Cash management takes a great deal of a business owner's time, but it's necessary. Keeping track of cash flow is essential for the survival of your small business. Sometimes, however, the terms used in describing cash management can be a little confusing. For example, accountants sometimes speak about the Statement of Cash Flows and the Cash Budget. What do they mean, exactly, and how are they different?
Cash Budget Basics
The cash budget is important because it helps the business owner manage the networking capital of the company. Business owners normally prepare a cash budget every month, although some business owners choose to prepare the cash budget quarterly. You can think of the cash budget as a short-term financial instrument; it's less formal than a comprehensive statement of cash flows and, therefore, easier and faster to prepare. It describes how much cash your firm is taking in and how much cash it is taking out. The cash budget document, therefore, tells you how much cash is available to the firm at the end of each month.
If the cash budget shows an increase in net working capital, you may use that increase to reduce operating costs - by repaying borrowed money, for example. If the cash budget shows a decrease in net working capital, you may need to find some way of increasing available cash - by drawing on a line of credit, taking out a bank loan or by factoring. Factoring, which is particularly common in the clothing industry, consists of selling your accounts receivable at a discount to a third-party. Because the factoring party takes over the ownership of the receivable from the business owner, therefore looking to your customers rather than to your company for payment, it's a good way of raising capital when your credit status may not support a loan.
Example of a Cash Budget
Here's what a simple cash budget document looks like:
Sources of Cash
|Accounts receivable collected||$12,000|
|Total Cash Available||$24,000|
Uses of Cash
|Sales and Administration||$3,000|
|Total Cash Used||$18,000|
In this example, the ending available cash ($24,000) exceeds the ending cash used ($18,000) by $6,000, which represents the net cash available and the beginning cash position for the following month.
Statement of Cash Flows
The Statement of Cash Flows is a more comprehensive statement prepared along with the Income Statement and Balance Sheet. Generally speaking, the Statement of Cash Flows is a more formal presentation of the credit and debit items presented in the cash budget. It looks at many of the same sources and uses of cash presented in the Cash Budget document over a longer period of time, normally at the end of the fiscal quarter and again a year's end.
Differences Between Cash Budgets and Statement of Cash Flows
One of the differences between the Cash Budget and the Statement of Cash Flows is that for public companies, the Statement of Cash Flows is part of the required financial statement that must be prepared and presented according to the standards of the FASB (the independent Financial Accounting Standards Board). Although not legally required, most accounting firms preparing financial statements for private companies adhere to the same FASB standards.
Another big difference between the short term Cash Budget and the longer-term Statement of Cash Flows is that the latter includes depreciation. Although the depreciation expense does not change a company's net cash position, the real value of a company necessarily accounts for the decline in value of most business assets over time.
In order to adequately manage a company, the small business owner must prepare both financial statements regularly and analyze them carefully.