The Cash Budget Concept

Many large companies have developed elaborate models for cash budgeting; others use a spreadsheet program to plan their cash needs. The procedures of smaller firms may be less formal. But there are common issues that all firms must face when they forecast.

The same differential basis of analysis must be followed by the banks while analysing the future needs and the repayment capabilities of their customers. In fact, the banks would be more comfortable in

assessing the creditworthiness oftheir clients if they too carry out the cash budgeting of their customers.

Most firms keep track of the average time it takes the customers to pay their bills. From this they can forecast what proportion of a quarters sales (or monthly or annual sales, depending on the banks requirements and the nature of business the company is into) is likely to be converted into cash in that quarter, and what proportion is likely to be carried over to the next quarter as accounts

receivable

So much for the incoming cash. There always seem to be many more uses for cash than there are sources. Companies generally use the cash flows for purposes such as payments of bills for raw materials, spare parts, electricity, wages, administrative and other expenses, capital expenditure, taxes, interest, and dividend payments.

The forecasted net inflow of cash (sources minus uses) indicates how much finance the firm will have to raise if its cash-flow forecasts are right.

Most financial managers regard a planned cash balance of zero as driving too close to the edge of the cliff. They establish a minimum operating cash balance to absorb unexpected cash inflows and outflows.

Also, banks usually require firms to absorb unexpected cash inflows and outflows. They usually ask firms to maintain a minimum average cash balance as partial compensation for services the bank provides to the firm.

Net operating cycles

The net operating cycles, as the name implies, relate to the manufacturing cycles of a product. Depending on the cycle, the raw materials would record a turnover a certain number of times in a year. And the need for working capital will be determined based on the turnover of raw materials during a year.