What is a Cash Budget?
Regardless of the size of a corporation, understanding the cash flows for firm is critical. For example, some companies do business using credit or an invoice method. Because of this, cash flows may happen immediately or at some point in the future. Because of the discrepancies as to when a company may receive cash, a cash budget is a critical tool for any size Corporation. Cash budgets may be made on a monthly basis, quarterly basis, or on an annual basis. However, a critical objective for the cash budget is to line up when cash is received and when accounts payable are due. The most popular type of cash budget is a monthly cash budget. This helps managers determine when cash flows will be received and when bills need to be sent out. From this, businesses will be able to set up additional funding if cash balances are determined to be dangerously low. Further, companies may be able to plan for using excess cash when cash reserves are expected to be above operational necessities. The end result is that managers are prepared to fund their operations through cash budgeting.
Why Is Cash Budgeting Important?
Cash budgeting is important particularly for managers. As previously discussed, managers need to understand when cash inflows and outflows will take place. From this, strategic planning may be done for operational purposes. However, most managers are not familiar with constructing and maintaining a cash budget. This leads to the need for basic training regarding constructing, implementing, and adjusting cash budgets on a monthly, semiannually, in yearly basis. Further, when business owners apply for additional funding, business plans are usually requested from lending institutions. A critical component of any business plan is the cash budget. Lenders want to know if the company will be able to pay back the loan. From this, and in-depth analysis of the cash budget will take place by the lender.
Who Needs to Know Cash Budgeting?
Understanding the intricacies of cash budgeting is needed by accounting students, finance students, small business owners, and lending institutions. Accounting students need to understand the cash budget because other financial statements are tied to this analysis. Finance students need to master cash budgeting because numerous classes cover the concept. Specifically, corporate finance, managerial finance, and financial statement analysis courses examine cash budgets in depth. Finally, small business owners must understand how to create and analyze cash budgets to make sure their future operations are not impacted due to budgetary constraints.
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Step by Step Cash Budgeting Explanation
Cash Budgeting Terminology:
Cash budgeting it is a popular concept covered in managerial, accounting, and finance courses. From this, there are numerous terms used the students must understand. Popular terms associated with capital budgeting are as follows:
- Collections- when dealing with cash budgets, collections refers to cash receipt for the period.
- Costs – Costs refer to expenses that need to be paid in the period. Common costs include utilities, lease payments, taxes, wages, and cost of goods.
- Net cash gain/loss - this line item indicates the dollar amount a business will either have an access or loss for the period. When the net cash gain is a positive, then business owners will likely invest the excess funds into profit generating accounts such as money market accounts. In the event of a loss, business owners need to arrange financing to ensure adequate funds for operations.
Cash Budgeting - Step by Step:
When conducting a cash budget, specific steps must be followed. First, business owners must identify when cash funds will be received. From this, cost must be identified and determine when payments must be made. Further, some cost may be put off to an additional period. Because of this, managers need to determine the value of paying a bill now or in the future. Finally, analysis of the net cash gain/loss must be done. As previously stated, if funds are in access, the management needs to investor access funds into a profit bearing account. Conversely, if funds are a loss, then financing must be arranged to ensure the company has funds for operations.
Concluding Thoughts on Cash Budgets:
Cash budgeting is a critical concept this should be understood by finance students, accounting students, management students, small business owners, and commercial lenders. By understanding how to create a cash budget, analyze the budget, and make strategic decisions based on the analysis, students and business owners will be able to garner a competitive advantage over competition and ensure smooth operations for the company.