A cash budget details a company’s cash inflow and outflow during a specified budget period, such as a month, quarter or year. Its primary purpose is to provide the status of the company’s cash position at any point of time.

This helps the company make critical decisions such as creating cash reserves to make arrangements for projected shortages and using excess funds prudently. Additionally, the cash budget helps in prioritizing payments in the budget period. It also helps in analyzing budget-versus-actual variances in cash inflow and outflow.

• How does a Cash Budget Help in Decision Making?
• What are the Main Purposes of Budgeting?
• Why is it Important to Draw up a Cash Budget?
• What are the Key Components of a Cash Budget?
• How do you Prepare a Cash Budget Example?
• What are the Limitations of Cash Budget?
• What is Budget Decision?

How does a Cash Budget Help in Decision Making?

Your small business succeeds or fails based on the quality of your decisions. If you make things up as you go along, basing decisions on feelings and wishful thinking, you can get in trouble fast. A budget for your overall business and each of your departments can provide guidelines for decision-making and future planning.

Read Also: The Ultimate Beginners Guide to Budgeting and Saving

Eliminating Emotionalism

You create your budget by sitting down in a rational moment and considering the best ways to spend your money. Numbers and facts guide this process. For example, if you know your income will allow for $25,000 of investment in marketing, recording this figure during the budgeting process keeps you from over-spending when a salesperson gets you excited about a media campaign.

Providing Balance

Your budget should consist of several smaller budgets. You need one for operating expenses, sales, purchases of new equipment and property, marketing, new hiring and production, to give a few examples.

By looking at all of these areas of your business together, you can make wise decisions based on a balanced view of the needs of all aspects of your business. For example, if you overspend on hew hiring, you could have no money left for marketing.

Adjusting Strategy

Your budget tells you how you’re doing. The foundation of your budget is your income. If you find that you are missing your income targets and have to cut back on expenditures, this tells you that you must make smarter decisions about where to focus your money.

For example, missing income targets might cause you to reallocate funds for marketing and sales to boost income levels. Keep this strategy adjustment in mind when you create your next budget.

Built-in Growth

If you include plans for expansion and purchases of equipment and property in your budget, you include growth in your budget. Such a budget helps you focus on setting aside money for growing your business, not merely surviving. This focus makes your decisions wiser, because you not only watch your current bottom line, you plan to grow your income for your future bottom line.

What are the Main Purposes of Budgeting?

The purpose of a budget is to plan, organize, track, and improve your financial situation. In other words, from controlling your spending to consistently saving and investing a portion of your income, a budget helps you stay on course in pursuit of your long-term financial goals.

The tough sell is that budgeting is not just a quick fix. If you start budgeting with the attitude that it will instantly solve all your financial problems, you are bound for disappointment. Budgeting is hard work. It takes consistency over a long period of time.

The good news is that if you dedicate yourself to a budget, the financial results you will experience are phenomenal. But, if you still can’t see the purpose of a budget, here are 10 good reasons to start budgeting as soon a possible whether as an individual or a small business.

1. Increase Your Savings

For most people, the reason they get into budgeting in the first place, is to increase the amount of money they save each month. Honestly, this was the case for me.

Truthfully, when you start planning out your financial life, it is hard not to find areas to save money. Whether you are just spending too much money on frivolous purchases or spending more money on groceries than you really need, budgeting helps you find areas to save a little extra money.

Plus, one of the staples of good budgeting, is planning out your savings and paying yourself first. In other words, instead of making a paycheck, spending money, and saving whatever financial scraps are left over, budgeting helps you plan your finances so you can save first.

This places a higher level of priority on saving money, which can only lead to one thing: a bigger savings account.

2. Gain Financial Control

There is no person that enjoys feeling out of control. And when it comes to financing, living even a little out of control can lead to major problems. Budgeting keeps everything in check and puts you in the driver’s seat of your finances.

So, instead of letting your financial life just happen to you, you can take the reins and direct it where you want to go. And the more disciplined you are with your budget, the more your money will behave.

