What is a cash budget?

A cash budget is an estimate of an organization's cash flow for the future period. A cash budget forecasts future cash receipts and payments from various sources for a fiscal year. A cash budget can be created once a month or once a week to determine the organization's cash position and ensure its performance in relation to the budget. It aids in determining whether the company has enough cash and cash equivalents to meet its operational needs in the future. If cash receipts are insufficient to cover future expenses, an organization may plan to obtain funds from other sources. After estimating the sales, purchase, and capital expenditure budgets for the year, management develops a cash budget. These budgets are created to ensure that an organization's cash flow is managed. It is important to note that only cash transactions are recorded when actual cash enters and exits an organization.

Objectives of cash budget

• To know the future cash position of the organization.
• To ascertain the organization's future cash position.
• To forecast the period's cash surplus or deficit.
• To assist the organization in selecting appropriate finance to meet cash requirements.
• To put money to use without sitting on it.
• To keep enough cash on hand for working capital, investment, loans, and unforeseeable expenses.

Methods of cash budget

A cash budget is an important tool for determining the organization's cash position. The methods of cash budgeting are as follows:

Receipt and payment method

All expected actual cash receipts and payments are budgeted and recorded in separate columns using this method. All expected cash inflows, such as cash receipts from sales, debtors, and investment income, are recorded in cash receipts. All cash expenses such as advertising, selling, salary, and other expenses are recorded in cash payments. The total cash receipts are added to the opening cash balance, and the payments are deducted to bring the cash balance to a close. If payments exceed receipts, there will be a cash shortage at the end of the period. A cash surplus exists when cash receipts exceed cash payments at the end of the period.

Adjusted profit and loss method

The cash budget is created using this method by adjusting the non-cash expenses in the profit and loss statement in different categories. Cash receipts and payments are not considered when preparing the budget. Non-cash items such as depreciation, provisions, work in progress, and capital receipts, among others, are added to the profit. Any adjustments that increase the value of current liabilities while decreasing the value of current assets are added to the opening cash balance. Similarly, any changes that reduce the value of current liabilities or increase the value of current assets are deducted from the opening cash balance. In addition, some items, such as the purchase of a fixed asset, loan repayment, and share and debenture redemption, are deducted from profit. This method of calculating adjusted profit and loss is very similar to the cash flow statement. The main distinction is that a cash budget estimates figures for the future, whereas cash flow statements record actual cash transactions. This cash budget method is useful for long-term planning.

Balance sheet method

Changes in the values of assets and liabilities are taken into account in this approach to forecasting the balance sheet at the end of the next period. Expected assets and liabilities are recorded on the respective sides of the ledger using this method. The balance figure is made up of cash and bank balances. If the budgeted asset balance exceeds the budgeted liability balance, the difference is recorded as a bank overdraft. Similarly, if the budgeted liabilities balance exceeds the balance of the budgeted assets, the balancing figure is recorded as cash at the bank.

Importance of cash budget

Estimates future cash requirement

A cash budget estimates the amount of cash that will be available at the end of the specified time period. It aids management in developing a strategy to finance the cash needs for future periods or to use excess cash for other purposes.

Selecting a financing source

A cash budget will assist in determining whether the cash shortage will be short-term or long-term. It aids in locating a suitable additional financing source to meet the cash shortage required to run the business. A bank overdraft can be used to cover a short-term shortage. Accepting public deposits, issuing new shares, or issuing debentures would be appropriate financing sources if the shortage is long-term.

Utilizing cash surplus

When a cash budget shows a cash surplus at the end of the period, the organization's management can plan to use the extra cash for other income-generating investments. It is more profitable for the company to use excess cash rather than hold it.

Purchase plan

When a company decides to buy an asset, it checks to see if it has enough cash to do so. If cash is insufficient to purchase the asset, funds are raised from outside sources. A cash budget aids in determining whether the surplus cash is sufficient to purchase the asset or not.

Cash control

Actual receipts and payments are compared to the estimated cash budget at the end of the budgeted period. If there is any variation among them, management takes action to correct it. Thus, cash is managed through the use of a cash budget.

Restriction on overspending

With the assistance of a cash budget, the organization is aware of its future cash resources. It can keep extra expenses and payments under control by adjusting cash sources with the help of a budget.

Fixing dividend policy

Dividend payments necessitate a sufficient amount of cash. A cash budget is essential in developing a sound dividend policy for the organization. Even if it earns income from high dividend payments, the organization may not declare dividends. If the organization pays a large dividend, it will not have enough cash to repay debts, purchase inventory, and meet other cash needs. In order to maintain its cash position, the organization must decide on a dividend policy.

Context and Applications

The above-discussed topic will be helpful for students who are preparing to write professional exams for the following courses:

• Associate of Applied Science in Accounting Technology
• Bachelor of Science in Accountancy
• Master of Science in Accountancy
• Graduate Certificate in Forensic Accounting

Practice Problems

Question 1: Estimating future cash inflows and outflows is called _______.

1) Cash budget

2) Receivable budget

3) Payable budget

Answer: Option 1 is correct.

Explanation: A cash budget forecasts future cash receivables and cash payables over a specified time period. It forecasts an organization's cash flow, which aids in the planning of cash resource utilization and cash arrangements.

Question 2: Cash budget helps in deciding the _________ policy.

1) Income policy

2) Share policy

3) Dividend policy

Answer: Option 3 is correct.

Explanation: It is critical to developing a dividend policy because dividends will be distributed to shareholders from profits. It is necessary for an organization to have a sufficient amount of cash in order to run a business smoothly. The cash budget forecasts future cash flows, allowing the organization to decide whether to declare a dividend or keep the profit for other purposes.

Question 3: Adding total receipts to opening cash balance and deducting cash payments to arrive at closing balance is _______ method of cash budget.

1) Cash inflows method

2) Receipt and payment

3) Balance sheet

Answer: Option 2 is correct.

Explanation: In receipt and payment, cash receipts are added to the opening cash balance and cash payments are subtracted to arrive at the closing cash balance. The difference between cash payments and cash receipts indicates whether the organization is able to generate surplus or deficit cash.

Question 4: When account receivables increase, it will be ____________ to/from opening cash balance in adjusted profit and loss method cash budget.

1) Deducted

2) Added

3) Divided

Answer: Option 1 is correct.

Explanation: Any changes in a current asset are accounted for when preparing the cash budget with the adjusted profit and loss method. Accounts receivable is a current asset in this case, and any increase in the value of a current asset is deducted from the opening cash balance.

Question 5: A increase in the value of accounts payable will be __________ to/from opening cash balance in adjusted profit and loss account.

1) Deducted

2) Added

3) Divided

Answer: Option 2 is correct.

Explanation: Accounts payable is a current liability, so when the value increases, it is added to the open balance. Under the adjusted profit and loss method, any change in current liabilities will have an impact on the cash budget.