The cash budget provides an analysis of expected cash receipts, cash expenses, savings and investments and thus assists one in achieving the different financial goals in a timely manner.
A budget is a plan for expected incomes and expenses during a defined time in the future. The cash budget provides an analysis of expected cash receipts, cash expenses, savings, and investments and thus can assist one in achieving the different financial goals in a timely manner. One should prepare a cash budget keeping in view the lifestyle needs, family structure, and personal values. It can be prepared on a monthly, quarterly or even on an annual basis.
As the life goals of an individual advance over time, the cash budget also commensurately changes. This is because as one moves through various stages in the life cycle, the financial position of an individual becomes more complex. The number of income and expenditure items increases due to an increase in assets and liabilities and also due to an increase in the family size and one’s roles and responsibilities. Thus a periodic review and revision of the cash budget are required on a continuous basis.
Let us now look at the steps in preparing a cash budget and how the same is useful in personal financial planning. There are essentially three steps in preparation of a cash budget i.e. preparing an estimate of income, the estimate of expenses and finally ascertaining the net cash position. any anticipated changes in the cost of living should also be taken into account while preparing the budget along with the changes expected in the level of income.
Estimation of income.
The cash budget starts with preparing a realistic estimate of income from different sources such as salary, rental income, interest income, etc. Care should be taken to ensure that an item for which repayment has to be made, should not be taken as an income in the cash budget. For instance, a loan received, which will have to be repaid, is not a receipt of income and hence should not be included in the sources of income. Likewise, in the case of salary income, the take-home amount should be considered in the preparation of the cash budget and not the gross amount which is subject to certain deductions.
Estimation of expenses.
Preparing an estimate of expenses during the forthcoming period may call for a more thorough analysis of the current situation and future aspirations. It becomes easy to estimate the future expenses if one is habitual of maintaining a proper past record of bills, credit card payments, and bank account statements. Expenses can be appropriately estimated by analyzing the expenditures periodically incurred and then following the past trend to forecast the future.
Finalizing the cash budget.
After preparing a thorough estimate of income and expenses, the next step is to compare the two. Doing so helps one to identify the expected deficit or surplus. The deficit would arise where expenses are expected to exceed the income generation potential. One then can either focus upon reducing expenses to the extent possible or plan for the arrangement of funds to meet the shortfall. In case there is a surplus, it provides the individual an opportunity to initiate new investments and realize life goals through proper financial planning.
It is usually seen that the expenses are not exactly and uniformly matched up with income throughout the year. In some months of the year, there is a heavy expenditure planned while in other months the expenditure is at a significantly lower level. One can adopt different strategies to deal with such mismatched situations. To reduce the deficit in months of heavy expenditures, one may transfer some expenses (if possible) to months where cash surplus is significantly available. The deficit can alternatively be covered through savings and investment income or by borrowings. The loans and borrowings can then be repaid in months where the surplus is sufficiently available.
Preparing a cash budget is an essential prerequisite for proper financial planning. It helps one monitor his/her finances, allocate a part of income towards investment, instill discipline in spending and attain different life goals.
Will it be hard? Yes. Will it be worth it? Absolutely !