The Cash Budget formation process

A cash flow budget is a plan. External events may influence the actual performance as compared to the forecasted results, but it is this cash flow budget that would help a business get back on track through the review process. The cash flow budget may be prepared manually or by using computer software packages (Microsoft Excel spreadsheet) which streamline the processes markedly.

There are eight steps involved in the preparation of a cash flow budget.

Step Factors to be considered
1. Estimation of cash receipts, including the GST over the period of the budget Sales should not be over-estimatedAre the sales conducted on a Cash-only basis, credit-only basis or both?

In case of a mixture, what proportion of sales are in cash?

Is the proportion constant every month, or is it likely to fluctuate due to seasonal factors, political factors, etc.?

What is the likely pattern of cash receipts from debtors in case of credit sales? What percentage of debtors is likely to honor their payments on the first month of credit? Second month of credit? Or third month of credit, and so on? All these assumptions are to be listed and entered in a separate working sheet for inputs in the cash budget sheet.

A firm may consider selling its surplus assets. This may add to its cash receipts

Has the firm completed negotiating for loans that are represented in the cash flow budget in the said period? The loan proceeds would exhibit another form of cash receipts

2. Estimate the cash payments All the expenses incurred in the conduction of operations in the business need to be noted and listed in alphabetical orderFor every expense that is incurred, how much is to be paid, when is the payment required and what is the value of the payment?

Cash payments are to be fed in the system according to the month the payment will be made, and not on the period in which the obligation is made

Payment for raw material can be determined as a fraction of sales that is forecast ed.

If a firm’s current stock level is higher than the ideal level, the purchase figure should be reduced by the amount they need to reduce the stock i.e., as they sell stock, it should not be replaced with new stock.

If the firm intends to increase its stock levels, the annual purchases should be increased in proportion to the increase in stock.

Consideration on how the firm plans to spend its purchases over the period of time

On the basis of payment terms negotiated with the suppliers, the firm needs to determine when the payment is to be obliged. The firm may wish to maintain a separate working sheet as input to the cash flow budget.

For items whose payments are made on weekly basis, firms should allow for months that have five pay days instead of four.

All personal drawings from the business should also be included.

Apart from the regular expenses, the firm should not overlook items such as tax payments or the purchase of capital assets or plant and equipments or loans.

Ideally, it is best to first work on the cash payments side of a cash flow budget- expenditures are often easy to assess and the timings are usually determined more accurately.

Adoption of this approach has its positive side in the morale department too- it helps build confidence, especially if it is the first time the person is preparing a cash flow budget.

3. inclusion of a flexibility level in the cash flow budget by the way of easy, built-in way buffers It is important to keep contingency funds in the budget- anything may go wrong at the worst possible instant.One way to prepare for these catastrophes is to think of ‘what if’ scenarios, like what is the impact on the cash flow budget, should:

–          Sales drop by_____

–          Cost shoot up by ____

–          Interest rate elevate by ____

–          Suppliers go late on deliveries _____

4. Calculate net cash deficit or cash surplus each month These results are obtained by deducting the total cash payment from the total cash receipts- in case of estimated total cash receipts surpassing total cash payments, a surplus arises and incase the total cash payments exceed the estimated total cash receipts, a deficit arises.
5. Add in cash deficit or cash on hand at the beginning of the next budget period This is determined by the firm’s bank balance at the start of the period for which the budgeting is made. If the balance is an overdraft, brackets should be used to represent a negative figure.
6. Calculation of a closing bank balance figure and subsequently for every month thereafter This can be obtained by adding the months’ net cash deficit or surplus to the preceding month’s bank balance.
7. Listing each assumption independently while preparing the cash flow budget This can be a great guide when comparing the firm’s actual performance as compared to the budget projection.It also helps sharpen a person’s budgeting skills- in the process of reviewing the budget, he can identify assumptions/predictions that may have been set too conversely, too conservatively or too aggressively. While preparing the next cash flow budget, such assumptions can be kept in mind.

Only after considering the assumptions intensely, can a person will be able to evaluate the validity of such financial projections.

8. Making decisions with respect to the investment of any short term cash surplus that may have been generated or any short term loans that may be required to continue in the planned operations of the business. Such management decisions represent the actual rationale for creating a cash flow budget.

If there is arises a need for short term borrowings, the individual needs to approach the bank on time and establish that he is regulating the firm pro-actively.

If the projection shows cash surpluses, the firm can shop around for the most competitive interest rates, in sync with the level of risk he is prepared to undertake.

Priya Chetty

Partner at Project Guru
Priya is a master in business administration with majors in marketing and finance. She is fluent with data modelling, time series analysis, various regression models, forecasting and interpretation of the data. She has assisted data scientists, corporates, scholars in the field of finance, banking, economics and marketing.

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