Prepare a cash budget and explain the difference between profit and cash flow.

Building a cash budget from expected receipts and payments, distinguishing profit from cash flow, and using forecasts to manage liquidity and plan.

Generated by Claude Opus 4.77 min answerUpdated 2026-05-29

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What this dot point is asking

Budgeting is planning expressed in financial terms. A cash budget (cash flow forecast) is one of the most useful planning tools because it warns a business when it may run short of cash, giving time to arrange finance, delay payments or chase debtors.

Profit is not cash

The income statement is prepared on the accrual basis: revenue is recorded when earned and expenses when incurred. The cash budget is prepared on the cash basis: only actual money in and out is counted, in the period it moves. The two differ for several reasons:

Credit sales increase profit now but cash arrives later when debtors pay.
Credit purchases and accrued expenses reduce profit now but cash leaves later.
Buying a non-current asset is a large cash outflow but only a small depreciation expense each year.
Loans, capital contributions and drawings move cash but are not revenue or expenses.
Depreciation is an expense that reduces profit but involves no cash payment.

Structure of a cash budget

A cash budget is usually set out month by month with three sections:

\text{Closing Cash} = \text{Opening Cash} + \text{Total Receipts} - \text{Total Payments}

Receipts include cash sales, collections from debtors, capital contributions and loans received. Payments include cash purchases, payments to creditors, wages, rent, asset purchases, loan repayments and drawings. The closing balance of one month becomes the opening balance of the next.

example Two-month cash budget

Scenario

Brae Trading expects: opening cash $5,000 in July. Cash sales$ 12,000 in July and $14,000 in August. Debtors will pay$ 8,000 in July and $9,000 in August. Payments are: creditors$ 10,000 each month, wages $6,000 each month, and a new machine for$ 7,000 paid in August.

July

Receipts = $12{,}000 + 8{,}000 = \$ 20{,}000$.
Payments = $10{,}000 + 6{,}000 = \$ 16{,}000$.
Closing cash = $5{,}000 + 20{,}000 - 16{,}000 = \$ 9{,}000$.

August

Opening cash = $9{,}000$ .
Receipts = $14{,}000 + 9{,}000 = \$ 23{,}000$.
Payments = $10{,}000 + 6{,}000 + 7{,}000 = \$ 23{,}000$.
Closing cash = $9{,}000 + 23{,}000 - 23{,}000 = \$ 9{,}000$.

Interpretation

Cash holds steady at $9,000. The machine purchase in August used the entire month's surplus, so the business has no buffer. Brae Trading might delay the purchase, arrange a short-term overdraft, or speed up debtor collections to build a safety margin.

Using budgets

Budgets also let a business compare actual results to plan (variance analysis), set targets and coordinate departments. A favourable variance means actual cash was better than budgeted; an unfavourable variance prompts investigation and corrective action.