A cash budget is a projection of how your business will earn and spend money during an upcoming period. Preparing a cash budget is important because the process forces you to think about your expectations and plan for the future. It is important to follow your cash budget--unless unforeseen circumstances arise--because adherence to a plan can discipline your spending.
The process of creating a cash budget is important in and of itself because it forces you to ask important questions that can guide you as you plan future business activities. As you prepare your cash budget, you must determine how much it will cost you to run your company during the period it covers, how much you expect your business to take in, and how you will make up for any shortfall. Developing answers to these questions helps you to stay a step ahead of potential difficulties.
It is essential to make assumptions when creating your cash budget, but it is also important to be aware of the assumptions you are making, and adjust them as you go along, if necessary. When creating a cash budget you must project the availability of working capital, which depends on sales volume as well as outside funding. You must also project your upcoming expenses, which include fixed expenses such as rent and business licenses, variable expenses such as utilities and materials, and occasional, often unanticipated expenses such as equipment repairs.
Your cash budget is a tool to gauge your ability to meet expectations and live up to predictions. But it is virtually inevitable that your day-to-day financial activities will not precisely conform to your cash budget simply because it is impossible to predict the future. The process of comparing your actual income and expenses with the numbers that you project in your cash budget provide you with a fertile opportunity to evaluate your expectations and take a close look at your assumptions.
As you compare your actual business activities with the predictions you made in your cash budget, you glean information that will be useful in preparing future cash budgets and planning future business activities. For example, it is natural to assume that your business will grow as a result of making investments such as upgrading the appearance of your product or expanding to new markets. But it is impossible to know exactly what kind of effect these changes will actually have on your sales volume. Comparing your cash budget with your actual business activities provides you with information about the impact of this kind of change that will help with future planning.