Cash Budget | Cash Budgeting

06/04/2011 14:36


Cash Budget | Cash Budgeting:

Learning Objectives:

  1. Define and explain a cash budget.
  2. What is the purpose of a cash budget
  3. How to prepare a cash budget.

Definition and Explanation:

Cash budget is a detailed plan showing how cash resources will be acquired and used over some specific time period.

Cash budget is composed of four major sections.

  1. The receipts section.

  2. The disbursements section

  3. The cash excess or deficiency section

  4. The financing section

The cash receipts section consists of a listing of all of the cash inflows, except for financing, expected during the budgeting period. Generally, the major source of receipts will be from sales. The disbursement section consists of all cash payment that are planned for the budgeted period. These payments will include raw materials purchases, direct labor payments, manufacturing overhead costs, and so on as contained in their respective budgets. In addition, other cash disbursements such as equipment purchase, dividends, and other cash withdrawals by owners are listed.

The cash excess or deficiency section is computed as follows:

Cash balance beginning
Add receipts

Total cash available
Less disbursements

Excess (deficiency) of cash available over disbursements


If there is a cash deficiency during any period, the company will need to borrow funds. If there is cash excess during any budgeted period, funds borrowed in previous periods can be repaid or the excess funds can be invested.

The financing section deals the borrowings and repayments projected to take place during the budget period. It also include interest payments that will be due on money borrowed. Generally speaking, the cash budget should be broken down into time periods that are as short as feasible. Considerable fluctuations in cash balances may be hidden by looking at a longer time period. While a monthly cash budget is most common, many firms budget cash on a weekly or even daily basis.

Example of Cash Budget:

(See explanation of this budget)

Hampton Freeze Inc.
Cash Budget
For the Year Ended December 31, 2009



  Other budget ref. 1 2 3 4 Year
Cash balance, beginning   $42,500 $40,000 $40,000 40,500 42,500
Add receipts:
Collections from customers See sales budget 230,000 480,000 740,000 520,000 1,970,000
    ------------ ------------ ------------ ------------ ------------
Total cash available   272,500 520,000 780,000 560,500 2,012,500
    ------------ ------------ ------------ ------------ ------------
Less disbursements:            
Direct materials material budget 49,500 72,300 100,050 79,350 301,200
Direct labor Labor budget 84,000 192,000 216,000 114,000 606,000
Manufacturing overhead Overhead budget 68,000 96,800 103,200 76,000 344,000
Selling and Administrative sell. & adm. budget 93,000 130,900 184,750 129,150 537,800
Equipment purchases   50,000 40,000 20,000 20,000 130,000
Dividends   8,000 8,000 8,000 8,000 32,000
    ------------ ------------ ------------ ------------ ------------
Total disbursements   352,500 540,000 632,000 426,500 1,951,000
    ------------ ------------ ------------ ------------ ------------
Excess/deficiency of cash available over disbursements   (80,000) (20,000) 148,000 134,000 61,500
Borrowings (at beginning)*   120,000 60,000 - - 180,000
Payments (at beginning)   - - (100,000) (80,000) (180,000)
Interest**   - - (7,500) (65,00) (14,000)
    ------------ ------------ ------------ ------------ ------------
Total financing   1200,000 (60,000) (107,500) (86,500) (14,000)
    ------------ ------------ ------------ ------------ ------------
Cash balance, ending   $40,000 $40,000 $40,500 $47,500 $47,500
    ====== ====== ====== ====== ======

The company requires a minimum cash balance of $40,000. Therefore, borrowing must be sufficient to cover the cash deficiencies of $80,000 in quarter 1 and to provide for the minimum cash balance of $40,000. All borrowings and repayments of principal are in round $1,000 amount.

**The interest payment relate only to the the principle being repaid at the time it is repaid. For example, the interest in quarter 3 relates only to the interest due on the $100,000 principle being repaid from quarter 1 borrowing:

$100,000 × 10% per year × 3/4 year = $7,500

The interest paid in quarter 4 is computed as follows:

$20,000 × 10% per year × 1 year $2,000
$60,000 × 10% per year × 3/4 year 4,500
Total interest paid $6,500

Explanation of cash budget for Hampton Freeze Inc.

