How are an operating budget and a cash budget linked?

An operating budget and a cash budget are two related financial planning tools that help organizations manage their finances effectively. They are linked because the operating budget provides the foundation for the cash budget.

1. Operating Budget: An operating budget outlines the planned revenues and expenses of a company over a specific period, usually a year. It includes various components such as sales forecasts, production costs, overhead expenses, and income projections. This budget helps organizations plan their financial activities and assess their financial performance.

2. Cash Budget: A cash budget, on the other hand, focuses on tracking and forecasting the inflows and outflows of cash for a specific period. It helps organizations understand how much cash they will have on hand at any given time and plan their cash flow accordingly.

The link between the operating budget and cash budget lies in the timing of cash inflows and outflows. While the operating budget provides information on expected revenues and expenses, it does not specify when the cash will be received or paid. This is important because cash flows may not always correspond strictly with the timing of operating activities.

To establish this link between the two budgets, you need to consider factors that affect cash flow, such as credit terms, inventory and accounts payable turnover, and other working capital management practices. By incorporating these factors into the cash budget, you can align the projected cash inflows and outflows with the timing of the operating activities outlined in the operating budget.

For example, if the operating budget projects a sale in January, but the cash from that sale is not expected to be received until February due to credit terms, the cash budget will reflect this delay. This ensures that the cash budget accurately reflects the organization's actual cash position, rather than just the projected operating performance.

In summary, an operating budget serves as the basis for the cash budget by providing information on expected revenues and expenses, while the cash budget focuses on the timing of cash inflows and outflows. By aligning the two budgets, organizations can better manage their financial resources and make informed decisions about cash flow management.