What is a cash budget and why essential?

• A. Inventory level projection; ensures stockouts avoidance.
• B. Forecast of cash inflows and outflows; ensures liquidity.
• C. Only estimates cash receipts from sales; ensures pricing.
• D. Forecast of all costs for the year; ensures accuracy.

Answer: (B)

A cash budget is a forecast of cash inflows and outflows over a period to manage liquidity. It focuses on when cash is expected to come in and when it will go out, rather than on profits or non-cash accounting measures. This helps ensure the business always has enough cash to meet obligations, plan short-term financing if needed, and decide what to do with any surplus.

Typically, a cash budget starts with the opening cash balance, adds expected receipts (like cash sales and collections from customers, or borrowing), lists planned payments (such as purchases, wages, taxes, loan repayments, and capital expenditures), and ends with a projected closing cash balance. By laying out timing, it highlights potential shortfalls or surpluses so management can arrange overdrafts, credit lines, or short-term investments in advance.

The correct choice captures this idea: a forecast of cash inflows and outflows to ensure liquidity. The other options focus on inventory levels, only cash receipts from sales, or yearly cost estimates, none of which address the timing and sufficiency of cash necessary to run the business.