After a company has prepared its operating budget, it will often draw up a separate cash budget as a means of tracking income and cash expenditures throughout the year. Such a budget has a number of practical uses, all of which center around being able to accurately predict when the company will be flush and when cash flow may be restricted.
Map Inflows and Outflows
The primary use of a cash budget is that it allows a company to map out expected inflows and outflows of cash during a specified period of time, usually a year. This map will take into account when the company expects to receive revenues and when it may need to spend those revenues on expenses not covered in the operating budget. This serves as a road map, giving the company a rough outline of how much cash it will need during the year.
Predict Cash Shortages
One advantage of cash budgeting is that this method can be used to accurately predict when the company will have less cash on hand than it might need to run the business. This gives the company the option to plan ahead and either shift cash inflows or obtain additional funds in advance. By predicting cash flow trends, the company can avoid having a midyear cash crunch.
Show Potential Surpluses
In addition to predicting cash shortages, cash budgeting is an excellent tool for predicting when a company will have more money than it would normally expect. By detecting surpluses, particularly long-term surpluses, the company can potentially target other uses for this money. Investing the money back into the business is generally more profitable in the long term than keeping large cash reserves.
If the company discovers in the course of preparing its cash budget that it will have a cash shortage that cannot be resolved by diverting funds from other sources, the company may choose to borrow money. By knowing how much cash it will have on hand, the company will be able to ascertain how much money it needs to borrow as well as when it will be able to repay the loan.