Cash Budget:

The principal aim of the cash budget, as a tool of planning, is to ascertain whether, at
any time, there is likely to be an excess or shortage of cash. The preparation of cash budget involves
various steps.
The first element of a cash budget is the selection of the period of time to be covered by
the budget. Alternatively, it is referred to as the “planning horizon”. The planning horizon means the
time span and the sub-periods within that time of span over which the cash flows are to be projected.
There is no fast and hard rule. The period coverage of a cash budget will differ from firm to firm
depending upon its nature and the degree of accuracy with which the estimates can be made. As a
general rule the period selected should be neither too long nor too short. If it is too long, it is likely that
the estimates will be upset as we cannot visualise them at the time of the preparationof the Budget. If
on the other hand, the time span is too small, the disadvantage are:
i Failure to take into account important events which lie just beyond the period covered by the
budget;
ii Heavey workedload in preparation;
iii Abnormal factors that may be operative.

The planning horizon of a cash budget should be determined in the light of the circumstances
And requirements of a particular case. For instance if the flows are expencted to be stable and
dependable, such a firm may prepare a cash budget covering a long period, say, a year and
uncertain, a quarterly budget divided into monthly intervals may be sub-divided into weekly or
even daily budgets may be necessary. If the flows are subject to extreme fluctuations, a daily
budget may be called for. The idea behind sub-dividing the budget period into smaller intervals is
to highlight the movement of cash from one sub-period to another. The sub-division will provide
information on the fluctuations in the cash reservoir level during the time span covered by the
budget.
The second element of the cash budget is the selection of factors that have a bearing on cash
flows. The items included in the cash budget are the cash items only, non-cash items such as
depreciation are excluded. The factors that generates cash flow are generally divided, for purpose
of constrcting a cash budget, into two broad ctegories:
(a) Operating and
(b) Financial

This two-fold classification of cash budget items is based on their “nature”. While the
former category includes cash flows generated by the operations of the firms and are known as
“operating cash flows”, the letter consist of “financial cash flows”. The major components of the two
types of cash flows are outlined below.

The most important budget which is prepared under this functional area is the cash budget. It is
an estimate of the expected cash receipts and cash payments during the budget period. Thus by
preparing the cash budget, it is possible to predict whether at any point of time, there is likely to be
excess or shortage of cash. If the shortage of cash is estimated, it may be required to arrange the cash
is estimated, it may be required to arrange the cash from some other source. If the excess of cash is
estimated, it may be possible to explore the investment opportunities. Before preparing the cash
budget, following principles should be kept in mind.

i) The period for which cash budget is prepared should be selected very carefully. There is no
fixed rule as to the period to be covered by the cash budget. It may vary from company to
company depending upon the individual requirements. As a general rule, the period covered
by the cash budget should niether be too long or too short. If it is too long, it is possible that
the estimate will not be accurate. If it is too short, the factors which are beyond the control of
management will not be given due consideration.
 ii) The items which should appear in the cash budget, should be carefully decided. Naturally, all
those items which do not involve cash flow will not be considered while preparing the cash
budget. Eg. As the cost of depreciation does not involve any cash outflow, it does not affect
the cash budget, though the amount of depreciation affects the determination of tax liability
which involves cash outflow.

A cash budget may be prepared in any of the following three methods,

1. Receipts and Payments method:

This method is useful for short temi estimations. It lists the
various estimated sources of cash receipts on one hand and the various estimated applications of
cash on the other.

While preparing the cash budget by this method, the various items appearing on
the same may be classified under the following two categories:
i) Operating Cash Flows:
These are items of cash flows which arise as a result of regular
operations of the business.

ii) Non-operating Cash Flows:

These are items of cash flows which arise as a result of
regular operations of the business.

The standard items which may appear on the cash budget prepared by this method
may be stated as below:

Operating :
Cash sales
Collection form debtors
Interest / Dividend received
Non-operating
Issue of shares / debentures
Receipts of loans and borrowings
Sales of fixed Assets
Sales of Investments

Cash Outflow

Operating :
Payment to creditors
Cah purchase of raw materials
wages / salaries
Various of kinds of overheads
(To the extent they are actully paid)
Non-operating
Redumption of shares / debentures
Loan installments
Purchase of fixed assets
Interest
Taxes
Dividends.
 Thus finally cash budget appears in the form of opening cash balance, to which various
estimated cash receipts are added, the estimated cash payment being deducted from this sum to arrive
at the closing cash balance.

2. Balance Sheet Method:

This method is usefull for long term estimates. According to this
method, the budgeted Balance Sheet is prepared for the following budget period, after considering
the various terms viz. Capital , Long Term Liabilities , Current Liabilities , Fixed Assets , Current
Assets , But Except Cash. After bothe the sides of Balance sheet are balanced, the balancing figure
indicates the estimated cash balance in the hand at the end of that period. This method does not
consider the expenses and assumes the reular pattern of inflow and outflow of cash. Further, it
indicates the cash requirement only at the end of budger period, any excess or shortage of cash
during the budget period are not considered.

Adjusted Profits/ Losses Method :

This method also is useful for long term estimates. According
to this method, the cash budget is prepared in the following way to show the estimated cash balance
at the end of the budget period.

Opening Cash Balance

Add : Profit before depreciation, provision and other non – cash expenses
Add : Decrease in Current assets or Increase in Current Liabilities
Add : Capital Receipts
Add : Receipts of Loans / Borrowings
Less : Capital Expenditure
Less : Repayment of Loan Installments
Less : Payment of dividends / taxes

In the other words, cash budget prepared as per this method is in the form of cash flow
statement.