Question

What are various components involved in Cash budgets and explain how the importance of cash budgets.

Answer 1

The cash budget consists of three parts:

1. The forecast of cash inflows

The first section represents incoming cash, or cash receipts. It includes only the money you actually receive. Do not count credit sales or sales on account until you physically have the money. Some of the sources of incoming cash include product sales, service revenue and rental income. Loan funds are not considered incoming cash, as they must be paid back.

2. The forecast of cash outflows

Outgoing cash is section for all of the payments you make in the period. Rent or lease payments, payroll, payments to your vendors and suppliers and any other expenses that you have to physically pay during the reporting period belong here. So do loan and interest payments. Like the incoming cash section, this is to see where the most substantial expenditures are.

3. The forecast of cash balance

The surplus or deficiency section clearly illustrates whether you have enough incoming cash to cover the expenditures that the business needs to make. This section consists of one line that reflects the difference between the incoming cash and the expenditures. If a deficiency exists, we may need to consider how to generate more incoming cash or seek financing alternatives.

Importance of Cash Budget :-

1. Cash budget is an extremely useful 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.
7. 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.
8. The firm will have to either renew the loans to make it long-term or an entirely new loan must be negotiated. In either case the negotiations are on a much shorter notice than the original loan and the renewal or new loan will very likely be made with less favourable terms. Further, planning for cash may engender the confidence of suppliers of cash and credit to such an extent that they are more likely to grant loans on easier terms.
9. With these reports finance manager can find out deviations and study reasons for variation and finally take steps to remedy the variations.