Prepare a Cash Budget
Just as you would not purchase new furniture for your home without enough cash, or at least a solid plan to cover a personal loan from your bank, your business needs the same careful handling of its expenditures. All businesses, no matter what type or size, need to properly develop a plan for their expected cash intake and spending. This plan is commonly known as a cash budget, and it can be prepared quarterly or annually.
I. Purposes of Cash Budgeting
Properly preparing your cash budget will show how cash flows in and out of your business. Also, it may then be used in planning your short-term credit needs. In today's financial world, you are required by most financial institutions to prepare cash budgets before making capital expenditures for new assets as well as for expenditures associated with any planned expansion. The cash budget determines your future ability to pay debts as well as expenses. For example, preliminary budget estimates may reveal that your disbursements are lumped together and that, with more careful planning, you can spread your payments to creditors more evenly throughout the entire year. As a result, less bank credit will be needed and interest costs will be lower. Banks and other credit-granting institutions are more inclined to grant you loans under favorable terms if your loan request is supported by a methodical cash plan. Similarly, businesses that operate on a casual day-to-day basis are more likely to borrow funds at inopportune times and in excessive amounts. Without planning, there is no certainty that you will be able to repay your loans on schedule. However, once you've carefully mapped out a cash budget, you will be able to compare it to the actual cash inflows and outflows of your business. You will find that this comparison will
go a long way in assisting you during future cash budget preparation. Also, a monthly cash budget helps pinpoint estimated cash balances at the end of each month which may foresee short-term cash shortfalls.
Cash budgeting is a continuous process that can be checked for consistency and accuracy by comparing budgeted amounts with amounts that can be expected from using typical ratios or financial statement relationships. For example, your treasurer will estimate the payments made to your suppliers of merchandise or materials, the payments to employees for wages and salaries, and the other payments that you are obligated to make. These payments can be scheduled by dates so that all discounts will be taken, and so that no obligation will be overlooked when it comes due. Cash collections from customers can also be estimated and scheduled by dates along with other expected cash receipts. With careful cash planning, you should be able to maintain a sufficient cash balance for your needs and not put yourself in the position of holding excessive balances of nonproductive cash. In the normal course of operations in a merchandising business, for example, merchandise is purchased and sold to customers who eventually pay for the merchandise sold to them. Usually there is a time lag in business operations. It may be necessary to pay the suppliers for merchandise before the merchandise is sold to the customers. Before and during a busy selling season the demand for cash may be higher than the inflow of cash from operations. In this case it may be necessary to arrange short-term loans. When the selling season is over, cash collections from customers will be relatively large and the loans can be paid off.
Example of a Cash Budget
The following is an example of a cash budget for the 90 days provided below for the XYZ Company.