how a cash budget works
companies use sales and production forecasts to create a cash budget along with assumptions about necessary spending and accounts receivable collections a cash budget is necessary to assess whether a company will have enough cash to continue operations if a company does not have enough liquidity to operate it must raise more capital by issuing stock or taking on more debt a cash roll forward computes the cash inflows and outflows for a month and it uses the ending balance as the beginning balance for the following month this process allows the company to forecast cash needs throughout the year and changes to the roll forward to adjust the cash balances for all future months short term cash budget vs long term cash budgetcash budgets are usually viewed in either the short term or the long term short term cash budgets focus on the cash requirements needed for the next week or months whereas long term cash budget focuses on cash needs for the next year to several years short term cash budgets will look at items such as utility bills rent payroll payments to suppliers other operating expenses and investments long term cash budgets focus on quarterly and annual tax payments capital expenditure projects and long term investments long term cash budgets usually require more strategic planning and detailed analysis as they require cash to be tied up for a longer period of time it s also prudent to budget cash requirements for any emergencies or unexpected needs for cash that may arise particularly if the business is new and all aspects of operations are not fully realized at the end of each budgetary term the ending balance of the cash budget is carried forward to the next term s cash budget special considerationsmanaging a cash budget also comes down to carefully managing the growth of the business for example all businesses want to sell more and grow but it is crucial to do so in a sustainable way for example a company may implement a marketing strategy to boost brand awareness and sell more products the ad campaign is successful and demand for the product takes off if the company isn t prepared to meet this increase in demand for example it may not have enough machinery to produce more goods enough employees to conduct quality checks or enough suppliers to order the required raw materials then it could have many unhappy customers the company may want to build out all these aspects to meet demand but if it doesn t have enough cash or financing to be able to do so then it cannot therefore it is important to manage sales and expenses to reach an optimal level of cash flow example of a cash budgetfor example let s assume abc clothing manufactures shoes and it estimates 300 000 in sales for the months of june july and august at a retail price of 60 per pair the company estimates sales of 5 000 pairs of shoes each month abc forecasts that 80 of the cash from these sales will be collected in the month following the sale and the other 20 will be collected two months after the sale the beginning cash balance for july is forecast to be 20 000 and the cash budget assumes 80 of the june sales will be collected in july which equals 240 000 80 of 300 000 abc also projects 100 000 in cash inflows from sales made earlier in the year on the expense side abc must also calculate the production costs required to produce the shoes and meet customer demand the company expects 1 000 pairs of shoes to be in the beginning inventory which means a minimum of 4 000 pairs must be produced in july if the production cost is 50 per pair abc spends 200 000 50 x 4 000 in the month of july on the cost of goods sold which is the manufacturing cost the company also expects to pay 60 000 in costs not directly related to production such as insurance abc computes the cash inflows by adding the receivables collected during july to the beginning balance which is 360 000 20 000 july beginning balance 240 000 in june sales collected in july 100 000 in cash inflows from earlier sales the company then subtracts the cash needed to pay for production and other expenses that total is 260 000 200 000 in cost of goods sold 60 000 in other costs abc s july ending cash balance is 100 000 or 360 000 in cash inflows minus 260 000 in cash outflows 