Definition
A cash budget is a financial statement with itemized projected cash inflows and cash outflows, and a projected cash balance at the end of a budget period. It is necessary to know in advance about any cash flow gaps or idle cash balances. In other words, preparing a cash budget is an essential stage of cash management and financial planning.
If a company’s management determines there is a cash flow gap, it has to arrange additional financing in advance to provide a sufficient amount of cash. Idle cash can be used to repay loans or invested in marketable securities.
Primary purpose and components of a cash budget
Primary purpose
The primary purpose of cash budget preparation is to determine if a business will generate sufficient cash inflows to meet cash outflows in a particular budget period. In other words, it answers the question as to whether or not a business will have sufficient cash to operate.
Relationship with other budgets
A cash budget is a component of the master budget, but preparation involves using input data from other budgets, i.e., sales budget, direct material budget, and direct labor budget. In turn, the itemized cash flows are used as input data for financial budget preparation.
Template
The cash budget format usually has two parts:
- Cash inflows
- Cash outflows
Common examples of cash inflows are proceeds from cash sales, accounts receivables collected, fixed assets sales, sales of financial assets, proceeds from investing activities, and proceeds from long-term and short-term debt.
Common examples of cash outflows are direct materials and labor expenses, manufacturing overhead, administrative and selling expenses, purchases of fixed assets, purchases of financial assets, payments of short-term and long term debts, and dividends payout.
The template of a cash budget should include:
- Cash balance at the beginning of the budget period
- Itemized cash inflows
- Itemized cash outflows
- Cash surplus (deficit)
- Cash balance at the end of the budget period
An example of such a template is shown below.
US$, in thousands
Cash budget preparation example
The projected sales of Stiltrade LTD in the first quarter are as follows:
US$, in thousands
It is expected that 50% of accounts receivable will be collected in the same month when credit sales are made, 40% in the following month, and the remaining 10% the next month. Credit sales in December were $3,200,000 and $2,800,000 in November.
The projected direct materials expenses are estimated as 20% of total sales in the relevant month, direct labor expenses as 15%, manufacturing overhead as 25%, administrative expenses as 10%, and selling expenses as 5%.
It is also known that:
- Cash balance on 1 January is $125,000
- Interest expenses are estimated as $55,000 per month
- Stiltrade LTD declared dividends of $1,450,000 to be paid in February
Thus, the cash budget of Stiltrade LTD for the first quarter should be as follows:
US$, in thousands
January
Beginning cash balance = $125,000
Cash sales = $600,000
Collection of accounts receivables recognized in January = ($3,500,000 – $600,000) × 50% = $1,450,000
Collection of accounts receivables recognized in December = $3,200,000 × 40% = $1,280,000
Collection of accounts receivables recognized in November = $2,800,000 × 10% = $280,000
Direct materials = $3,500,000 × 25% = $875,000
Direct labor = $3,500,000 × 30% = $1,050,000
Manufacturing overhead = $3,500,000 × 15% = $525,000
Administrative expenses = $3,500,000 × 10% = $350,000
Selling expenses = $3,500,000 × 5% = $175,000
Interest paid = $55,000
Cash surplus = $600,000 + $1,450,000 + $1,280,000 + $280,000 – $875,000 – $1,050,000 – $525,000 – $350,000 – $175,000 – $55,000 = $580,000
Ending cash balance = $125,000 + $580,000 = $705,000
February
Beginning cash balance = $705,000
Cash sales = $500,000
Collection of accounts receivables recognized in February = ($3,200,000 – $500,000) × 50% = $1,350,000
Collection of accounts receivables recognized in January = ($3,500,000 – $600,000) × 40% = $1,160,000
Collection of accounts receivables recognized in December = $3,200,000 × 10% = $320,000
Direct materials = $3,200,000 × 25% = $800,000
Direct labor = $3,200,000 × 30% = $960,000
Manufacturing overhead = $3,200,000 × 15% = $480,000
Administrative expenses = $3,200,000 × 10% = $320,000
Selling expenses = $3,200,000 × 5% = $160,000
Interest paid = $55,000
Dividend paid = $1,450,000
Cash deficit = $500,000 + $1,350,000 + $1,160,000 + $320,000 – $800,000 – $960,000 – $480,000 – $320,000 – $160,000 – $55,000 – $1,450,000 = $895,000
Ending cash balance = $705,000 – $895,000 = -$190,000
March
Beginning cash balance = -$190,000
Cash sales = $800,000
Collection of accounts receivables recognized in March = ($3,900,000 – $800,000) × 50% = $1,550,000
Collection of accounts receivables recognized in February = ($3,200,000 – $500,000) × 40% = $1,080,000
Collection of accounts receivables recognized in January = ($3,500,000 – $600,000) × 10% = $290,000
Direct materials = $3,900,000 × 25% = $975,000
Direct labor = $3,900,000 × 30% = $1,170,000
Manufacturing overhead = $3,900,000 × 15% = $585,000
Administrative expenses = $3,900,000 × 10% = $390,000
Selling expenses = $3,900,000 × 5% = $195,000
Interest paid = $55,000
Cash surplus = $800,000 + $1,550,000 + $1,080,000 + $290,000 – $975,000 – $1,170,000 – $585,000 – $390,000 – $195,000 – $55,000 = $350,000
Ending cash balance = -$190,000 + $350,000 = $160,000
As we can see, the dividend payout scheduled for February causes a cash flow gap of $190,000. So, the company’s management has to raise additional funds to cover it.
