Question

Why is a cash budget important even when there is plenty of cash in the bank? Explain.

Answer 1

Cash budget details cash inflows/receipts and cash outflows/payments for budget period. This will help in evaluation of liquidity position and show when company may be short of cash or when company will have excess case,

Cash budget is important even when company will have excess cash or plenty of cash in bank. One purpose of cash budget is optimum use of cash. In case of excess cash, company can:

• Invest cash on short term investments and earn interest and improve profitability/ earning per share.
• Evaluate whether excess can be used to pre-pay loan/borrowings, thus save on interest payments and improve profit
• Evaluate if it can use excess cash to pay of payables where it can earn cash discounts
• Evaluate whether it can buy raw materials in volumes so that it can take advantage of available trade discounts on volume buying  

Overall even if there is excess cash is available cash budget will show for what duration such cash is available so the above possibilities can be evaluated and cash is invested/ used in payments to earn extra interests or get disounts which will improve profitability. Thus cash can be optimally used through cash budget.