The primary reason that managers impose a minimum cash balance in the cash budget is

When you first begin to manage your cash flow, a budget can be your best friend, but what exactly is a cash budget, and how is one prepared? In this guide, we’ll talk you through all the basics, discussing why you need a cash budget, and we’ll lay out the steps you should take to prepare your first, thorough cash budget. 

What is a cash budget?

In its simplest form, a cash budget is a plan for expected cash receipts and disbursements during a given period. A budget should include all cash inflows and outflows, from revenues collected and expenses incurred to loan receipts and payments. 

Businesses will develop cash budgets after making sales, purchases, and expenses, using this information to create balance sheets and accurately assess the amount of cash that comes and goes during a set budget period. 

RELATED: How to Accurately Forecast Sales for Your Business

What is the purpose of the cash budget?

The primary purpose of a cash budget is to provide businesses with the status of their cash position so they can determine cash shortages or whether there is an excess of cash. Cash budgets detail all ingoings and outgoings for the specified period, whether that’s weekly, monthly, quarterly or annually. 

How a cash budget is prepared

When preparing a budget, you first need to define three key criteria: the period of time you wish to cover, estimated sales and expenses, and a desired cash position. This will help you outline the budget scope and get a greater understanding of your estimated cash balance over the budget period you’re looking at. 

Once you have gathered all the necessary information you need, you can begin to put together a basic outline of your budget. All cash budgets feature the same four main items. These are: 

• Opening balance: This is the amount of money available in the account at the beginning of the week, month, or quarter (depending on the length of time you want the budget to cover). This is the same amount as the closing balance of the previous period budgeted for. 

• Receipts: This is a list of the money coming into the business during the budget period. Receipts will account for any and all revenue, including rent revenue or income from cash or credit sales. 

• Payments: This is the cash flow out of the business and includes operating overheads, like rent and utilities, staff salaries, and other business expenses. 

• Closing balance: This is the amount of cash left at the end of the period after all payments have been made and all receipts have been collected. It will also be the opening balance of the next period in your budget.

Some smaller businesses creating their first budgets may want to take a shorter-term look at their finances for a cash budget, working on a monthly or quarterly basis. This kind of short-term financing can help to identify where they may need to cut back on expenses or focus on increasing revenue. 

For example, if a small, locally run business has an opening balance of £2000 in the month, they have receipts of £1300, but payments totaling £1500, they end the month on £1800. As their closing balance is less than their opening balance, they are running at a deficit and should seek to increase receipts and lower their payments, in an effort to create a profit. 

For start-ups, it’s equally important to prepare a cash budget to accompany a business plan, especially if additional funding is required from a third party. The cash budget and business plan will show potential investors how the business intends to operate when it begins trading and in the months that follow. This gives an insight into how much money they are likely to spend and make in that period, allowing investors to determine whether it would be a good investment or not. 

RELATED: How To Write A Bulletproof Business Plan 

In larger businesses, cash budgets are usually set for the long term, and finance teams, including possibly an accounts receivable department, typically handle preparation. These departments will regularly take stock of cash receipts, cash outflow, cash balances, and cash sales to accurately track the company’s financial status, ensuring it’s in line with the projected cash budget. 

The importance of cash budget in managerial decision making

The main purpose of preparing a cash budget is to allow management teams to conduct accurate cash flow forecasting, identifying times where there may be a shortage of cash in the business and when extra funds may be needed, such as overdraft agreements or loans. 

When forecasting cash disbursements in the cash budget, it’s important to identify where expenses may need to be regulated. This could include the cost of raw materials from suppliers, staff salaries, or other direct expenses like advertising and marketing. 

For a more in-depth look at how cash budgets work, there are free-to-use accounting cash budget examples, finance plans, and budgeting cash receipts formulas online for small businesses to follow when creating their first cash budget. 

Now that you’ve learned everything you need to know about how to prepare a cash budget, check out our guide to sales pipelines and discover how you can build one. 

Rovva can help you succeed in
the virtual world

Why do we need minimum cash balance?

What is minimum cash balance in cash budget?

What is the primary purpose of a cash budget?

Why do managers prepare a cash budget?