Discuss how a Cash Budget may help a business to predict its future funding requirements

‘A cash budget is a detailed plan that shows how cash resources will be acquired and used over a specified time period’ (Seal et al, 2015 p468).

It is usually compiled to show monthly inflows and outflows of cash to the business. Inflows could come from sales of products or assets and outflows could be to suppliers or to pay expenses. The difference between these two figures is the net cash flow for the period. Once this is added to the opening balance, an estimation of the closing cash balance at the end of the period is made.

There is often a time lag between sales and the inflow of the cash from sales because of the sale of goods on credit terms. The same could occur with payments to suppliers. The cash budget shows when the expected movement of cash will occur. Some items that appear in the Income statement of a business will not appear in the cash flow budget e.g. Depreciation and bad debts. The cash budget is prepared on a cash basis whereas the Income statement is prepared on an Accruals basis, and the timing of transactions will therefore differ.

The cash budget forms part of the Master budget of an organisation, and information from the cash budget will included in the Balance sheet. A business can thereby see what their Balance sheet may be showing at the year end. If there is a deficiency in the cash balances a business can take steps to secure additional funding for the period in question.

It may be cheaper to acquire funding for a period when cash balances are lower if this can be predicted some time before the event. Last minute overdrafts can hopefully be avoided.

‘A company may consider that the cash budgets are higher than necessary and may decide to invest part of the cash balance in short-term investments’ (Drury, 2015 p386).

Alternatively, a business may decide to invest in additional equipment at a time when cash balances are healthy. Or to pay off any outstanding debts without using up resources required for working capital.

However, it could be argued that cash budgets are not very useful for helping a business to predict its future funding requirements because cash budgets require estimation. This therefore means that cash budgets are never 100% accurate. As a result, this reduces the usefulness of cash budgets as it will never be able to be used to get a precise figure on exactly how much funding the firm really needs.

In addition, cash budgets may not help a firm to predict its future funding requirements to a great extent because the firm may encounter unexpected cash inflows/outflows rendering the cash budget irrelevant and useless when making decisions about the funding of the business.

References

Seal, W, & Garrison, R (2015) Management accounting, McGraw Hill

Drury, C (2015) Management and cost accounting, Cengage learning

Wordcount  502 (about average for the submitted work)