Cash budget builds on the other budgets ( sales budget, material budget, Labor budgetOverhead budget, sell. & adm. budget) and on some additional data that are provided below:

  • The beginning cash balance is $42,500

  • Management plans to spend $130,000 during the year on equipment purchases: $50,000 in the first quarter; $40,000 in the second quarter; $20,000 in the third quarter; $20,000 in the fourth quarter.

  • The board of directors has approved cash dividends of $8,000 per quarter.

  • Management would like to have a cash balance of at least $40,000 at the beginning of each quarter for contingencies.

  • Assume Hampton Freeze will be able to get agreement from a bank for an open line of credit. This would enable the company to borrow at an interest rate of 10% per year. All borrowings and repayments would be in round $1,000 amount. All borrowings would occur at the beginning of the quarters and all repayments are made and only on the amount of principal that is repaid.

The cash budget is prepared one quarter at a time, starting with the first quarter. Management began the cash budget by entering the beginning balance of cash for the first quarter of $42,500--a number that is given above. Receipts--in this case, just the $230,000 in cash collection from customers--are added to the beginning balance to arrive at the total cash available of $272,500. Since the total disbursements are $352,500 and the total cash available is only $272,500, there is short fall of $80,000. Since management would like to have a beginning cash balance of at lease $40,000 for the second quarter, the company would need to borrow $120,000.

Required borrowing at the end of the first quarter

Desired ending cash balance $40,000
Plus deficiency of cash available over disbursements 80,000
Required borrowings $120,000

The second quarter of cash budget is handled similarly. Note that the ending cash balance of the first quarter is brought forward as the beginning cash balance for the second quarter. Also note that additional borrowing is required in the second quarter because of the continued cash shortfall.

Required borrowing at the end of the second quarter

Desired ending cash balance $40,000
Plus deficiency of cash available over disbursements 20,000
Required borrowings $60,000

In third quarter, the cash flow situation improves dramatically and the excess of cash available over disbursement is $148,000. This makes it possible for the company to repay part of its loan from the bank, which now totals $180,000. How much can be repaid? The total amount of the principle and interest that can be repaid is determined as follows:

Total maximum feasible loan payments at the end of the third quarter

Excess of cash available over disbursement $148,000
Less desired ending cash balance 40,000
Maximum feasible principle and interest payment $108,000

The next step--figuring out the exact amount of loan payment--is tricky since interest must be paid on the principle amount that is repaid. In this example, the principle amount that is repaid must be less than $108,000, so we know that we would be paying of part of the loan that was taken out at the beginning of the first quarter. Since the repayment would be made at the end of the third quarter, interest would have accrued for three quarters. So the interest owed would be 3/4 of 10% or 7.5%. Either a trial and error or an algebraic approach will lead to the conclusion that the maximum principle repayment that can be made is $100,000. The interest payment would be 7.5% of this amount, or $7,500--making the total payment $107,500.

In the fourth quarter, all of the loan and accumulated interest are paid off. If all loans are not repaid at the end of the year and budgeted financial statements are prepared, then interest must be accrued on the unpaid loans. This interest will not appear on the cash budget (since it has not yet been paid), but it will appear as interest expense on the budgeted income statement and as a liability on the budgeted balance sheet.

As with the production budget and raw materials budget, the amounts under the year column in the cash budget are not always the sum of the amounts for the four quarters. In particular, the beginning cash balance for the year is the same as the beginning cash balance for the first quarter and the ending cash balance for the year is the same as the ending cash balance for the fourth quarter.

Burlington Northern Fe (BNSF) operates the second largest railroad in the United States. The company's senior vice president, CFO, and treasure is Tom Hunt, who reports that "as a general theme, we have become very cash-flow oriented." After the manager of the Burlington Northern and Santa Fe railroads, the company went through a number of years in which they were investing heavily and consequently had negative cash flow. To keep on top of the company's cash position, Hunt has a cash forecast prepared every month. "Everything falls like dominoes from free cash flows," Hunt says. "It provides us with alternatives." Right now, the alternative of choice is buying back our own stock...[b]ut it could be increasing dividends or making acquisitions. All those things are not even on the radar screen if you don't have free cash flow."

Source: Randy Myers, "Cash Crop: The 2000 working capital survey," CFO, August 2000, pp. 59-82.