Cash budgets may also cause distortions. Cash inflows do not equate to profit. Cash inflows resulting from security deposits, fines, the sale of capital assets, or any other one-off, non-sustainable activity do not necessarily represent reliable ongoing sources of revenue. On the other hand, reduced cash flow need not always be a cause for concern. At times, selling items with long credit periods might result in a much larger profit in the long run and will more than cover the interest associated with securing short-term loans to meet immediate obligations. Managerial judgment is necessary to interpret the results.
Cash budgets are susceptible to manipulation. For instance, making a huge payout a day or two before the end of period, instead of a day or two after the start of the next period, may be misleading. It restricts cash flow for one period and inflates cash flow for the other period. Even if company operations are experiencing a loss, postponing payouts might show a positive cash flow. Similarly, making payments early might result in negative cash flows, even when operations remain profitable.
A bigger disadvantage is the reliance on estimates. Cash budgets use cash flow one year to allocate cash for the next year, when there is no guarantee that cash flow levels, or revenue and expenditure levels, will remain the same. Moreover, with cash budgets, management commits funds for various projects and expenditures and there is little opportunity to reallocate the funds based on changed circumstances, unless management decides to revise the budget as a whole.
At times, non-financial factors have a major impact in decisions. For instance, a product might not generate much cash flow, or generate negative cash flow. People, however, might have a favorable association with the product, and equate the product with the company, providing intangible value. Making decisions based solely on a cash budget would leave this product as a prime candidate for the chopping block. Similarly, one bank may charge a slightly higher rate of interest, but also offer better customer service than a bank that charges low interest. With a cash budget, only the low interest rate counts.
The advantages of cash budgeting make them an indispensible financial tool. Use and prepare them properly to experience the benefits, but understand the possibilities for distortion and other limitations too.