Why Is Cash Budgeting Important to the Organization?

The difference between a company that succeeds and one that fails is often cash management. Having too little cash means a business may have to pass on profitable ventures or take out loans to overcome liquidity issues. Too little cash may also mean a company may be unable to operate at normal levels or be forced to shut down completely. To avoid these issues, companies rely on a cash budget to plan and control cash receipts and payments.

Tip

Cash budgeting is vital to an organization because it allows them to ensure they have enough cash on hand to cover periods of increased expenses and unforeseen circumstances in the market.

The cash budget is management’s approximation of cash on hand at the beginning of a budget period and the estimated cash inflows and outflows. The cash inflows may include those that result from cash sales, the sale of assets, the collection of accounts receivable, borrowing cash or stock issuance. The cash outflows may include disbursements for material purchases, debt repayment, asset acquisition, taxes, manufacturing costs and dividends.

The cash budget highlights a company’s probable income or deficit for a period, the latter of which the company must address by increasing sales or decreasing expenditures. The advantages of a cash budget lies in its ability to identify a company’s future financing needs, highlight the need for corrective actions and evaluate a company’s performance.

One of the advantages of a cash budget is that a company can anticipate when a cash deficit might exist and the extent of that shortfall. In turn, the budget indicates when a difference between budgeted and actual values might need to be made up by borrowing. Short-term financing might be required to acquire inventory, promote products or pay monthly expenses.

By predicting cash requirements, a company can also evaluate future business opportunities in part based on an opportunity’s probable financing needs and costs. For instance, financing costs will influence the profitability of a merger and product development. This process allows a company to select only those organizational goals that are financially feasible.

A cash budget is a way to determine if a company has the cash necessary to meet upcoming obligations and to trigger corrective actions if a company experiences cash budget problems. For example, a company experiencing cash budget problems may need to borrow money in the short term for emergency equipment repairs, the payment of taxes or a monthly payroll.

The company may also need to borrow money in the long term for the introduction of a new product to the market or the replacement of equipment. Or the company might need respond to a sharp decline in market sales by adjusting spending or prices or negotiating more favorable terms with lenders.

A cash budget is used to illustrate a company’s financial position to internal and external stakeholders — individuals with an interest in the company — including investors, suppliers and company leadership. For example, increasing cash flow may indicate strong demand for the company’s products and opportunities for company expansion, which are positive signals to current and potential investors.

In contrast, if company expenses are significantly more than the company’s cash inflow, the investment risk is high and may deter additional investment in the company. Declining cash flow may also make it more difficult for a company to obtain additional vendor credit or pay its existing debt, which might force the company into bankruptcy.