It’s no use budgeting for purchases and consumption if during the budget period, you run out of cash. Cash budget is necessary so that any shortage of cash can be known in advance and early preparations can be made to ensure continuous cash flow.
Some of the early preparations may be cutting back on spending or arranging for loans or an overdraft. Sometimes, a cash budget may predict a cash surplus at some future point, in which case, appropriate use (investment) for the surplus can be planned rather than having idle cash in a bank account.
Cash budget shows a summary of expected cash receipts (inflow) and expected cash payments (outflow) during the budget period.
Cash budget shows the effect of budgeted activities on cash flow. It’s usually subdivided into short periods of weeks and months and rolled forward as time progresses.
What does a cash budget contain?
A cash budget must contain every cash inflow or receipt and every type of outflow or payment. In addition to amounts, the timings of receipt and payment must also be predicted.
Typically, receipts include cash sales, sales of fixed assets, interest and dividends received, loan stock, receipts from debtors, receipts from loan repayment and so on.
All payments usually include payments to creditors for assets purchased, payments of salaries, bonuses and overhead. Others are payments of interest, taxes, dividends, loans and so on.
It’s important to understand that cash receipts and payments are not the same as sales and cost of sales. This is because,
- Not all cash payments affect cost of sales , example the purchase of a fixed asset,
2. Not all cash receipts affect profit and loss account income, example proceeds from issue of new shares,
3. Of depreciation and the loss or profit on the sale of fixed assets and,
4. The timing of cash receipts and payments doesn’t happen at the same time with the profit and loss in an accounting period. An example, credit sales are recognized once a formal offer is accepted but cash payment from the debtor may not be made within the same accounting period.
As mentioned earlier, date of sales and date of receipt of cash will not usually be the same, except in few cases. The same is true for date of purchases and date of payment of cash.
There is therefore need for accurate timing of cash receipts and payments. It’s for this reason and others, that the preparation of cash budget must follow guidelines.
Guidelines for the preparation of cash budget:
A. To establish cash receipts from debtors;
- Forecast expected credit sales period by period taking into consideration antecedents and trends,
2. Forecast typical payment pattern of debtors,
3. Based on (1) and (2), determine when the budgeted sales revenue would be received in cash. Make allowances for prompt payment, discounts allowed and bad debts,
4. Allow for cash receipts from opening debtors.
B. To establish cash payments to creditors;
- Based on experience, calculate material usage quantities period by period,
2. Calculate the costs,
.3. Decide the length of credit period to be taken from creditors and calculate when cash payments would be made and,
Allow for cash payments to opening creditors.