Cash Budgeting

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Robert Buckman
Using a Cash Budget for Planning Purposes
Let me begin by explaining what a cash budget is. A cash budget is a tool that helps individuals and companies forecast a short term financing needs. Investopedia defines a cash budget as, “an estimation of the cash inflows and outflows for a business or individual for a specific period of time.” (Cash Budget) A cash budget is used to determine the borrower’s ability to generate cash and repay debt. A cash budget also provides an estimate of a company’s or an individual’s short term cash position. In this paper I will reveal the primary uses of cash budgets, as well as lay out a format for a cash budget, explain which borrowers should prepare a cash budget and explain the application of cash budgets. Over View

A variety of companies, and every individual, would benefit from the use of cash budgets as a part of their own financial planning process. “Cash budgets are often used to determine if the business has enough money to fund its regular day to day routine or whether it has too much cash set aside which could be better utilized.” (Cash Budget) Banks review the cash budgets and examine the underlying assumptions, checking to see if they are realistic. For example when a person is starting a new company, the banks look at how the economic state is and see if the expected amount of sales is reasonable when compared to competitors. Banks also check if the projections are supported by the past performance of the company, when they are the look to see if the projections are dependable and conservative. They also want to see if the assumptions are within an individual’s control, such as the wage an individual would expect to earn or if management can make decisions which could affect profit. It almost goes without saying that we want to see past data is reliable. Banks don’t want to make a million dollar loan to an individual who only makes twenty thousand dollars a year or based on collateral of a building that doesn’t exist. One of the Senior Members of Standard Bank told me when he was younger his manager was fired because he approved a one million dollar loan based on the collateral of a building that didn’t exist. For the company one million dollars was a relatively low amount and the sum was just written off but it just goes to show you need to back your decisions with facts and numbers. A cash budget would be prepared based on interviews, historical financial statements, accounts receivable turns, inventory management, and accounts payable terms. Obviously an individual wouldn’t have an accounts receivable but consider an annuity from a deceased relative. Their accounts payable could be their monthly bills, a mortgage and etc. Then the cash budget would be used to examine the inflows and outflows. This is done on a cash basis as opposed to an accrual basis because even though you made the sale it doesn’t mean the funds are available to you right away. “Financial Plans are prepared so that a minimum balance of cash will be available at all times. The amount that a company holds will depend on the estimated future cash flows and the financial policy adopted. The cash balance should be large enough to enable the company to meet its payrolls and its operating costs for the next month, with some allowance made for contingencies and miscalculations in planning. By holding adequate cash reserves, management can cope with small adversities and will not be forced to borrow under unfavorable conditions. Let’s face it ‘luck favors the prepared’, when problems arise, and they will occur, the company that plans will have a reserve to fall back on. While the reserve is being utilized, management can make alternative plans and secure additional funds from various other sources to meet future demands. With regard on how much should be held in reserve, this is strictly up to the company’s discretion. Some companies hold sizeable cash balances as well as a...
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