## **Learning Outcomes**

After reading this article, you should be able to explain the role of cash budgeting in liquidity management, identify and construct cash budgets, describe key forecasting techniques, and evaluate how cash forecasts inform treasury decisions. You will understand the main tools available to manage liquidity, the importance of monitoring cash flows, and how to assess potential liquidity shortfalls in the context of ACCA Advanced Financial Management (AFM).

## **ACCA Advanced Financial Management (AFM) Syllabus**

For ACCA Advanced Financial Management (AFM), you are required to understand both the theoretical importance and practical application of cash and liquidity management. This article addresses the following key syllabus areas:

- The principles and techniques of cash budgeting for short-term liquidity planning
- Forecasting and monitoring cash flows and identifying cash surpluses or deficits
- The role of the treasury function in managing liquidity and short-term financing
- Methods to improve cash flow and control cash balances
- Evaluation of tools such as cash flow forecasts, rolling budgets, and scenario analysis

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Why is cash flow forecasting critical for treasury management?
2. List three key inputs required to build an accurate cash budget for a multinational company.
3. True or false? A rolling cash flow forecast always shows the same period as a fixed cash budget.
4. A company faces net cash outflows for the next three months. Name one short-term action it can take, and explain the possible risks.
5. Explain the difference between a cash surplus and liquidity.

## **Introduction**

Effective cash and liquidity management underpins corporate stability and supports strategic decision-making. Companies must ensure they have sufficient cash not only to meet obligations but also to respond swiftly to opportunities or disruptions. Cash flow forecasting helps identify potential shortages or surpluses so that appropriate financing or investment actions can be taken.

This article examines how to prepare cash budgets, the main forecasting techniques, and the essential role cash forecasts play in managing corporate liquidity.

> **Key Term: cash budget**
> A financial plan detailing expected cash inflows and outflows over a set period to project net cash requirements and facilitate liquidity management.

## **CASH BUDGETING AND ITS ROLE IN CASH MANAGEMENT**

A cash budget is a core forecasting tool for short-term financial control. By projecting receipts and payments, it highlights periods where cash may be insufficient or unexpectedly abundant.

### Structure of a Cash Budget

Most cash budgets cover weeks or months and are updated regularly. The process includes:

- Estimating cash collections (from sales, receivables, investments)
- Forecasting outflows (payments to suppliers, payroll, taxes, investments, debt service)
- Calculating opening and closing cash balances for each period

This provides visibility into periods of potential liquidity shortfall or surplus, enabling timely decisions.

> **Key Term: liquidity**
> The availability of sufficient liquid resources (usually cash or assets easily convertible to cash) to meet obligations as they fall due.

### **Worked Example 1.1**

**A company's treasurer prepares a three-month cash budget: expected receipts are \$60,000 in Month 1, \$70,000 in Month 2, \$90,000 in Month 3. Payments are \$80,000 each month. The opening cash balance is \$10,000. What are the closing balances?**

> **Answer:**
>
> - Month 1: \$10,000 + \$60,000 - \$80,000 = -\$10,000
> - Month 2: -\$10,000 + \$70,000 - \$80,000 = -\$20,000
> - Month 3: -\$20,000 + \$90,000 - \$80,000 = -\$10,000

### **Benefits of Cash Budgets**

- Advance warning of financing needs or idle balances
- Supports negotiation with banks and suppliers
- Assists in investment planning for surpluses
- Enables scenario analysis (“what if” testing on key assumptions)

## **FORECASTING TECHNIQUES FOR CASH FLOW**

Accurate cash budgeting depends on reliable forecasts. The main forecasting approaches include:

### 1. Receipts and Payments Method

Uses detailed schedules of all anticipated cash inflows and outflows, broken down by timing. This method is best suited for short-term forecasting (weeks to months) when cash timing is predictable.

### 2. Adjusted Profit Method

Starts with forecast profit and adjusts for non-cash items (e.g. depreciation), changes in receivables, payables and inventory. Particularly useful for longer-term planning but less precise for short-term liquidity.

### 3. Rolling Forecasts

A rolling (continuous) forecast is updated for a set future time horizon (e.g., always projecting the next three months, updated monthly). This gives a constantly refreshed view of future liquidity.

> **Key Term: rolling cash flow forecast**
> A forecast that continually extends by one period at each review, maintaining a constant forecast horizon to support ongoing liquidity planning.

### 4. Scenario and Sensitivity Analysis

Used to assess the impact of changes in assumptions (such as delayed customer payments or increased raw material costs). Essential for evaluating risk and planning contingencies.

### **Worked Example 1.2**

**A retailer expects monthly sales of £120,000, but historical analysis shows payments are delayed by one month for 40% of customers. What value should be included as receipts for Month 1 if 60% of customers pay immediately?**

> **Answer:**
> Month 1 receipts = 60% paid immediately: £120,000 × 60% = £72,000 (from current sales).
> No receipts yet from the remaining 40%, as these will come in Month 2.

## **USE OF CASH FORECASTS IN TREASURY DECISIONS**

Treasury teams use cash forecasts to:

- Identify funding needs and arrange overdrafts or credit lines if deficits are predicted
- Plan investment of temporary surpluses in low-risk instruments
- Manage liquidity buffers to meet unexpected demands
- Report to management on projected liquidity, supporting board-level decisions

> **Key Term: liquidity buffer**
> A reserve of cash or near-cash assets maintained to absorb unexpected cash flow fluctuations and protect against liquidity shortfalls.

## **MANAGING CASH SURPLUSES AND SHORTFALLS**

### Surplus Cash

When forecasts indicate large or recurring surpluses, the treasury should seek safe but profitable short-term investments (e.g., money market funds, short-term deposits) or consider early repayment of costly debt.

### Shortfall/Deficit

Deficits require proactive measures such as:

- Arranging short-term borrowing (overdraft, revolving credit)
- Negotiating delayed payments to suppliers (within reason)
- Tightening credit control to accelerate cash receipts

### **Worked Example 1.3**

**A business forecasts a cash deficit in the second quarter due to seasonal sales patterns. Suggest two actions and outline their possible risks.**

> **Answer:**
>
> - Arrange short-term bank borrowing (risk: interest expense, covenant risk if debt increases too high)
> - Seek to delay supplier payments (risk: supplier relations, possible supply disruption)

### **Revision Tip**

Develop the habit of updating cash forecasts frequently, using actual figures to replace estimates. This strengthens reliability and builds confidence in the budgeting process.

## **LIMITATIONS AND COMMON PITFALLS**

Cash budgets are only as reliable as their assumptions. Issues include:

- Over-optimism in sales or receipt timing
- Failing to account for non-routine payments (tax, bonuses)
- Ignoring currency effects in multinational operations

### **Exam Warning**

A common exam error is to confuse profit with cash flow. Always adjust profit-based forecasts for movements in working capital and exclude non-cash items.

## **Summary**

Cash budgeting and forecasting are critical to short-term financial management. Using structured forecasts, companies can proactively plan for liquidity needs, support operational continuity, and avoid cash crises. The choice of forecasting technique depends on the time horizon and the granularity of information available.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Explain the purpose and structure of a cash budget
- Identify and apply appropriate cash forecasting methods
- Use rolling forecasts for continuous liquidity management
- Evaluate and respond to predicted cash surpluses and deficits
- Recognise the limitations of cash budgeting and avoid common errors

## **Key Terms and Concepts**

- cash budget
- liquidity
- rolling cash flow forecast
- liquidity buffer

Cash and liquidity management - Cash budgeting and forecasting techniques