Cash Budget

A cash budget is an estimation of the cash inflows and outflows for a business over a specific period of time. This budget is used to assess whether the entity has sufficient cash to operate. Companies use sales and production forecasts to create a cash budget, along with assumptions about necessary spending and accounts receivable. If a company does not have enough liquidity to operate, it must raise more capital by issuing stock or by taking on debt.

A cash budget is necessary to assess whether a company has enough cash to operate. For 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 revenue 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, or 80% of $300,000. ABC also projects $100,000 in cash inflows from sales made earlier in the year.

ABC also must calculate the production costs required to produce the shoes and meet customer demand. The company expects 1,000 pairs of shoes to be in beginning inventory, which means 4,000 pairs must be produced in July. If the production cost is $50 per pair, ABC spends $200,000, or $50 x 4,000, on the cost of sales, which is the manufacturing cost. The company also expects to pay $60,000 in costs not directly related to production, such as insurance.

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 adjust the cash balances for all future months.

In the above example, ABC computes the cash inflows by adding the receivables collected during July to the beginning balance, which is $360,000, or the $20,000 beginning balance + $240,000 in June sales + $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, or $200,000 in cost of sales + $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.