Explain how cash budget is prepared with example?

A cash budget is a financial tool that helps businesses plan and manage their cash flow. It outlines the expected cash inflows and outflows over a specific period of time, typically on a monthly basis. By creating a cash budget, businesses can anticipate potential cash shortages or surpluses and make informed decisions to ensure they have enough cash on hand to meet their financial obligations.

To prepare a cash budget, follow these steps:

1. Start by listing all sources of cash inflows, such as sales revenue, loans, investments, and any other sources of income.

2. Next, list all cash outflows, including expenses such as rent, utilities, payroll, inventory purchases, loan payments, and any other expenses.

3. Estimate the timing of these cash inflows and outflows. For example, sales revenue may come in at the end of the month, while rent and payroll may be due at the beginning of the month.

4. Calculate the net cash flow for each month by subtracting total cash outflows from total cash inflows.

5. Determine the beginning cash balance for each month, which is the ending cash balance from the previous month.

6. Add the net cash flow to the beginning cash balance to calculate the ending cash balance for each month.

7. Review the cash budget to identify any potential cash shortages or surpluses. If there are cash shortages, consider ways to increase cash inflows or decrease cash outflows. If there are cash surpluses, consider investing excess cash or using it to pay down debt.

Here is an example of a cash budget for a small business:

Month: January

Beginning Cash Balance: $10,000

Cash Inflows:
- Sales Revenue: $20,000
- Loan: $5,000

Total Cash Inflows: $25,000

Cash Outflows:
- Rent: $2,000
- Payroll: $8,000
- Utilities: $1,000
- Inventory Purchases: $7,000
- Loan Payment: $2,000

Total Cash Outflows: $20,000

Net Cash Flow: $5,000

Ending Cash Balance: $15,000

By preparing a cash budget like the one above, businesses can better manage their cash flow and make informed financial decisions to ensure their financial stability and success.

Steps to Prepare a Cash Budget:

1. Gather Data:

- Historical cash flow data
- Projected revenues and expenses
- Beginning and ending cash balances

2. Project Revenues:

- Estimate sales based on historical trends, market research, and customer orders.
- Consider seasonal variations and payment terms.

3. Project Expenses:

- Identify all categories of expenses (e.g., rent, salaries, utilities).
- Estimate amounts based on past spending, contracts, and growth projections.
- Consider seasonal variations and timing of payments.

4. Calculate Net Cash Inflow (Outflow):

- Subtract total expenses from total revenues to determine the net cash inflow or outflow for each period.

5. Adjust for Non-Cash Transactions:

- Depreciate fixed assets (add to cash), which is a non-cash expense.
- Adjust for any gains or losses on investments (subtract from cash).

6. Calculate Ending Cash Balance:

- Start with the beginning cash balance.
- Add net cash inflow or outflow from each period.
- Subtract any cash dividends or withdrawals.

7. Forecast Future Cash Needs:

- Identify any potential cash shortages or surpluses.
- Plan for additional financing or adjust spending if necessary.

Example:

Consider a business with the following data:

- Beginning cash balance: $50,000
- Projected revenues:
- Month 1: $100,000
- Month 2: $120,000
- Month 3: $90,000
- Projected expenses:
- Month 1: $60,000
- Month 2: $70,000
- Month 3: $50,000
- Depreciation: $5,000 per month

Cash Budget:

| Period | Revenues | Expenses | Net Cash Inflow/Outflow | Non-Cash Adjustments | Ending Cash Balance |
|---|---|---|---|---|---|
| Month 1 | $100,000 | $60,000 | $40,000 | $5,000 | $95,000 |
| Month 2 | $120,000 | $70,000 | $50,000 | $5,000 | $145,000 |
| Month 3 | $90,000 | $50,000 | $40,000 | $5,000 | $185,000 |

The cash budget shows that the business will have a positive cash flow in all three months, with ending cash balances increasing each month.