Question

why is it important for a firm (and individuals) to prepare a cash budget?

How can firms deal with a cash shortage

how should they deal with a cash surplus

Answer 1

A cash budget helps the managers of a company as it states all the cash inflows and cash outflows. It helps in determining amount of credit that a company can extend without any affect on it's liquidity position. The cash budget, provides the picture of cash flows in a company at a given point of time. It also helps in preventing cash shortage, when the expenses are at all time high in a company.

A company can face a cash shortage by speeding up on the receivables collection ,converting some of it's assets into cash, cutting it's expenses, renegotiating terms with suppliers, better managing of the inventory levels in the company.

When a company has a cash surplus, it may need to do nothing at all. It can distribute dividends, invest in stocks, bonds. The company can make pension contributions into the retirement account of it's employees.