How to Construct a Cash Budget
What is a Cash Budget?
A cash budget is an internal report that lists the cash receipts and cash payments for future period of time.
They are used by management to determine the cash flow of the business and determine whether there is sufficient cash in the bank to support future expenditure decisions. A low cash balance may indicate a business may need to cut spending or seek alternative funding sources to stay afloat.
Structure of a Simple Cash Budget
The structure of a cash budget is relatively simple. There are two main ways of constructing a cash budget, the first method (left) is the one we will use in the worked example. It's constructed by obtaining the cash balance at the beginning of the period, adding cash receipts and taking cash payments to obtain the cash balance at the end of the period.
The second method (right) works by listing the cash receipts and cash payments to obtain the cash surplus/deficit, and showing the cash beginning and end balances at the bottom.
Worked Example: Simple Cash Budget
Prepare a Cash Budget for Gregson Traders for the Month Ending 31st August 2020. For the month of August,
Gregson has the following expected transactions:
Cash sales of $25,000 and Credit Sales of $45,000. Credit sales are received in the month following the sale. July Credit sales was $30,000.
Inventory purchases are paid in the month following the sale. Purchases for July was $20,000 and August is expected to be $30,000.
General and Admin Expenses of $10,000, Wages to be paid of $5,000 and Insurance of $2,000 to be paid.
The business is expected to purchase new plant and equipment costing $15,000, with 10% depreciation using the Straight Line Method.
The cash balance at the start of the month (1/8/2020) is $5,000
Step 1: List the Beginning Cash Balance and Cash Receipts
The first step is to list the beginning cash balance, which from the question is $5,000. Afterwards, we list the respective cash receipts for the period. There are two seperate entries for the cash receipts, the first, cash sales and the second collections from credit sales. The cash sales is $25,000 which we can include instantly as cash sales are collected when the payment is made.
The second is credit sales - the question specifies that credit sales are collected in the month following the sale. Therefore, we must ignore the August credit sales and focus on the credit sales from the previous month, July. We can assume from the question, that all the credit sales of July, $30,000, will be collected in the Month of August. After we have listed both cash receipts, we can conclude that the beginning balance + the cash receipts is $60,000.
Step 2: List the Payments and Closing Balance
After we have listed the cash receipts, it's time to list the cash payments. From the question, we can conclude that purchases are paid in the month after purchase. Therefore, we can assume that the purchases in July, $20,000, are paid for in the month of August. Afterwards, we can list the other expenses in each separate line, of General and Admin ($10,000), Wages ($5,000) and Insurance ($2,000).
Hint: If it does not state when the expense will be paid, assume it will be paid in the month the expense is incurred. We must also include the cost of payment for the Plant and Equipment as the cash budget is recording all expected future cash inflows and cash outflows.
Therefore, we include the cost of Plant and Equipment, $15,000, however, we do not include the cost of depreciation as this is a non-cash item. Afterwards, we calculate the total cash payments and deduct it from the total cash receipts + cash balance to obtain the closing cash balance.
Step 3: Overview
Putting it all together, to construct a cash budget, it is simply the cash balance at the start of the period, add the cash receipts, less the cash payments, resulting in the cash balance at the end of the period.