3. Increase Your Net Worth

In this day and age, it’s more common to hear people worrying about their credit score than their net worth. But budgeting will shift that mindset in you.

When you start planning, monitoring, and getting better with your money, you will find something amazing happens. Your net worth will begin to increase.

For example, if you are disciplined with your budget, you will learn to control your spending, which will help you save money. In addition, if you are in debt, budgeting will help you plan a debt payoff strategy, which will reduce your total liabilities and increase your net worth. Finally, budgeting will help you allocate more money to investments, which will put your money to work, and grow your net worth.

4. Achieve Your Financial Goals Faster

The first step in the budgeting process is to set some financial goals. In fact, we have discussed this at length in a number of other posts, and I highly recommend you go read those after this one.

Anyway, part of setting financial goals, is developing a plan to achieve them. And that’s where your budget will shine.

If you were to set a goal of saving $10,000 in the next 12 months, you can divide $10,000 by 12 months and get your monthly savings goal of $834. Now, with your budget, all you have to do is plan your saving and spending to make it work. Then, all you have to do is stick to the budget, and you will for sure meet your goal.

Heck, you might even find that your goals are a little too easy, and that if you stick to a budget you could save $15,000 per year or more. You won’t know until you get on a budget.

5. Reduce Financial Stress

Whether that means worrying about making your monthly rent payments, paying off your student loans, getting out of credit card debt, or just affording groceries, financial stress can be debilitating.

The good news is, budgeting can take a lot of the financial worries out of your life.

Think about it, if you create a plan for your finances each month, and know exactly what you can and can’t spend your money on, you are eliminating most of the unknown in your financial life.

As we mentioned earlier, this will help you to feel like you are more in control, which will in turn, reduce a lot of your financial stress.

6. Get Out Of Debt Faster

Debt is a monster that feeds on your financial success. Seriously, when it comes to your net worth, debt is literally a liability. But, if you aren’t on a budget, you might not realize how much money you are actually spending on debt each month.

Budgeting saved our financial future by opening our eyes to how much debt we were paying, but it also helped us create a road map to eliminate it. And honestly, and we believe it’s the key to staying out of debt.

7. Minimize Financial Arguments

Money fights in marriage are a very real problem. When you take two people that have handled their finances on their own for their entire adult life, and then combine their finances, there’s bound to be some disagreements.

Budgeting, however, is the best way to prevent these uncomfortable financial arguments.

First of all, budgeting as a couple forces you to get on the same page, and plan your future together. When you both take the time to come up with a financial plan you agree on, you are being proactive instead of reactive. Plus, you are teaming up instead of combating one another.

Additionally, if one of you decides to overspend, or deviate from the plan, you can’t get mad at your spouse because you participated in the budgeting process.

Budgeting in marriage holds you accountable, and keeps you focused on a goal, rather than fighting with each other.

8. Prioritize Your Finances

The more you focus on budgeting, the more you will begin to place priority on your financial goals. When you take time each day to track your expenses, reconcile your budget, and make sure you are staying on track, it is like a little reminder to stay focused on what really matters.

So, when you go shopping, you won’t just be thinking about how bad you want that pair of shoes, you will also be weighing that purchase against your financial success. Trust me, you are much less likely to spend money on stuff you don’t actually need, when you have multiple goals topping your priority list.

9. Identify Wasteful Spending

Ok, so this could probably go at the very top of this list, but budgeting helps you identify all sorts of wasteful spending in your finances. And identifying (and eliminating) wasteful spending is one of the best ways to increase your savings.

When you start budgeting, you will be amazed at all the waste you can find in your day-to-day spending.

10. Improve Your Self-Discipline

There are no two ways about it, sticking with a budget takes self-discipline. You have to be a self-starter. You have to wake up each day and commit to abiding by the budget you put in place. By doing this, you will be developing your self-discipline. And the more disciplined you become with your budget, the better the financial results will be.

