Cash Budget | Objectives | Utility | Methods of Preparing

Why are Cash Budgets prepared?

A large number of transactions that take place in a firm generate a ‘flow of cash’. The flow of cash may be into or out of the firm. A cash budget is prepared to show the cash inflows and outflows expected in a budget period and net effect of these flows on cash balances. Cash Budget enables management to obtain a preview of the cash position of the firm.

Cash Budget

Cash Budget

Objectives of Preparing Cash Budget

The objective of preparing cash budget is to enable the management to meet its cash obligations as and when they fall due and to keep idle cash to a minimum level. If at any time cash is much in excess of requirements, this means the firm is holding a sterile asset. Shortfall of cash may at times prove suicidal. It should also be clearly understood that the liquidity provided by cash holding is at the cost of profits which would otherwise have been earned by investing cash elsewhere.

Utility of Cash Budget

1. It indicates the effect on the cash position of seasonal requirements, large inventories, unusual receipts and slowness in collecting bills receivable.

2. It indicates cash requirements for a plant or equipment expansion programme.

3. It points to the need for additional funds from external sources such as bank loans. issue of securities.

4. It indicates the availability of cash for taking advantage of discounts offered.

5. It helps in planning redemption of preference shares or redeemable debentures, payments of pension etc.

6. It shows the availability of excess funds for short or long term investments.

Methods of preparing Cash Budget

A cash budget can be prepared under any of the following methods:

  1. Receipts and Payments Method
  2. Adjusted Profits and Loss Method.
  3. Balance Sheet Method.

1. Receipts and Payments Method

This is the most simple and popular method of preparing cash budget. This method is useful for preparing short term cash budget. Under this method, all expected cash receipts and payments of budget period are considered for preparing cash budget.

Accruals and adjustments are ignored while preparing the cash budget by receipts and payments method. The cash budget starts with the opening cash in hand and at bank. All expected cash receipts from various sources such as cash sales, cash collected from debtors, dividends, interest on bonds, proceeds from sale of assets, bank loans, etc., are added to the opening balance of cash Items of expected cash payments such as cash purchases, payment to creditors, payment of expenses, dividends, tax and purchase of fixed assets, etc. whether on capital or revenue accounts, are deducted.

The excess of cash receipts (including opening balance) over cash payments represents closing cash balance at the end of the period and the excess of cash payments over cash receipts would indicate the overdraft requirements.

According to Receipts and Payment method, the cash budget can be prepared in the following form:

Cash Budget for three months ended 30th June 2016.

Particulars April May June
Estimated opening balance xx xx xx
Add: Estimated Cash Receipts xx xx xx
Cash Sales xx xx xx
Collection from debtors xx xx xx
Sale of assets xx xx xx
Dividends xx xx xx
Interests on bonds xx xx xx
Other receipts xx xx xx
Total Receipts (A) xx xx xx
Less: Estimated Cash Payments
Cash Purchases xx xx xx
Payments to creditors xx xx xx
Payment of expenses xx xx xx
Purchase of fixed assets xx xx xx
Other payments xx xx xx
Total Payments (B) xx xx xx
Estimated Closing Cash Balance (A-B) xx xx xx

2. Adjusted Profit and Loss Method

This method is usually followed in preparing long term cash budgets and it provides lesser details than the receipts and payments method. Under this method, profit and loss account is used as a basis for making the cash forecast. This method is based on the analogy that profit made during the period should increase the cash balance.

While preparing the usual profit and loss account, many items which do not involve cash outlay such as depreciation, transfer to reserves, fictitious assets written off, goodwill written off etc. are subtracted from gross profit. But the amount so subtracted from profit remains in the business. To arrive at the cash balance available at the closing date, these items are added back to the net profit. A specimen of cash budget based on this method is given below.

Cash Budget for the period ended 30th June 2016

Particulars Rs. Rs.
Estimated opening Cash balance xxx
1. Adjusted Net Profit:
Net Profit as given in the budgeted P&L A/c xx
(+) Depreciation xx
Goodwill written off xx
Fictitious assets written off xx xxx
2. Decrease in current assets xxx
3. Increase in current liabilities xxx
4. Issue of shares and debentures xxx
5. Sale of fixed assets xxx
1. Increase in current assets xx
2. Decrease in current liabilities xx
3. Prepayments xx
4. Purchase of fixed assets xx
5. Payment of dividends and tax xx xxx
Estimated closing cash balance xxx

3. Balance Sheet method

This method is also useful for preparing long term cash budgets. Under this method, a budgeted balance sheet is prepared for a certain future period showing all liabilities and assets except cash and bank balances. The cash or bank balance is arrived at as the balancing figure of the two sides of the balance sheet. If the liabilities side is more than the assets side, the excess is taken as closing cash on hand or at bank. If the assets side is heavier than the liabilities side, the difference is considered as overdraft. The main defect of this method is that it ignores the items of income and expenditure. The second defect is that the exact cash position shall be known only when the balance sheet is prepared at the end of the year.