Cash Budget Meaning, Elements, Methods, Types

Table of Contents:

  • What is Cash Budget?
  • Cash Budget Meaning
  • Elements of Cash Budget
  • Methods of Preparing Cash Budget
  • Types of Cash Budget

What is Cash Budget?

The cash budget is considered an integral part of the total budgeting process, and it is prepared only after all functional budget, such as sales and production, are finalized.

However, to implement buffer control on cash flow, the scope of cash budgets can be expanded in two ways: firstly, to cover each function or subunit separately, and secondly, to develop a rolling cash flow plan for each subunit, as well as the  organization as a whole.

The cash budget aims to estimate the cash requirements of a business well in advance.

According to Solomon, “The cash budget is an analysis of the cash flow in a business over a future, short or long period. It is a forecast of expected cash intake and outlay.”

Therefore, it describes the anticipated cash flow and the timing of receipts and disbursements based on projected revenues, production schedules, and expenses.

This budget holds importance because it helps  management plan to avoid unnecessary inactive cash balances on one hand or unneeded expensive borrowings on the other. It indicates the total amount of financing required and its timing.

Cash Budget Meaning

A Cash Budget summarises the firm’s expected cash inflows and outflows over a projected period. A cash budget involves projecting future cash receipts and disbursements across various time intervals. When preparing a cash budget, seasonal factors must be taken into account, and in practical terms, a cash budget is typically scheduled every month. The availability of other appropriations is evaluated in terms of cash availability. A cash budget is also referred to as a cash flow statement, indicating cash inflows and outflows, and is generally prepared for a maximum period of one year.

A cash budget aids management in:

  1. Determining the future cash needs of the business.
  2. Planning for the financing of these needs.
  3. Managing and controlling the cash and liquidity of the firm.

The overarching objective of a cash budget is to enable the firm to meet all its commitments promptly while preventing the accumulation of unnecessary large balances.

Elements of Cash Budget

The cash flow budget, as mentioned earlier, serves as a statement detailing the target cash inflows, cash outflows, net change in cash for the period, and any additional financing required. The generic sub-elements of cash inflows and outflows are outlined as follows:

Cash Inflows:
1. Cash sales
2. Collection of receivables
3. Sale of investments
4. Sale of fixed assets
5. Interest and dividend collections
6. Bank loans
7. Issuance of shares and debentures

Cash Outflows:
1. Payment of current liabilities such as supplies of materials, payable expenses, taxes, etc.
2. Draft payments
3. Purchase of capital assets
4. Repayment of loans
5. Other cash outflows like interest expenses, etc.

Methods of Preparing Cash Budget

A cash budget is a summary statement of the firm’s expected cash inflows and outflows over a projected period, typically prepared for a maximum duration of one year. Given below are three methods of preparing a cash budget:

  1. Receipts and Payment Method,
  2. Adjusted Profit and Loss Account Method, and
  3. Balance Sheet Method.

The three techniques for preparing a ‘Cash Budget,’ are discussed as follows:

Receipt and Payment Method

In this method, all anticipated cash receipts, such as cash sales, collections from debtors, interest on investments, proceeds from the sale of assets, royalties, and bank loans, are carefully forecasted. Similarly, cash disbursements for material purchases, supplies, salaries, loan repayments, dividends, taxes, expenses, and the acquisition of plant or equipment are also determined.

The preparation of a cash budget using this method necessitates the use of several budgets, including:

  1. Sales budget.
  2. Direct materials budget.
  3. Direct labor budget.
  4. Factory overhead.
  5. Selling and administrative expense budget.
  6. Capital expenditure budget.
  7. Research and development budget.
  8. Finance budget, which covers dividends, loans, income taxes, etc.

Consequently, this method involves a line-by-line estimate of receipts and payments. Outstanding payments and receipts are excluded from the cash budget since this method relies on actual cash flows rather than accruals.

When preparing a cash budget using this method, the opening balance of cash for a period involves adding the estimated cash receipts and subtracting the estimated cash payments to determine the closing balance. This closing balance then serves as the opening balance of cash for the subsequent period.

Under this method, all receipts are aggregated, and the sum of all payments is subtracted from the total to determine the balance in hand. The closing balance in writing for a specific month becomes the opening balance for the next month, added to the total receipts to ascertain the overall cash availability during the month. Receipts and payments throughout the budget period are derived from various prepared functional budgets. Factors such as the credit extended to debtors, the credit extended to us by suppliers, delays in wage and other expense payments, etc., are considered to determine the timing of receipts and payments.

Advance payments and receipts are included, while gains in abeyance and income accrued on outstanding amounts are excluded from the cash budget. Both revenue and capital receipts and expenses are recorded in the cash budget.

