The primary purpose of the cash budget is to forecast income. true false
The correct answer and explanation is:
Correct Answer: False
The primary purpose of a cash budget is not to forecast income but to project cash inflows and outflows over a specific period. It helps ensure that a business or individual has enough liquidity to meet short-term obligations and avoid cash shortages or surpluses.
A cash budget focuses strictly on cash transactions, not on income as recorded under accrual accounting. For example, a company may record sales revenue on its income statement even if the customer hasn’t paid yet. However, those unpaid amounts (accounts receivable) do not count as cash until they are actually received. A cash budget only includes cash that is physically received and cash that is actually paid out.
The core components of a cash budget include:
- Beginning cash balance
- Expected cash receipts (from sales, loans, asset sales, etc.)
- Expected cash payments (operating expenses, debt repayments, purchases, etc.)
- Ending cash balance
The cash budget enables managers to:
- Plan for times when cash may be tight
- Arrange for short-term financing if needed
- Avoid unnecessary borrowing during cash-rich periods
- Identify opportunities to invest surplus funds
It also plays a critical role in decision-making. For example, if a business sees that it will have excess cash in one month, it may choose to purchase more inventory, invest in equipment, or pay down debt early. Conversely, if a shortfall is anticipated, the company may delay certain expenditures or arrange for a line of credit.
In summary, the cash budget is a vital short-term financial planning tool. It is focused entirely on cash management, not on forecasting income or profit. Therefore, saying that the main purpose of a cash budget is to forecast income is incorrect.