The cash budget is a tool companies can use to track all the movements of cash within their firms. Both inflows and outflows are written down in the budget; this information will usually come from the company's normal business operations. Advantages of the cash budget include discovering the amount of expected cash received from customers, calculating the amount of credit the company can extend to clients, estimating expenses, and providing focus for management. This budget can also help companies reduce expenditures and begin to control costs.
High sales revenue does not always equal high cash flows; this increases the importance of the cash budget. Companies can often take their amount of sales each month and calculate the amount of cash they expect to receive. This process is especially important for companies that allow customers to purchase items on credit. Each company will often have a historical percentage that indicates how much cash it can expect to collect from sales. The remaining amount may be uncollectable, indicating the company will lose this amount of money.
Through the calculation of received cash from sales, companies can determine how much credit to extend to customers. For example, if a company has $100,000 US Dollars (USD) in sales and expects to collect $95,000 USD, the company cannot extend credit above $95,000 USD without experiencing cash flow problems. If the normal time to collect receivables is 30 days, the company must plan to have enough cash to last this amount of time without having to borrow money.
Estimating expenses is another advantage of the cash budget. Companies can write the amount of normal expenditures they experience each month to produce revenue. Then all ancillary cash outflows need recording in the budget. This allows the company to determine how much it spends on activities that do not add value to the firm. A reduction in expenditures or decreasing cash budget cap limits can help the company increase its gross profit.
Not all managers care cash-savvy in a business. In fact, very few managers may have a good understanding of accounting processes. Creating a cash budget allows owners and executive managers to involve all individuals within the firm and help them understand the importance of the cash budget.
Involving all managers in the budget process can help give each one a sense of purpose. Managers can then help the company reduce expenditures and refine the company's operations. This will help ensure the company does not become cash poor during its operational lifetime.