receipts and payments for a specified period is called cash budget. It is usually prepared monthly, however, there is no hard and fast rule. It can be prepared on quarterly, semi-annually, or annual basis as well.
As there are large volume of cash transactions in day to day running of the business, management needs to plan it more frequently as compared to other functional budgets.
Cash budget format
The format of the cash budget is given below.
Importance of cash for business
Cash is the lifeblood of business. A loss-making business having a strong cash position can survive in the short run, but a profit-making business having a weak cash position may find it difficult to survive. This is mainly because a business needs to pay its day-to-day operational expenses. For example, there is a list of expenses that a business needs to pay for the next 30 days like rent of the building, salaries of employees, payment to suppliers for materials purchased, utility costs, etc. For all these liabilities, the business needs cash to pay, otherwise it cannot continue its operations.
Let us take the example of Mr. Sharin, who owns a company. The company earned good profits in recent months due to favorable market conditions. Unfortunately, Mr. Sharin learned that the company has a very low bank balance and it is struggling to recover its debts. In the meanwhile, two major amounts have to be paid in the next few days, one is paid to the supplier for materials purchased in the previous month and the other is the payroll cost. If Mr. Sharin delays the payments, the consequences are adverse. Relations with suppliers will worsen and suppliers may refuse to give further credits to the company. Similarly, employees cannot be retained if they are not paid on time. Mr. Sharin can go to the bank and borrow a short-term loan. This would increase the finance cost of the company. If cash flow problems are not solved properly and mismanagement of cash continues for a long time, the company might go into liquidation due to pressure from creditors and banks.
Better management of cash
Knowing the importance of cash for the business, management must set a solid plan for cash management. At times, a business has surplus cash balance. Management should plan what to do with the surplus. They can pay out liabilities or invest in short-term assets so that they can use them later in times of need.
Similarly, businesses may have cash deficits in a trading period; management must plan how to finance the deficit. They can withdraw cash from short-term investments, or they can borrow short-term loans.
For all the above reasons, a business must have a plan for cash inflows and cash outflows of each month. The most important and technical thing is to plan for cash inflows from debtors. Management estimates the recovery time based on the past trend of payments by debtors. Similarly, the business buys materials on credit, management should plan when and how they are going to pay suppliers.
Example – Cash budget
The management of VP Laboratory has provided you with the following information:
- 10% of the sales are in cash.
- Receivables normally pay 50% in the month of sale and 45% remaining in the following month.
- 5% of debts are not recovered at all.
- Purchases are paid in the month following purchase.
- Wages are paid 70% in the same month and the remaining 30% in the following month.
- Overheads are paid in the month in which the expense is incurred. Overheads include $12,000 annual depreciation of machine which is divided over each month.
- Closing cash balance of January is $13,000.
Prepare cash budgets from February to April.