Introduction to Corporate Finance

PART 5: SPECIAL TOPICS

A cash budget is a statement of the company’s planned inflows and outflows of cash. Companies use

the cash budget to ensure they will have enough cash available to meet short-term financial obligations.

Any surplus cash resources can be invested quickly and efficiently. Typically, the cash budget spans a one-

year period, with more frequent breakdowns provided as components of the budget. The CFO of Finish

Line Pty Ltd, a specialty retailer, once described his company to us as a ‘cash and inventory business’.

What he meant was that running a successful retail enterprise requires close attention to managing

cash flows and inventory. A company like Finish Line needs to know its exact cash position at the end

of every business day. For other companies, monitoring cash positions on a weekly or monthly basis

may be sufficient. Besides the volume of cash transactions, other factors that determine the frequency

with which companies construct cash budgets include the volatility of prices and sales volume, and the

importance of seasonal fluctuations.

Running out of cash is an ever-present threat at small and medium-size companies. Vulnerable

companies include those that are growing rapidly and those that are in distress. Even in large corporations,

though, astonishing changes in cash reserves can occur over just a few years. For example, in September

2007, General Motors reported cash and marketable security holdings of $30 billion, but over the

following six quarters the company’s cash reserves fell to $11.6 billion. Although $11.6 billion may seem

like plenty of cash, GM reported a net cash outflow of $10.2 billion in just the first quarter of 2009! By

the first quarter of 2015, GM had grown cash reserves to $ 17.2 billion, reporting a net cash outflow of

$3.2 billion. With the possibility of such dramatic swings in cash holdings, even large companies must

monitor their cash positions closely.

As is the case with pro forma financial statements, the key input required to build a cash budget

is the company’s sales forecast. On the basis of this forecast, the financial manager estimates the

monthly cash inflows from cash sales, receivable collections and other sources. Naturally, a complete

cash budget also contains estimates of cash outflows; some of these vary directly with sales and some

do not. Cash outlays include purchases of raw materials, labour and other production expenses,

selling expenses and investments in fixed assets. A cash budget usually presents projected inflows

(cash receipts) first. Next come the projected outflows (cash disbursements). Finally, the cash budget

shows whether the company expects a net cash inflow or outflow for the period. Depending on

the company’s cash balance at the start of the period, the cash budget will either reveal a need for

additional financing or demonstrate that the company will have surplus cash to invest in short-term

marketable securities.

Cash receipts

Cash receipts include all the company’s cash inflows in a given period. The most common components

of cash receipts are cash sales, collections of accounts receivable and other cash receipts. The

company estimates collections of accounts receivable using the past payment patterns of its

customers.^6

6 We discuss payment patterns more fully in the online Chapter 18.

cash receipts

All of a company’s cash

inflows in a given period

Beth Acton, Vice President

and Treasurer of Ford

Motor Co. (former)

‘Because there is a

long cycle of developing

product from concept to

customer, it is critical

that we understand what

the business implications

are for the business

planning period.’

See the entire interview on

the CourseMate website.

COURSEMATE
SMART VIDEO

Source: Cengage Learning

cash budget

A statement of a company’s

planned inflows and outflows

of cash