QUESTION
The research paper should include “Analyzes cash budget and how cash budget can help managers to control planning budget management and make decisions. Also, how can the statement are used to help to reduce the amount of cash that firms need to carry”.
SOLUTION
Cash Budget:
Cash Budget is an estimation of the cash inflows and outflows for a business or individual for a specific period of time (www.investopedia.com). It is prepared after preparing operating budget and capital expenditure budget. Cash budget starts with the available balance at the starting of the duration for the budget. Cash inflows are added to the balance and cash outflows are subtracted to calculate the cash balance at the end of the duration. These cash inflows and outflows also include the transactions under financing activities (debt repayment, interest repayment etc). From this cash budget, managers can decide what actions to follow in case of cash surplus or cash deficiency. Cash budget helps the firm in tackling liquidity issues.
Firms hold some of their assets in cash forms. They need cash to meet the liquidity for their day to day activities. Cash budget provides insight for the optimal level of cash required to carry these activities without taking high liquidity risk.
A cash budget generally has three sections; receipts, payments and summary of bank account. Receipts are used to display the estimated cash inflows from various activities such as cash sales, fixed assets sales, debtor realization, borrowing, capital induced or shares issued. Payments are used to demonstrate the estimated cash outflows from activities such as cash purchase, fixed assets purchase, creditors payment, debt repayment and interest repayment. Non-cash activities (depreciation etc) are not utilized in the preparation of cash budget. The summary of bank account is provided in the end of the cash budget.
The main difficulty in preparing cash budget arises due to timings of various receipts (cash inflows) and payments (cash outflows). As the cash budget deals only with cash objects, only the actual amount of money to be paid or received is used in preparation of cash budget.
Importance of Cash Budget for manager:
Cash budget is an important management tool for a manager in making financial decisions. It helps managers to take strategic financial decisions about borrowing and investing with minimum liquidity risk. Cash budget is also helpful in planning the budget management of the firm.
Control planning of budget management:
Budget management is utilized for the financial planning for the firm. Cash budgets can help in preparation of this financial plan. Cash budgets provide more detailed information than cash flow statement. For example cash collected from credit customers and cash collected from cash sales are put together in cash flow statement but they are put in separate entries in cash budget. Besides, cash budgets are prepared for higher frequency with smaller time duration (weekly, fortnightly, monthly). This way cash budget provides more timely information than cash flow statement. Generally the complexity level of a firm’s operation dictates the need of the details in cash budgets (www.wiki.answers.com). Cash budget help in planning of various financial decisions. Financial activities can be planned with the help of cash budgets to avoid excessive risk. Cash budgets are also utilized in rescheduling the debt payments to avoid borrowing and liquidity issues. In this way, cash budgets help in control planning of budget management.
Decision Making:
Cash budgets help managers in decision making about various financing activities. Some of these financial decisions are given below:
Plan Financing Activities: Cash budgets provide insights for the projected cash inflows and outflows, which in turn provide insight of the free cash flows. Free cash flows indicate whether a firm needs to borrow money or it needs to invest the additional cash. In this way cash budgets can help managers to make effective decisions about financing activities (such as investment decisions, retiring debt, increasing dividends, borrowing money).
Optimal Cash Level: Besides cash budgets are used in making strategic and tactical decisions. Cash budgets help the managers to decide an optimum level of cash to carry without taking excessive risks. This reduced level helps the firm to reduce the holding costs and transaction costs associated with cash.
Scheduling Debt Payment: Managers can decide on the schedule for the debt payment with the help of cash budget in such manner that firm is not under liquidity pressure or there is not any excess unutilized cash balance.
Budget Management: Cash budget helps controlling and planning of organizational budget. The details are provided in the above paragraph.
Importance of Cash Budget for the organization:
Cash budget is extremely important for the organizations, especially for smaller firms. It helps the organization to determine the extent of credit amount that can be extended to the customers or borrowing required to avoid the liquidity related issues.
Reduce the amount of cash needed to carry:
Firms need cash for various day to day operations. There is some degree of uncertainty associated with the future cash requirements of the firm. Firms need to carry a precautionary balance above the transactional needs to meet the uncertainty. Beside these, firm need to carry speculative balance for managing uncertain future opportunities. And finally, firm may also keep additional cash as compensating balance in exchange for the bank services. With this non interest earning or low interest earning compensating balance, firm compensates bank for the loans and other services provide by the bank. There are two types of costs involved with these various cash balances; holding costs and transaction costs. Holding costs of the cash arises from the opportunity cost that could have earned with the cash. Transaction costs arises when firm raises cash by liquidating some assets or by borrowing cash. Therefore firms want to minimize the amount of cash required to carry. Cash budgets can help firms in this because cash budgets provide a detailed consolidated picture of cash inflows and outflows of the firm. By predicting the transactions need and using cash budgets firm can decrease the precautionary balance. Cash budget will also indicate the timing for borrowing and investing which in turn maintain the cash on optimal level. Besides, firm can reschedule its payments to maintain lower cash balance. In this way, cash budgets can help a firm in reducing the amount of the cash needed to carry.
References:
Cox David and Fardon Michael. (2004). AS Accounting for AQA. UK: Osborne Books Ltd.
Fabozzi Frank J. and Peterson Pamela P. (2003). Financial Management and Analysis (2nd ed.). New Jersey: John Wiley & Sons.
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