Example_1:

A company named XYZ recently initiated manufacturing operations on January 1, 2003, and has secured adequate funding for fixed assets. The company has requested that you prepare an estimate of the funds required for working capital, keeping in mind the following considerations:

a) In the first month, there will be no sales. In the subsequent months, sales will be 25% cash and 75% credit. Customers will be allowed one month of recognition.

b) Payments for the purchase of raw materials will be made on a one-month credit basis.

c) Wages will be paid fortnightly on the 7th and 22nd of each month.

d) Other expenses will be paid one month in arrears, except that 5% of selling expenses are to be paid immediately upon the sale being effected.

The estimated sales and expenses for the first six months, evenly spread over the period and subject to condition (a) above, are as follows: [Include the relevant sales and expense details.]

Sales(in rupees) 3,60,000
Material Consumed 1,50,000
Wages 60,000
Manufacturing Exp. 48,000
Administrative Expenses 54,000
Selling Expenses 42,000
Depreciation on fixed assets 50,000

The produced article is subject to excise duty, which amounts to 10% of the selling price. This duty is payable on March 31, June 30, September 30, and December 31 for sales up to February 28, May 31, August 31, and November 30, respectively.

Prepare a Cash Budget for each six months, indicating the working capital requirements.

Solution:

Cash Budget (for the six months ending on June 30, 2003)

Particulars January(Rs.) February(Rs.) March(Rs.) April(Rs.) May(Rs.) June(Rs.)
Receipts:
Opening Balance (-) 7,500 (-) 45,000 (-) 39,200 (-) 26,200 (-) 13,200
Cash Sales 18,000 18,000 18,000 18,000 18,000
Receipts from customers 54,000 54,000 54,000 54,000
Cash Available (A) 10,500 27,000 32,800 45,800 58,800
Payments:
Wages 7,500 10,000 10,000 10,000 10,000 10,000
Materials 25,000 25,000 25,000 25,000 25,000
Manufacturing Exp. 8,000 8,000 8,000 8,000 8,000
Administrative Exp. 9,000 9,000 9,000 9,000 9,000
Selling Exp. 3,500 7,000 7,000 7,000 7,000
Excise Duty 7,200 21,600
Total Payments (B) 7,500 55,500 66,600 59,000 59,000 80,600
Closing Balance (A–B) (-)7,500 (-)45,000 (-)39,200 (-)26,200 (-)13,200 (-)21,800

Note: The company requires an overdraft facility to the extent indicated above for every month.

Adjusted Profit and Loss Method

The starting point for this method is the budgeted profit reflected in the income statement. Essentially, the projected profit converts from an accrual to a cash basis. In other words, the budgeted profit for a period is adjusted for non-cash transactions and expected cash-oriented changes in asset and liability accounts remain unaffected by profit calculations. Non-cash items, such as depreciation, bad and doubtful accounts, expired insurance premiums, expenses, and income tax accruals, are considered in this adjustment.

Following this adjustment, anticipated decreases in current assets or liabilities are added, while anticipated increases in existing assets or decreases in current liabilities are deducted. The budgeted cash at the end of a period is determined by adding the cash balance at the beginning of the period to the net cash increase indicated in the analysis of the adjusted profit method.

The budgeting conducted using the Adjusted Profit and Loss Account method is known as a cash flow statement and is more suitable for long-term forecasting. Under this method, profit is considered equivalent to cash, and necessary adjustments are made for non-cash transactions. The net estimated profit serves as the base, and non-cash items such as depreciation, outstanding expenses, provisions, etc., which were initially deducted to arrive at the net profit, are added back.

Additionally, capital receipts, reduction in debtors and stocks, increase in liabilities, and the issuance of share capital and debentures are added to compute the total cash receipts. On the other hand, payments of dividends, prepayments, capital payments, increases in debtors, increases in stock and decreases in liabilities are deducted from the total cash receipts. The profit adjusted in this manner represents the estimated cash available.

The cash available during the budget period is calculated as follows:

Cash Budget: For the period ending March 31st…………….

Opening balance of Cash (in Rupees) x x x
Add :
Net profit for the year x x x
Funds from operations :
Depreciation x x x
Provision and write off x x x
Loss on sale of assets x x x
 x x x
Less : Profit on sale of assets x x x x x x
“ Decrease in debtors x x x
“ Decrease in Stocks x x x
“ Decrease in other assets x x x
“ Decrease in prepaid exps. x x x
“ Increase in Capital x x x
“ Increase in liabilities x x x
“ Increase in debentures x x x x x x
x x x
Less:
Dividends x x x
Capital payments x x x
Repayment of loans x x x
Increase in Debtors x x x
Increase in Stock x x x
Decrease in liabilities x x x x x x
Closing balance of Cash  x x x

Example_2:

The following data is available to you. Prepare a cash budget using the Adjusted Profit and Loss method.

