Cash Budget – Definition, Objectives, Features, and Advantages

Meaning and Definition of Cash Budget

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. Thus Cash Budget is a planning tool in the hands of management of a business organization. As we have discussed earlier, the objective of cash management is to ensure that the firm has optimum balance of cash only i.e. neither the firm has excess cash balance nor shortage of cash at any stage. Cash budget is a statement of estimated cash inflows and cash expenditure over the firm’s planning horizon and it helps the business organization in identification of periods when there will be excess cash and also those periods when there will be shortage of cash. After identification of cash surplus and cash shortage periods firm will be in a better position to do the appropriate planning for cash.

Objectives of Cash Budget

The objectives of preparing the cash budget are:

1. To identify the period when there is likely to be shortage of cash.
2. To identify the period when there is likely to be excess cash.
3. To enable the firm to do proper planning for the procurement of cash at the least possible cost during the periods when there is shortage of cash.
4. To enable the firm to do proper planning for the investment of cash at the highest possible rate of return when there is surplus of cash.
5. To help in selection of proper source of financing cash requirements of the firm.
6. To permit planning for financing in advance of need. By indicating when cash will be required, the budget helps the management to arrange in advance bank loans or other short-term credits, to prepare for a sale of securities or to make other preparations for  new financing.
7. With advance planning through cash budget, firms get adequate time to take the necessary action for borrowing and lending of cash on the terms most advantageous to it.

Features of  Cash Budget

Major features of cash budget are:

1. The cash-budget period is broken down into periods, mainly in months.
2. The cash-budget is always in columnar form i.e. column showing each month.
3. Payments and receipts of cash are identified in different heading and showing total for each month.
4. The surplus of total cash payment over receipts or of receipts over payment for each month is shown.
5. 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.

Advantages 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 summarized as follow:

• 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.
• Practical Benefits : The most immediate practical benefit of a cash budget is restricting your spending so you do not incur debt. A cash budget involves a realistic assessment of how much money you will have coming in during an upcoming period. Your determinations of how much money your business has available to spend are based on these forecasts, forcing you to spend within your means. It forces you to restrict discretionary purchases to items that you can pay for out of the cash you have on hand.
• 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.
• 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.
• Strategic Implications: A cash budget also provides the benefit of forcing you to think critically about your company’s financial situation and make realistic predictions. This process is useful to you as a business owner working to maintain an accurate sense of your company’s operations. When you prepare a cash budget, look closely at past patterns and use them to forecast future business activity. This exercise familiarizes you with the rhythms of your company’s sales and expenditures, as well as variables that can affect changes.
• 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.
• Seasonal Planning : A cash budget can help to prepare you financially for seasonal fluctuations in sales and expenditures. If you are required to renew expensive licenses at a particular time of year, for example, a cash budget can help you to set aside money over time for these outlays. Preparing a cash budget can help you to identify times of year when you may have a surplus to put aside to prepare yourself for leaner periods.
• Evaluation of Performance : Cash budget acts as a standard for evaluating the financial performance.
• 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.
• Self-Evaluation : A cash budget provides you with a basis for comparing your predictions and assumptions with actual events as they unfold. Your cash budget is not a plan set in stone, but rather a flexible road map meant to keep your spending on track if everything goes as planned. As the period covered in your cash budget elapses, you will find that some of your income and spending predictions were off base. These discrepancies provide you with valuable feedback. Sometimes they occur because of  circumstances that you could not have foreseen, but just as often they are the result of faulty reasoning that you can correct in the future.
• 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.
• 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.

Preparing Cash Budget

1. Planning Period : The first step in the process of preparation of cash budget is the selection of period to be covered by the cash budget and also the sub periods within that time span over which the cash flows are to be projected. There is no fixed rule for this legally or even otherwise. Planning period to be covered varies from firm to firm depending upon the business scale, nature of the business, credit policy and degree of uncertainty involved in the business. Higher the degree of certainty in a business, longer can be the horizon of cash budget and vice-versa. In case of organizations facing extreme degree of fluctuations, cash budget can be prepared even on daily basis.
2. Consideration of Factors having a bearing on Cash Budget : The second step in the process of preparation of cash budget is the identification of the factors effecting cash estimation and the magnitude of their effect on the cash positions. For the purpose of preparation of cash budget, cash receipts and cash payments can be classified into two categories i.e. Operating and Financial. Operating cash flows are the cash flows associated with the operations of the firm while financial cash flows include cash flows which have resulted from sources other than the operations of the business. The examples of operating cash flows include: receipts from sales, collections from debtors, Payments to suppliers, administrative and selling expenses etc. Examples of financial cash flows include Loan and Borrowings, interest received, Dividend received, interest paid, dividend paid etc. After the decision is taken about the span of cash budget and also the factors to be considered in preparing the cash budget, one can move ahead and start preparing the cash budget.