What is Cash Budget and its Purpose,Objectives and Need

What is Cash Budget and its Purpose,Objectives and Need : The net cash position of a firm as it moves from one budgeting sub period to another is highlighted by the cash budget. Cash budget is a statement showing the estimated cash inflows and cash outflows over the planning horizon.

The various purpose of cash budget are:

  • To coordinate the timing of cash need.
  • It pinpoints the period when there is likely to be excess cash.
  • It enables the firm which has sufficient cash to take the advantage of cash discount on its account payable to pay the obligations when due to formulate the dividend policy.
  • It help to arrange needed funds so that the most favourable terms and prevents the accumulation of excess funds.

The principle aim of cash budget as a tool to predict cash flows over a given period of time is to ascertain whether at any point of time there is likely to be an excess or shortage of cash.

The preparation of cash budgets involves various steps and is called the element of cash budgeting system. The first element is selection of period of time to be covered by the entire budget. It is referred to as the planning horizon which mean the time span and the sub period within that time span and the sub period within that time span over which the cash flows are to be protected.

The second element of cash budget is the selection of the factors that have a bearing on cash flows. The items included in the cash budget are only cash items. The factors that generate cash flows are generally divided for the purposes of preparing cash budget into two broad categories: (a) operating (b) financial.

While the former category includes cash flows generated by the operations of the firms and are known as operating cash flows.

Cash Budget And Cash Flows Statement

Cash budget is a statement showing the estimated cash inflows and cash outflows over the planning horizon. In other words, The net cash position of a firm as it moves from one budgeting sub period to another is highlighted by the cash budget.
Cash Flow Statement generally prepared annually, which shows the sources and the uses of cash during that period. It measures the changes in the financial position on each basis.

Cash Budget Objectives

  • To coordinate the timing of cash need.
  • It pinpoints the period when there is likely to be excess cash.
  • It enables the firm which has sufficient cash to take the advantage of cash discount on its account payable to pay the obligations when due to formulate the dividend policy.
  • It help to arrange needed funds so that the most favourable terms and prevents the accumulation of excess funds.

Cash Flow Statement Objectives

  • Cash Flow Statement is useful for the management to assess its ability to meet the obligation to trade creditors and to pay bank loan to pay interest to debenture holders and dividend to its shareholders.
  • Cash Flow Statement can also be prepared month wise which is useful in presenting the information of excess cash in some months and shortage of cash in other months.

Need For Preparing A Cash Budget

The principle aim of preparing a cash budget, as a tool to predict cash flows over a period of time is to ascertain whether at any point of time there is likely to be an express or shortage of cash.

The preparation of cash budget involved various steps. They may be described as the elements of the cash budgeting system.

Cost of Capital
The cost of capital is the rate of return the company has to pay to various suppliers of funds in the company. There are variations in the costs of capital due to the fact that different kinds of investment carry different levels risk which is compensated for by different levels of return on the investment.

Opportunity Cost of Capital
When an organization faces shortage of capital and it has to invest capital in more than one project, then the company will meet the problem by rationing the capital to projects whose returns are estimated to be more. The firm might decide to estimate the opportunity cost of capital in other projects.

Financial Leverage
This ratio indicates the effects on earnings by rise of fixed cost funds. It refers to the use of debt in the capital structure. Financial leverage arises when a firm deploys debt funds with fixed charge.

Operating Leverage
Operating leverage is concerned with the operation of any firm. The cost structure of any firm gives rise to operating leverage because of the existence of fixed nature of costs. This leverage relates to the sales and profit variations. Sometimes a small fluctuation in sales would have a great impact on profitability. This is because of the existence of fixed cost elements in the cost structure of a product.

Combined Leverage
The operating leverage has its effects on operating risk and is measured by the
percentage change in EBIT due to percentage change in sales. The financial
leverage has its effects on financial risk and is measured by the percentage change in EPS due to percentage change in EBIT. Since both these leverages are closely concerned with ascertaining the ability to cover fixed charges, if they are combined, the result is total leverage and the risk associated with combined leverage is known as total risk.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.