Balance Sheet as on 31st December, 2005
Liabilities Amount (Rs.) Assets Amount (Rs.)
Share Capital 1,00,000 Premises 50,000
General Reserve 20,000 Machinery 25,000
Profit and Loss A/c 10,000 Debtors 40,000
Creditors 50,000 Closing Stock 20,000
Bills Payable 10,000 Bills Receivable 5,000
Outstanding Rent 2,000 Prepaid Commission 1,000
Bank 51,000
1,92,000 1,92,000

Projected Trading And Profit and Loss Account for the year ending December 31, 2005

Rs. Rs.
To Opening Stock 20,000 By Sales 2,00,000
To Purchases 1,50,000 By Closing Stock 15,000
To Octori 2,000
To Gross Profit c/d 43,000
  2,15,000 2,15,000
To Interest 3,000 By Gross Profit b/d 43,000
To Salaries 6,000 By Sundry Receipts 5,000
To Depreciation (10% on Premises and Machinery) 7,500
To Rent 6,000
Less: Outstanding
(Previous Year)
2,000
4,000
Add-Outstanding
(Current Year)
1000 5000
To Commission 3,000
Add-Prepaid (Previous Year) 1000 4000
To Office Expenses 2000
To Advertisement Expenses 1000
To Net Profit c/d 19,500
  48,000 48,000
To Dividends 8,000 By Balance of Profit (from last year) 10,000
To Addition to Reserves 4,000 By Net Profit b/d 19,500
To Balance c/d 17,500  
  29,500 29,500

Closing Balance of certain items is as follows:

Share Capital Rs. 1,20,000, 10% Debentures Rs. 30,000, Creditors Rs. 40,000, Debtors Rs. 60,000, Bill Receivable Rs. 4,000, Bills Payable Rs. 12,000, Furniture Rs. 15,000 and Plant Rs. 50,000 (both of these assets are purchased at the end of the year).

Cash Budget
For the period ending 31st December, 2005
Closing Balance as on 31st December, 2005 33,000
Rs.  Rs.
Opening Balance as on 1st January, 2005 51,000
Add:
Net Profit for the year 19,500
Depreciation 7,500
Decrease in Bills Receivable 1,000
Increase in Bills Payable 2,000
Issue of Share Capital 20,000
Issue of Debentures 30,000
Decrease in Prepaid commission 1,000
Decrease of Stock 5,000 86,000
1,37,000
Less:
Purchase of Plant 50,000
Purchase of Furniture 15,000
Increase of Debtors 20,000
Decrease of Creditors 10,000
Decrease in Outstanding Rent 1,000
Dividends Paid 8,000 1,04,000

Balance Sheet Method

In this approach, the closing balances of all budgeted balance sheet items, excluding cash and bank balances, are determined and incorporated into a budgeted balance sheet. If the total of the liabilities side items exceeds the capacity of asset side items, the balancing figure will be the cash/bank balance. Conversely, if the sum of asset side items surpasses the total of liabilities side items, the balancing figure will be a bank overdraft or a shortage in cash.

The budgeted figures for closing balance sheet items can be derived by adjusting the opening balance sheet items with the anticipated transactions for the year. All balance sheet items, excluding the cash balance, are altered considering changes that may occur between the current and projected balance sheets.

Under this method, a projected balance sheet is created at the end of the budget period, outlining various assets and liabilities, excluding cash and bank balances. The balancing figure would represent the estimated closing cash/bank balance. Therefore, under this method, closing ratios other than cash/bank must be determined first to be included in the budgeted balance sheet. This can be achieved by adjusting the anticipated transactions of the year in the opening balances. If liabilities surpass assets, it indicates a balance of cash/bank, and if assets exceed liabilities, it signifies a bank overdraft.

In essence, under the Adjusted Profit and Loss method, the amount of cash is computed by preparing a Cash Flow Statement, and the same amount is determined as a balancing figure under the Balance Sheet method.

Example_3:

Prepare the Cash Budget using the Balance Sheet method based on the data provided in Example 2.

Solution:  Budgeted Balance Sheet as on 31st December, 2005 

Liabilities Amount(Rs.) Assets RS. Amount(Rs.)
Share Capital 1,20,000 Premises 50,000
10% Debentures 30,000 Less : Depreciation 5,000 45,000
General Reserve 24,000 Machinery 25,000
(Rs. 20,000 +Rs. 4000)
Profit and Loss A/c 17,500 Less: Depreciation 2,500 22,500
Creditors 40,000 Furniture 15,000
Bills payable Debtors 60,000
Outstanding Rent 1,000  Bills Receivable 4,000
Plant 50,000
Closing Stock 15,000
Bank (Balancing Figures) 33,000
2,44,500  2,44,500

Types of Cash Budget

There are two types of cash budgets:

  1. Fixed budget
  2. Variable budget

A fixed budget is a plan of cash inflows and outflows at a specific activity level. In this scenario, the estimates and the need for new financing are relevant only for the particular activity level for which they are computed. The main limitation of a fixed cash budget arises when the firm operates at a different level of activity than the one anticipated during the preparation of the cash budget, rendering the targeted cash flows irrelevant.

To overcome this limitation, cash budgets are prepared for varying activity levels, referred to as flexible cash budgets. These types of funding are preferred because they offer additional information to management regarding the range of the firm’s potential financing needs at different activity levels. Additionally, they serve as performance standards against which subordinates’ performance can be measured and evaluated.

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