The best part is that budgeting is a self-reinforcing process. You see, the more results you see from your budgeting, the more you will want to stick with it. And the longer you stick with your budget, the better your finances will be. It is a never-ending loop of financial improvement. And it all starts with budgeting.

Why is it Important to Draw up a Cash Budget?

A cash budget is a projection of how your business will earn and spend money during an upcoming period. Preparing a cash budget is important because the process forces you to think about your expectations and plan for the future. It is important to follow your cash budget–unless unforeseen circumstances arise–because adherence to a plan can discipline your spending.

The difference between a company that succeeds and one that fails is often cash management. Having too little cash means a business may have to pass on profitable ventures or take out loans to overcome liquidity issues.

Too little cash may also mean a company may be unable to operate at normal levels or be forced to shut down completely. To avoid these issues, companies rely on a cash budget to plan and control cash receipts and payments.

Cash budgeting is vital to an organization because it allows them to ensure they have enough cash on hand to cover periods of increased expenses and unforeseen circumstances in the market.

Using a Cash Budget

The cash budget is management’s approximation of cash on hand at the beginning of a budget period and the estimated cash inflows and outflows. The cash inflows may include those that result from cash sales, the sale of assets, the collection of accounts receivable, borrowing cash or stock issuance.

The cash outflows may include disbursements for material purchases, debt repayment, asset acquisition, taxes, manufacturing costs and dividends.

The cash budget highlights a company’s probable income or deficit for a period, the latter of which the company must address by increasing sales or decreasing expenditures. The advantages of a cash budget lies in its ability to identify a company’s future financing needs, highlight the need for corrective actions and evaluate a company’s performance.

Financing Needs and Costs

One of the advantages of a cash budget is that a company can anticipate when a cash deficit might exist and the extent of that shortfall. In turn, the budget indicates when a difference between budgeted and actual values might need to be made up by borrowing. Short-term financing might be required to acquire inventory, promote products or pay monthly expenses.

By predicting cash requirements, a company can also evaluate future business opportunities in part based on an opportunity’s probable financing needs and costs. For instance, financing costs will influence the profitability of a merger and product development. This process allows a company to select only those organizational goals that are financially feasible.

Corrective Actions for Cash-Flow Issues

A cash budget is a way to determine if a company has the cash necessary to meet upcoming obligations and to trigger corrective actions if a company experiences cash budget problems. For example, a company experiencing cash budget problems may need to borrow money in the short term for emergency equipment repairs, the payment of taxes or a monthly payroll.

The company may also need to borrow money in the long term for the introduction of a new product to the market or the replacement of equipment. Or the company might need respond to a sharp decline in market sales by adjusting spending or prices or negotiating more favorable terms with lenders.

Analyzing Company Performance

A cash budget is used to illustrate a company’s financial position to internal and external stakeholders — individuals with an interest in the company — including investors, suppliers and company leadership. For example, increasing cash flow may indicate strong demand for the company’s products and opportunities for company expansion, which are positive signals to current and potential investors.

In contrast, if company expenses are significantly more than the company’s cash inflow, the investment risk is high and may deter additional investment in the company. Declining cash flow may also make it more difficult for a company to obtain additional vendor credit or pay its existing debt, which might force the company into bankruptcy.

What are the Key Components of a Cash Budget?

To make your company a success, you must understand your revenue and expenses. A cash budget allows you to estimate and track all of the money that comes into your business and leaves it. Every cash budget, whether used by a corporation or an individual, contains the same basic components.

General Components

Cash budgets contain three general parts, as indicated by the eSmallOffice website: the time period, desired cash position and estimated sales and expenses. The time period specifies how long the given cash budget will apply, such as six months or two years.

The desired cash position shows how much cash you should have on hand; this is your reserve. The last part of a cash budget involves estimated sales and expenses, including items like payroll, advertising, and receipts and other income.

Income and Expenses

Estimated sales and expenses represent the most complex part of a cash budget. The elements of this part include the beginning cash balance, cash collections, cash disbursements, cash excess or deficiency, and ending cash balance. The beginning balance shows how much money you have before you’ve accounted for any expenditures or additional income.

