Forecasting Cash Inflows and Outflows
The first step in cash budgeting is to forecast the earnings from sales and cash inflows from other sources such as fixed asset sales. For retail businesses where many sales are made in cash the pattern of cash flow will match earnings closely. For other businesses that make mainly credit sales the position is more uncertain because the cash flow depends on the success of collecting the debts. Accurate cash flow prediction, therefore, depends on forecasting both sales volume and the average period required for debt collection.
Other types of cash inflow include dividends and interest in addition to cash from the sale of investments. Income is also earned from the sale of fixed assets or from rent received from letting or subletting of office or factory space. Cash inflows may also arise from the issue of bonds or shares.
Cash outflows relate to the direct costs of labor and materials and general overhead expenses. Other outflows could arise from payments of interest, tax or dividends. There may also be planned investments in fixed assets. When a new capital project is started, it is likely that there will be separate cash flow projections done for the feasibility study on the project and these can be incorporated into the main cash budget. Most of the expenses are likely to be on credit terms and the actual cash outflow will occur some time after the expense is incurred. This may allow the enterprise some latitude to adjust the outflow of cash, depending on the terms negotiated with creditors and the interest charged by the suppliers and other creditors. For some types of expenditures the cash amounts will be payable in advance and this must be taken into account when preparing the cash budget. Any loan repayments that arise also need to be considered.
When the total cash inflows and outflows for the period have been computed, and the cash balance at the beginning of the period is taken into account, the cash budget arrives at the cash balance at the end of the period. This may be compared to the level of cash reserve required by the enterprise and any shortfall can be quantified. The cash level must be enough to deal with payments as they arise and to also cover minor emergencies that may occur in the course of business activities.
When the forecast cash level is not sufficient, it may lead to a course of action aimed at improving the cash flow in the period in question. If the enterprise is holding investments that can be readily turned into cash, the sale of some investments must be planned in advance. The need for financing at various times needs to be assessed and the enterprise must decide on the term for which financing would be required. Interest arising and loan repayments resulting from the additional financing would then need to be included in the cash budget for future periods.