Meaning, Types of Cash Budgets

1st August 2020 0 By indiafreenotes

The Cash Budget is a budget prepared to estimate the cash inflows and outflows during a specific period of time. In other words, cash budget shows the cash inflows and cash outflows expected to occur in the immediate future period.

The purpose of preparing the cash budget is to determine that whether the enterprise has sufficient cash balance to meet out its short-term cash requirements or whether too much cash is being left idle and unproductive in the organization. Thus, it helps the management to determine the surplus and shortage of funds so that suitable actions can be undertaken.

One of the major advantages of cash budget is that it provides a clear picture of all the expected cash flows, thereby enabling the firms to plan their expenditures accordingly. Also, the companies can raise adequate funds in case of the shortage of the cash balance and can make an optimum utilization of funds in case of cash surplus, for example investing in marketable securities.

But however, these cash budgets are not free from the limitations. These are less reliable as the future is uncertain and the cash forecast may not be correct. For example, unseen demands of cash, delayed cash collection, unanticipated cash disbursements, etc. Also, the cash budget is inefficient to track a significant movement in the working capital items.

The cash budget consists of three parts:

(1) The forecast of cash inflows,

(2) The forecast of cash outflows, and

(3) The forecast of cash balance.

Principal Objectives of Cash Budget:

Cash budget in a firm is prepared to accomplish the following objectives:

(1) To project firm’s cash position in future period.

(2) To predict cash surplus or deficit for the ensuing months.

(3) To permit planning for financing in advance of need. By indicating when cash will be required, the budget helps the management to arrange in advance bank loans or other short-term credits, to prepare for a sale of securities or to make other preparations for new financing.

(4) To help in selection of proper source of financing cash requirements of the firm.

(5) To permit proper utilisation of idle cash.

(6) To maintain adequate balance between cash and working capital, sales, investments and loans.

(7) To exercise control over cash expenditure by limiting the spending of various departments.

Utility of Cash Budget:

Cash budget is an extremely important tool available in the hands of a finance manager for planning fund requirements and for controlling cash position in the firm. As a planning device, cash budget helps the finance manager to know in advance the cash position of the firm in different time periods.

The cash budget indicates in which months there will be cash surfeit and in which months the firm will experience cash drain and by how much.

With the help of this information finance manager can draw up a programme for financing cash requirements. It indicates the most opportune time to undertake the financing process. There will be two advantages if the finance manager knows in advance as to when additional funds will be required. First, funds will be available in hand when needed and there will be no idle funds.

In the absence of the cash budget it may be difficult to determine cash requirements in different months. If cash required is not available in time it will entail the firm in a precarious position. The firm’s output is reduced because of imbalance in financial structure and the rate of return consequently declines.

If the firm is marginal, the decline in profits could lead to disaster. Further, it would be difficult for the firm to meet its commitments and would consequently lose its credit standing. A firm with a poor credit standing stands little chance of success.

With the help of cash budget finance manager can determine precisely the months in which there will be cash surplus. Nevertheless, a reasonable amount of cash adds to a firm’s debt paying power of the firm, holding excess cash for any period of time is largely a waste of resource yielding no return. This will result in the decline in profits.

The cash budget offsets the possibility of decline in profits because the finance manager in that case will invest idle cash in marketable securities. Thus, with the help of the cash budget, finance manager can maintain high liquidity without jeopardizing the firm’s profitability.

The cash budget, besides indicating cash requirements, reflects the length of time for which funds will be needed. This will help the finance manager to decide the most likely source from which the funds can be obtained. A firm which stands in need of funds for a short-term duration will use a source different from the one requiring funds for a long time.

Features of Cash Budget

  1. The cash-budget period is broken down into periods, mainly in months.
  2. The cash-budget is always in columnar form i.e. column showing each month.
  3. Payments and receipts of cash are identified in different heading and showing total for each month.
  4. The surplus of total cash payment over receipts or of receipts over payment for each month is shown.
  5. The running balances of cash, which would be determined by taken the balance at the end of the previous month and adjusting it for either deficit or surplus of receipts over payments for current month, is identified.

Importance of Cash Budget

Cash budget is an important tool in the hands of financial management for the planning and control of the working capital to ensure the solvency of the firm.  The importance of cash budget may be summarised as follow:

  1. Helpful in Planning: Cash budget helps planning for the most efficient use of cash. It points out cash surplus or deficiency at selected point of time and enables the management to arrange for the deficiency before time or to plan for investing the surplus money as profitable as possible without any threat to the liquidity. 
  2. Forecasting the Future needs: Cash budget forecasts the future needs of funds, its time and the amount well in advance. It, thus, helps planning for raising the funds through the most profitable sources at reasonable terms and costs. 
  3. Maintenance of Ample cash Balance: Cash is the basis of liquidity of the enterprise. Cash budget helps in maintaining the liquidity. It suggests adequate cash balance for expected requirements and a fair margin for the contingencies. 
  4. Controlling Cash Expenditure: Cash budget acts as a controlling device. The expenses of various departments in the firm can best be controlled so as not to exceed the budgeted limit. 
  5. Evaluation of PerformanceCash budget acts as a standard for evaluating the financial performance. 
  6. Testing the Influence of proposed Expansion Programme: Cash budget forecasts the inflows from a proposed expansion or investment programme and testify its impact on cash position.
  7. Sound Dividend Policy: Cash budget plans for cash dividend to shareholders, consistent with the liquid position of the firm. It helps in following a sound consistent dividend policy. 
  8. Basis of Long-term Planning and Co-ordination: Cash budget helps in co-coordinating the various finance functions, such as sales, credit, investment, working capital etc. it is an important basis of long term financial planning and helpful in the study of long term financing with respect to probable amount, timing, forms of security and methods of repayment.