The cash budget is a critical component of the financial budget, which goes into the master budget. A cash budget is a plan that helps manage cash flows by identifying budgeted cash receipts and disbursements for a period. Inadequate cash flow is one of the main reasons businesses fail. The cash budget helps to reduce such risk while effectively managing a company's cash flow. This plan summarizes all budgeted cash receipts and disbursements for the planning period, and it is usually prepared after all the operating budgets have been completed.
Cash available is the starting point to create the cash budget. An accountant determines this by taking beginning cash from the balance sheet and adding information from a cash receipts budget. A cash receipts budget shows cash payments collected from customer sales made during the period. It may require review of past collections history to estimate future patterns.
Next is the cash disbursements section. Cash disbursements is the part of the cash budget that lists each type of cash (noncredit) payment that the company expects to make during the period. Here, the accountant summarizes all disbursements (payments) for the period, separated by expense category. Production cash outlays will come from direct materials, direct labor, and manufacturing overhead. To determine the cash payments for direct materials during a period, companies prepare a cash payments for materials budget, which details when payments for material purchases will happen.
The first line of a cash payments for materials budget will typically be the payment of accounts payable balances remaining from the previous year. Following this will be payments for current period items. Any amounts remaining to be paid will be reported in accounts payable on the pro forma balance sheet as a future obligation.
Other cash disbursement items include selling and administrative expenses, income tax payments, and payments for capital expenditures (such as buying equipment).
Once a company knows its total cash available to spend and total cash disbursements for a budget period, it can determine if the company will have enough cash to make planned payments on time.
If the difference between total cash available and disbursements is negative, that means not enough cash is on hand to meet expected obligations, and a company may need to engage in short-term financing. Short-term financing is brief loans that organizations make to cover periods of cash deficits. In other words, it may need to borrow money for brief periods. Borrowing levels, if necessary, are determined by how much more cash is required to meet planned cash disbursements and maintain minimum desired cash balances.
The last line of the cash budget is the ending cash balance for each period. This balance is calculated by adding cash receipts to the starting cash balance in order to arrive at cash available. Total cash payments are then deducted from the cash available to find the cash available before financing. Finally, any cash borrowed (or repaid) is added (or subtracted) to arrive at the ending cash balance.
The ending cash balance for the period becomes the beginning cash balance for the next period.
Example of a Comprehensive Cash Budget
|Heavenly Sleep Systems
For Year Ended December 31, 2019
|Starting cash balance||$20,000||$10,000|
|Manufacturing overhead budget||$9,000||$9,000|
|Total cash payments||$51,000||$41,000|
|Balance before financing||$4,000||$17,000|
|Ending cash balance||$10,000||$17,000|
After the cash budget has been created, the company now has enough information to complete its pro forma financial statements that make up its master budget.
The pro forma income statement is derived from the sales budget, selling and administrative budget, cost of goods sold budget, and a few other pieces of information. The sales budget provides the first item on the income statement, the sales in dollars. Next, cost of goods sold, from the cost of goods sold budget, is deducted from sales to arrive at gross income. Selling and administrative expenses are then deducted to arrive at operating income. Other information, such as possible interest expense and interest income, must be gathered and included. Finally, the company tax rate is applied in order to arrive at income tax and net income after taxes.
Another key pro forma statement is the balance sheet. The balance sheet is created using data from all the other operating and financial budgets along with estimates based on outside information. The cash and accounts receivable account balances can be derived from the cash budget. The inventory balances can be derived from the production budget. Other accounts that can't be derived directly from other budgets may need information outside the budgeting process. For example, if the company has long-term notes payable, to build the balance sheet for the next year it would look at the balance from the prior year, how much each monthly payment is, and when payments are due. This will help derive future monthly balances on the balance sheet.Typically, the master budget is submitted to a board of directors for approval and, if approved, becomes the budget for the projected periods.