CASH BUDGETING

The Cash Budget

What is a cash budget?

A forecasting tool that tracks all cash receipts

and cash disbursements.

Done on a shorter time frame than other

statements (i.e., month-by-month or even week-by week).

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Cash Budgeting

The Cash Budget

Why is a cash budget important?

Allows companies to predict possible cash shortages and take corrective action before a crisis occurs. Allows companies to see if large sums of excess cash are lying idlecould be put to better use.

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Cash Budgeting

Cash Budgeting
Disregard the principles of accrual accounting when developing a cash budget:

Instead of matching EXPENSES with REVENUES in the period in which they are incurred, now we are concerned with matching CASH INFLOWS and CASH OUTFLOWS in the periods in which they are incurred. All cash items, regardless of their classification (expense, asset, fixed cost, variable cost, etc.), are accounted for in a cash budget. Non-cash items (such as amortization) never appear.

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Cash Budgeting

Cash Budgeting
REMEMBER: A business that is UNPROFITABLE can SURVIVE but INSOLVENCY (i.e., insufficient cash to pay debts) could mean BUSINESS FAILURE.

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Cash Budgeting
Example:

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Cash Profit
Item
Fixed Assets

Effects on Cash Effect on Profit

Payment terms: likely year of purchase Age of accounts receivable Depreciate over useful life Revenue recognized when service earned

Credit Sales

Purchases on credit Intangibles

Supplier repayment Match with policy revenues Payment terms Amortize over useful life

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Methodology of the Cash Budget

1. Identify the nature and timing of all cash inflows. These include:

Inflows from financing (e.g., bank loans, capital infusions, proceeds from sale of fixed assets). Usually on a one-time basis. Investment income collections. Sporadic. Collections from sales (recurring over time). This may involve sales forecasts, collections schedules.

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Cash Budgeting

Methodology of the Cash Budget

Useful tools when forecasting sales:

Management estimates Historical sales patterns Industry trends Competitor's sales

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Methodology of the Cash Budget

2. Identify the nature and timing of all cash outflows. These include:

Cash operating expenditures Capital expenditures Financial commitments Equity reductions

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Methodology of the Cash Budget

3. Subtract outflows from inflows to get net cash flow for the period (either a surplus or deficit). 4. Add (subtract) cash flow for the period to the ending balance in cash from the previous period to get new ending balance.

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Uses of Cash Budgeting

Schedule timing of cash flows to:

Make efficient use of cash Analyze solvency Forecast financial requirements Prioritize and plan payments of outstanding accounts Perform SENSITIVITY to plan contingency action Categorize type of financing requirements

Note: Cash budgeting involves a FUTURE orientation

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Uses of Cash Budgeting

Implications:

KEY VARIABLES highlighted Constant fine tuning Not perfect

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Questions that Might be Asked Following a Cash Budget Analysis

1. What is the maximum cash requirement? In what month is it needed?
Can we secure this much financing?

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Questions that Might be Asked Following a Cash Budget Analysis

2. Is the overall cash flow + or ? If it is negative, what can be done?

3. Which variables have the biggest

impact on the cash flow? What happens if these variables change (sensitivity)?

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Questions that Might be Asked Following a Cash Budget Analysis

4. If a negative cash flow results, what is the main cause?
Is it a long-term or short-term problem? What is the best type of financing to alleviate the problem?

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