190 Understanding the Numbers
The cash budget is a very useful tool in cash management. Managers esti-
mate all expected cash f lows for the budget period. The typical starting point
is cash from operations, which is net income adjusted for non-cash items, such
as depreciation, and required investment in net working capital (accounts re-
ceivable and inventories less accounts payable). All nonoperating cash items are
also included. Purchase of land and equipment, sales of bonds and common
stock, and the acquisition of treasury stock are a few examples of nonoperating
items affecting the cash budget. The net income figure for an accounting pe-
riod usually is very different from the cash f low for the period because of non-
operating cash f low items or changes in working capital.
Often, cash budgets are prepared much more frequently than other bud-
gets. For example, a company may prepare quarterly budgets for all of its oper-
ating budget components such as sales and production and also for its other
financial budget components such as capital expenditures. For its cash budget,
however, the firm prepares weekly budgets to ensure that it has cash available
to meet its obligations each week and that any excess cash is properly invested.
In companies with very critical cash problems, even daily cash budgets may
be necessary to meet management’s information requirements. The frequency
of cash budgets depends on management’s planning needs and the potential for
cash management problems.
Cash management is intended to optimize cash balances; this means hav-
ing enough cash to meet liquidity needs but not so much that profitability is
sacrificed. Excess cash should be invested in earning assets and should not be
allowed to lie idly in the cash account. Cash budgeting is useful in dealing with
both types of cash problems.
Budgeted Statement of Cash Flows—
Indirect Method (42–55)
The final element of the master budget package is the statement of cash f lows.
The increased emphasis by management in recent years on cash and the
sources and uses of cash has made this an ever more useful management tool.
This statement is usually prepared from data in the budgeted income statement
and changes between the estimated balance sheet at the beginning of the bud-
get period and that at the end of the budget period.
The statement of cash f lows consists of three sections, net cash f lows
from operations, net cash f lows from investing activities, and net cash f lows
from financing activities. Net cash f lows from operations are equal to net in-
come plus depreciation expense plus or minus changes in current assets (other
than cash) and current liabilities (other than bank loans). Increases (decreases)
in current assets are treated as cash outf lows (inf lows), and increases (de-
creases) in current liabilities are treated as cash inf lows (outf lows).
Net cash f lows from investing activities consist of changes in long-term
assets. Since we do not project any capital expenditures, net cash f lows from
investing activities are equal to zero in all months.