Cash collections are any monies your business takes in, such as sales receipts. Cash disbursements show where you must spend some of your money, such as on employee pay. Cash excess or deficiency indicates whether your business funds are sufficient to meet operating expenses and pursue projects.

Financing indicates earnings on investments. The ending cash balance is how much you have left over once all your expenses are deducted and your income is added.

Complexity

Tracking all parts of a cash budget can be time-consuming, especially in a large corporation where millions of dollars may change hands, but is not necessarily complicated once the information is available. Often, a simple spreadsheet similar to a check register is all that you and your accountants need to detail financial events.

Although the approach to tracking all components of the budget is basic, cash budgets in large organizations often rely on information from different departments to put together the master document.

For example, sales managers may be responsible for tracking sales income and expenditures, while advertising agents may have to document the cost of promoting the business. These workers then have to provide the accounting department with their data, and the accountants ultimately have to compile the information to make it meaningful as a “big picture.”

Changes

Working with the components of a cash budget is a dynamic task, because the needs of the business can change over time. For example, a business may find that it needs to hire new workers to keep up with product demand. Economic conditions often dictate cash budget decisions and updates.

How do you Prepare a Cash Budget Example?

There are three main components necessary for creating a cash budget. They are:

• Time period
• Desired cash position
• Estimated sales and expenses

Time Period

The first decision to make when preparing a cash budget is to decide the period of time for which your budget will apply. That is, are you preparing a budget for the next three months, six months, twelve months or some other period? In this Business Builder, we will be preparing a 3-month budget. However, the instructions given are applicable to any time period you might select.

Cash Position

The amount of cash you wish to keep on hand will depend on the nature of your business, the predictability of accounts receivable and the probability of fast-happening opportunities (or unfortunate occurrences) that may require you to have a significant reserve of cash.

You may want to consider your cash reserve in terms of a certain number of days’ sales. Your budgeting process will help you to determine if, at the end of the period, you have an adequate cash reserve.

Estimated Sales and Expenses

The fundamental concept of a cash budget is estimating all future cash receipts and cash expenditures that will take place during the time period. The most important estimate you will make, however, is an estimate of sales. Once this is decided, the rest of the cash budget can fall into place.

If an increase in sales of, for example, 10 percent, is desired and expected, various other accounts must be adjusted in your budget. Raw materials, inventory and the costs of goods sold must be revised to reflect the increase in sales.

In addition, you must ask yourself if any additions need to be made to selling or general and administrative expenses, or can the increased sales be handled by current excess capacity? Also, how will the increase in sales affect payroll and overtime expenditures?

Instead of increasing every expense item by 10 percent, serious consideration needs to be given to certain economies of scale that might develop. In other words, perhaps, a supplier offers a discount if you increase the quantities in which you buy a certain item or, perhaps, the increase in sales can be easily accommodated by the current sales force; all of these types of considerations must be taken into account before you start budgeting.

Each type of expense (as shown on your income statement) must be evaluated for its potential to increase or decrease. Your estimates should be based on your experience running your business and on your goals for your business over the time frame for which the budget is being created. At a minimum, the following categories of expected cash receipts and expected cash payments should be considered:

• Cash balance:
• Expected cash receipts
• Cash sales
• Collections of accounts receivable
• Other income
• Expected cash expenses:
• Raw material (inventory)
• Payroll
• Other direct expenses:
• Advertising
• Selling expenses
• Administrative expense
• Plant and equipment expenditures
• Other payments

Following is a description of each line item:

Cash balance. The cash balance is your cash on hand. This includes what is in your checking accounts, savings accounts, petty cash and any other cash accounts that you might have.

Cash Sales. After arriving at a base figure of cash sales, it must be adjusted for any trade or other discounts and for possible returns. As stated previously, the base level of sales (and of accounts receivable) will be determined by the company’s projections, goals and past experience.

