Cash Planning or Cash Budget

Principle & Practice of Management

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Cash Planning or Cash Budget

Cash planning and control of cash is the central point of finance functions. Maintenance of adequate cash is one of the prime responsibilities of the financial manager. It is possible only through the preparation of cash planning. Cash control is also included in cash planning. Since planning and control are the twins of management. Cash planning is a technique to plan and control the use of cash. A projected cash flow statement prepared based on expected cash receipts and payments, is the anticipation of the financial condition of the firm. Cash planning may be prepared on the daily, weekly, monthly or quarterly basis. The period for which the cash planning is prepared depends on the size of the firms and management’s philosophy. Large firms prepare daily and weekly forecasts. Medium size firms prepare weekly and monthly forecasts. Small firms may not prepare cash forecasts due to non-availability of data and less scale of operations. But in a short period they may service but over a long period, they have to prepare cash planning for the success of the firm.

Cash Budget

Cash Forecasting and Budgeting

Cash forecast is used as a method to predict future cash flow because it deals with the estimation of cash flows (i.e., cash inflows and cash outflows) at different stages and offers the management an advance notice to take appropriate and timely action. The cash budget is an important tool for the flow of cash in any firm over a future period of time. In other words, it is a statement showing the estimated cash inflows and cash outflows over a planning period. It pinpoints the surplus or deficit cash of a firm as it moves from one period to another period. The surplus of deficit data helps the financial manager to determine the future cash needs of the firm, plan for the financing of those needs and exercise control over the cash and liquidity of the firm. The cash budget is also known as short-term cash forecasting.

Purpose of Cash Budget

Cash budget has proved to be of great help and benefit in the following areas:
1. Estimating cash requirements
2. Planning short-term finance planning
3. Scheduling payments, in respect of acquiring capital goods
4. Planning and phasing the purchase of raw materials
5. Evolving and implementing credit policies
6. Checking and verifying the accuracy of long-term cash forecasting.

Preparation of Cash Budget or Elements of Cash Budget

The above benefit areas clear that the main aim of preparing cash budget is to predict the cash flows over a given period of time and to determine whether at any point of time there is likely to be surplus or deficit of cash. Preparation of cash budget involves the following steps:
Step 1: Selection of period of time (planning horizon). The planning horizon is that period for which cash budget is prepared. There are no fixed rules for cash budget preparation. The planning horizon of a cash budget may differ from firm to firm, depending upon the size of the firm. Cash budget period should not be too short or too long. If it is too short many important events may come out in the planning period and cannot be accounted for the preparation of cash budget, which becomes expensive. On the other hand, if it is too long the estimates will be inaccurate. Then how to determine planning horizon? It is determined on the basis of the situation and the necessity of a particular case. A firm whose business is affected by seasonal variations may prepare monthly cash budgets. If the cash flow fluctuates, daily or weekly cash budgets should be prepared. Longer period cash budgets may be prepared when the cash flows are stable in nature.
Step 2: Selection of factor that has bearing on cash flows. The factors that generate cash flows are divided into two broad categories: (a) Operating, and (b) Financial.
1. Operating Cash Flows: Operating cash inflows are cash sales, a collection of accounts receivables and disposal of fixed assets and the operating cash outflows are billed payables, purchase of raw materials, wages, factory expenses, administrative expenses, maintenance expenses and purchase of fixed assets.
2. Financial Cash Flows: Loans and borrowings, the sale of securities, dividend received, refund of tax, rent received, interest received and the issue of new shares and debentures cash outflows are a redemption of the loan, repurchase of shares, income tax payments, interest paid and dividend paid.