The cash budget is a fundamental tool for the financial management of a company and, even more so, for that of a startup. Entrepreneur David Worrell explained it better than anyone else with this simple sentence:
“For a startup, a cash budget is like fuel for a spaceship: without it, you would be stuck on dry land.”
Don’t risk getting stuck, too: in this guide you’ll find the best tips for making the most of this very useful tool for business accounting management.
Cash budget: what it is and why it is so important
The first essential step is to clarify exactly what we are talking about: a cash budget refers to a statement that makes it possible to calculate cash flows in the short term and, therefore, to know in advance the company’s movements in terms of liquidity. The latter is the ability of a business to convert revenue into cash.
Many startups and small and medium-sized businesses struggle with calculating cash budgets because this operation requires knowledge of a multitude of data, and in the tight timeframe that characterizes these particular companies, retrieving this information may be too complicated.
You should know, however, that calculating a cash budget is important for a number of reasons: first, you need to consider that the business world today is increasingly uncertain and volatile, and this tool allows you to anticipate (and avoid) cash flow problems. With a cash budget and more efficient cash flow management, you can also better plan investments.
Calculating the cash budget becomes essential, in particular, in some specific cases: it is, for example, when the value of cash is close to zero (or to the overdraft limit granted), when the cash flow of the sources and uses budget is negative, or when there are orders that concentrate high shares of turnover and their payments could slip. Not only that, the cash budget is also an essential tool when it is necessary to carry out extraordinary operations or there are particularly important investment plans.
Differences between cash and treasury budgets
As much as, often, the terms “cash” and “treasury” are used synonymously when talking about business management, and as much as the cash budget and treasury budget are two business financial planning tools, there are differences.
The cash budget calculation results in an estimate of cash flows over a given period and, in practical terms, is a statement that is prepared at the end of the year and looks at the following 12 months. It is intended to ensure that the company always has sufficient cash to cover immediate expenses.
The treasury budget, on the other hand, is a tool that monitors cash flows and other components of a company’s liquid assets continuously throughout the year, usually over a period of 60 to 90 days. As a result, the treasury budget, which has a broader focus and is intended to optimize corporate financial management and minimize risk, is more accurate than the cash budget.
Difference between budget and cash flow
We have referred several times to the concepts of cash budget and cash flow, and so it is important to make a further clarification. The latter indicates the changes (either positive or negative) in a company’s liquidity that occur over a given period of time, usually a year. The cash budget, on the other hand, is the financial planning tool concerned with cash flow management.
How to calculate the cash budget
There are various methods for calculating the cash budget, and among them, the most widely used is certainly the so-called “direct” method, which starts with estimating income and expenses.
Estimation of income and expenditure
To calculate a cash budget you must first identify cash receipts. These can be, for example, receipts related to sales or investments, but also those from other sources, such as debt collection or loans or financing.
After identifying income, you need to estimate cash outlays: this category includes payments to suppliers, operating expenses, capital expenditures, and interest and principal payments on loans.
Cash balance analysis
Once you have identified revenues and estimated expenditures, proceed to calculate the beginning and ending cash balance. The beginning cash balance is the amount of money the company has at the beginning of the budget period. To proceed with the calculation of the ending cash balance, you must add the projected cash receipts at the time of the beginning cash balance and subtract the projected cash outlays.
Pay attention because cash balance analysis provides you with very valuable information: if the balance, in fact, is negative, it means that your startup may need new sources of investment.
Cash budget: example
A more practical example can be used to better explain how the cash budget calculation works.
If your startup plans to make new investments next year, in order to check its financial coverage, you need to compile a cash budget, paying special attention to a number of incoming and outgoing factors, such as, for example: average monthly receipts (which may decrease in some months), supplier payments (which may drop some months), spending related to monthly salary payments (which doubles in December with the 13th month), spending allocated to advertising, extra expenses for an event or new machinery etc.
In the month-by-month calculation, it will turn out that in some months the cash value will be positive, while in others it may be 0 or negative. This is certainly a problem, but having made this calculation in good time will enable you to take the necessary steps in advance to avoid cash flow crises at certain times of the year.
Strategies for effective cash management
It is time to understand, in more concrete terms, what strategies the cash budget allows you to adopt.
Liquidity management and risk control
As mentioned earlier, the cash budget allows you to identify in advance any periods of the year when you will have a shortage (but also a surplus) of cash. In case of a deficit you can, for example, request a deferment of payments or take out a new loan (otherwise, that is, if you anticipate a cash surplus, you could instead plan new investments or pay off any debts in advance).
The cash budget, therefore, allows you to better control and manage what is known as financial risk: if you do not have a clear view of future cash flow, you may find yourself in financial difficulty, but the preparation of this prospectus allows you, as already pointed out, to identify in good time and manage any potential risks, such as increased costs or decreased sales.
Financial planning and investment
The cash budget is a key financial planning tool because it allows you to assess the impact on your company’s liquidity of some potential strategic decision, such as an investment or company expansion. Through it, in more practical terms, you can understand whether you have the financial capacity to support that strategic decision or whether you need additional sources of funding.
Software and tools for cash budgeting
In the opening of this guide we highlighted the fact that small and medium-sized businesses and startups often find it difficult to succeed in calculating their cash budget. You should know, in this regard, that in order to save time and effort, it is possible to use several new technological tools, such as business financial management software, which can automate many of the steps required to complete the calculation and analysis of the cash budget.
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