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Meeting cash obligations as they come due is not as simple as it may appear. Profitability and
liquidity do not necessarily go hand in hand. Some firms experience their most critical liquidity
problems when they go from a break-even position to profitability. At that time, growing receivables,
increased inventories, and growing capacity requirements may create cash shortages.
The cash budget is a very useful tool in cash management. Managers estimate all expected cash
flows for the budget period. The typical starting point is cash from operations, which is net income
adjusted for noncash items, such as depreciation, and required investment in net working capital
(accounts receivable and inventories, less accounts payable). All non-operating 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 non-operating items affecting the cash budget. The net income
figure for an accounting period usually is very different from the cash flow for the period because of
non-operating cash flow items or changes in working capital.
Often, cash budgets are prepared much more frequently than other budgets. For example, a
company may prepare quarterly budgets for all of its operating 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 having enough cash to meet
liquidity needs and not having so much cash 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 flows. The increased emphasis
by management in recent years on cash and the sources and uses of cash have 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 budget period and
the budgeted balance sheet at the end of the budget period.
The statement of cash flows consists of three sections: net cash flows from operations, net cash
flows from investing activities, and net cash flows from financing activities. Net cash flows from
operations are equal to net income plus depreciation expense and plus or minus changes in current
assets (other than cash) and current liabilities (other than bank loans). Increases (or decreases) in
current assets are treated as cash outflows (or inflows) and increases (or decreases) in current
liabilities are treated as cash inflows (or outflows).
Net cash flows from investing activities consist of changes in long-term assets. Since we do not
project any capital expenditures, net cash flows from investing activities are equal to zero in all
months.