Collections of accounts receivable. After a base level of accounts receivable is established (based on sales projections), it must be adjusted to reflect the amount that will actually be paid during the time period. Typical adjustments for a small business might be to assume that 90 percent of accounts receivable will be collected in the quarter in which the sales occur, 9 percent will be collected in the following quarter, and 1 percent will remain uncollectible. Of course, past experience will be the most reliable indicator for making these adjustments.

Other Income. Your cash position may be affected positively by income other than that received from sales. Perhaps there are investments, dividends, or an expected borrowing that will be introducing cash to the company during the time period. These types of cash sources are referred to as “other income.”

Expected cash expenses:

• Raw materials (inventory). For small business retailers and manufacturers, the largest cash expense is usually the amount spent for inventory or raw materials. Again, past experience will be your best indicator of future cash outlays. But don’t forget to factor in any necessary increases to keep up with projected sales. You may also want to consult with your suppliers as to whether any pricing changes are expected.
• Payroll. Salaries are commonly the second largest expense item during an accounting period. Don’t forget to include estimates for all appropriate local, state, and federal taxes.
• Other direct expenses. Use this line item for any additional expense that does not fit conveniently under the other headings. If you are making payments on a loan, include it here.
• Advertising. The role of advertising varies by type of business. If you are projecting an increase in sales, is there an accompanying marketing or advertising campaign? These costs must be budgeted. Include any expenses for print (brochures, mailers, and newspaper ads), radio, or other advertising services.
• Selling expenses. Typical selling expenses include salaries and commissions for sales personnel and sales office expenses. However, this line item can also include any travel or other sales-related expense not covered elsewhere.
• Administrative expenses. General office expenses are included here. This will include your utilities, telephone, copying and day-to-day office expenses. Unless big changes are underway, past experience will guide you in evaluating future administrative expenses.
• Plant and equipment. Cash payments for equipment loans, mortgages, repairs, or other upkeep should be included here. Past experience will, again, be your guide.
• Other payments. If there are any cash payments you expect to make that are not covered in the above listing, include them here. (If they are repeatable, you may consider adding a separate line item.) However, typically, interest payments and taxes fall here.

For example, let’s assume ABC Clothing manufactures shoes, and it estimates $300,000 in sales for the months of June, July, and August. At a retail price of $60 per pair, the company estimates sales of 5,000 pairs of shoes each month. ABC forecasts that 80% of the cash from these sales will be collected in the month following the sale and the other 20% will be collected two months after the sale.

The beginning cash balance for July is forecast to be $20,000, and the cash budget assumes 80% of the June sales will be collected in July, which equals $240,000 (80% of $300,000). ABC also projects $100,000 in cash inflows from sales made earlier in the year.

On the expense side, ABC also must calculate the production costs required to produce the shoes and meet customer demand. The company expects 1,000 pairs of shoes to be in beginning inventory, which means a minimum of 4,000 pairs must be produced in July.

If the production cost is $50 per pair, ABC spends $200,000 ($50 x 4,000) in the month of July on the cost of goods sold, which is the manufacturing cost. The company also expects to pay $60,000 in costs not directly related to production, such as insurance.

ABC computes the cash inflows by adding the receivables collected from July to the beginning balance, which is $360,000 ($20,000 July beginning balance + $240,000 in June sales collected in July + $100,000 in cash inflows from earlier sales).

The company then subtracts the cash needed to pay for production and other expenses. That total is $260,000 ($200,000 in cost of goods sold + $60,000 in other costs). ABC’s July ending cash balance is $100,000, or $360,000 in cash inflows minus $260,000 in cash outflows.

What are the Limitations of Cash Budget?

Most businesses incorporate cash budgets in their overall budgeting process. Cash budgets review anticipated cash receipts and cash disbursement for the budget period. Managers use this information to determine if the company needs additional financing for the budget period. Like all processes, cash budgets come with several limitations, some of them are mentioned below.

Use of Estimates

The budgeting process relies on estimates of future events. Managers try to anticipate the future activities of the company. The cash budget relies on estimates of future sales and future collections received on those sales. The cash budget also relies on estimates of future expenses that the company expects to incur.

