The purpose of the cash budget is to provide a forecast of cash inflows and cash outflows during the year. This is very helpful in predicting months that you may need to draw on other sources of cash like a line of credit. Knowing your cash needs in advance will help you plan for the amount and timing of cash draws. It can also help you identify opportunities to adjust the timing of discretionary purchases, prioritize the purchase of fixed assets and other cash commitments.

The difference between a cash budget and an operational budget is that while the operational budget is concerned with planning Sales at the time they are earned and Costs and Expenses at the time they are owed, the cash budget shows Sales at the time it is collected and Costs and Expenses at the time they are paid. Another difference is that the cash budget is concerned with the cash flow needed to purchase fixed assets, pay the principle on loans and pay owners their draws.

Let’s start with Cash Budgeting the Sales. There are two basic ways to budget cash collected from sales.

  • What you are actually budgeting is the collection of your Accounts Receivable in each period the budget is presented. This can be budgeted by analyzing past collections and projecting into the future amounts you believe will be collected. This is not the preferred method.
  • The other method is to start by reviewing Sales projected in preparing your Operational Budget. Using your business’ payment terms, you would ‘lag’ the projected Sales. For example, if your payment terms are net 30, Sales projected for January would be collected in February. This is the preferred method because it recognizes that Accounts Receivable collections occur only after Sales have preceded them.

Costs and Expenses are budgeted much the same way. Just like the Cash Budget for Sales is really the collection of Accounts Receivable, the Cash Budget of Costs and Expenses is really the payment of Accounts Payable. You have already invested time in preparing the Operational Budget, so let’s use it to project your cash payments.

Costs and Expenses in the Operational budget differ from the Cash Budget because your suppliers and creditors have extended to you payment terms. Use those payment terms to ‘lag’ your Costs and Expenses. So if you incur a Cost in January and your payment terms are net 45, you really would not be paying that bill until mid February to early March.

After you have prepared the Cash Budget for your Income Statement, you are not quite finished. You next must review the balance sheet to determine which items you will be using cash for. One of those items is Fixed Assets. Fixed Assets are usually a significant drain on business resources, so they must be planned. The schedule used to planning the purchase of your Fixed Assets is used to project cash paid for your Cash Budget. (See Fixed Asset Budget).

Another common item is debt service on your notes payable. The income statement records interest expense, but it doesn’t address the repayment of the principle. Those principle payments must be scheduled on your Cash Budget.

Partner draws must also be scheduled. After having prepared the Cash Budget to this point, it is instructive in scheduling Partner draws.  You will easily be able to determine the best times of year to schedule the draws because your cash availability has pretty much been planned through this Cash Budgeting process.

Finally, there may be other items that are unusual that require thought to plan. Payments to the retirement plan or property tax are usually paid once a year, so their timing is different than the presentation on the financial statements.

Fixed Asset Budget

As noted in the Cash Flow Budget discussion, fixed assets such as major equipment, buildings, building improvements or leasehold improvements can be a major drain on cash. They often need to be planned in order to determine whether it is practical to purchase them at all, and if so if incurring debt is necessary to complete the purchase.

The need for Fixed Assets is usually determined in planning operations and determining how best to serve customers or produce the products that are anticipated to be in demand. In any case, the purchase of Fixed Assets and the related financing, if necessary must be researched and scheduled in conjunction with the Cash Flow Budgeting process.

Fixed Assets warrant special consideration due to the significant drain on your business resources.

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