A cash budget is essential for organizations to manage their cash flow effectively. It comprehensively estimates cash inflows and outflows over a specific period. By forecasting available cash, businesses can strategically plan expenditures, anticipate cash shortages, and mitigate risks related to overdrafts or emergency borrowing.

Consider a small manufacturing company that produces custom furniture. This company projects that over the next three months, it will receive $150,000 from customer payments. However, it anticipates expenses of $120,000 during the same period, including $60,000 for raw materials, $30,000 for employee salaries, $15,000 for rent, and $15,000 for utility bills and other overhead. While the overall cash flow seems positive, the timing of cash receipts and payments can present challenges.

For instance, if a significant portion of the customer payments is expected towards the end of the three-month period, but raw material costs and salaries are due earlier, the company might face cash shortages despite having sufficient projected income. By using a cash budget, the company identifies this potential gap and can plan accordingly by negotiating extended payment terms with suppliers or arranging short-term financing. This ensures the company can continue operations smoothly without financial disruptions.