Managers base estimates on their instinct rather than facts. Estimates limit the effectiveness of the cash budget because factual knowledge is not available.

Lack of Flexibility

The budget process involves creating numbers to enter in the budget, publishing the budget numbers and distributing those reports to management. Once published, these numbers don’t change. Cash budgets include information regarding the company’s expected financing needs.

Once management reviews the cash budget, they make decisions based on the expected financing needs. If the actual financing needs are less than the budget, management has already committed to the financing for the budget period.

If the actual financing needs are more than the budget, management has not committed to enough financing and will incur a cash deficit. Management will need to borrow money at higher than planned interest rates to meet their cash needs.

Manipulation

Managers with ulterior motives manipulate budget numbers to reflect well on themselves. A manager making decisions that impact the cash budget may underestimate her expenses for the budget period. This reports budgeted cash disbursements that are too low. The manager receives praise for her work on the budget.

However, when the actual expenses occur and do not meet the budget numbers, the cash disbursements will incur a variance. By that time the manager may be in a different position and not feel the repercussions of her actions.

Lack of Nonfinancial Factors

When using a cash budget to analyze financing needs and financing options, nonfinancial factors are omitted. A business owner may choose to borrow funds from one of two banks. One bank may offer a lower interest rate, which can be quantified and reported on the cash budget.

The other bank may offer better customer service and offer nonfinancial perks for borrowing from them. The nonfinancial factors are not reflected in the cash budget.

What is Budget Decision?

Capital budgeting in financial management develops a strategic plan for business growth. Financing structure defines how a strategic plan will be paid for – often, it’s paid for with debt, but sometimes, it’s paid for with retained earnings of the company or new investors.

These two concepts work hand-in-hand, along with the company’s working capital, which must remain strong, so the company can pay for its operational expenses throughout the business’ next 12-month period.

Capital Budgeting Decision

A strategic plan for a business involves evaluating the cost, compared to the potential return on investment. This is the foundation of capital budgeting; you need to know the cost and the eventual value. A company might seek $5 for every dollar invested in a new project. The size of the company and the complexity of the investment may affect how an executive actually approaches the decision.

Read Also: How to Budget for big Expenses

A small-business owner might use a simple payback-period method to determine the value of an investment. For example, if buying a new machine that costs $2,000 increases production time by 20 percent, and if it then generates an additional $2,000 within the first four months, then the investment makes sense. The investment gets a green light.

Larger companies or bigger investments use estimating to determine future cash flow, based on the investment. Estimating accounts for inflation with the time factor playing a role. For example, if a business wants to open a new call center, then it might take $500,000 and two years to implement the plan from the inception of the idea to employing new workers taking calls. Executives must decide how long is reasonable for them to see the project to begin returning its budgeted funds to be worthwhile.

Financing Decisions

Once a growth or strategic plan is deemed to have value, meaning that it is believed that a strategic growth plan will produce growth that results in higher revenues and net profits, the question moves to how will the project become funded. The budgeting decision defines the amount of money and what it will do. The financing decision defines where the money comes from.

Typical sources for financing projects are loans, investors or retained earnings. Loans may be small business loans, credit cards or private loans. Investors buy into the company through stock ownership or partnership. Retained earnings is profit held over from year to year and listed on annual financial statements. Retained earnings are held to use for capital expenses or emergency funds.

Business executives need to balance the credit vs savings components in a financing decision. Companies don’t like to be “cash poor” because it puts an unwarranted strain on production should there be an unforeseen problem Mixing cash investment with some form of loan often allows a business to keep loan costs down without utilizing all retained earnings.

Summary

Budgeting is a crucial ingredient in the success of any business. Through budgeting, a business makes decisions on how to move forward. Budgeting can be done by individuals or teams, depending on the size and character of the organization. By forecasting funds, prioritizing projects and allocating money to different sources, a budget is the backbone of any good business plan.