This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
A practical question that must be answered before the budget can be prepared is whether it should be based upon income and expenditures or upon cash receipts and cash disbursements. Income and expenditure constitute the correct measure of profits and therefore should be used whenever the prime purpose of the budget is to control expenditure and to insure a satisfactory showing of profits during the ensuing year. Cash receipts and cash disbursements, on the other hand, measure the financial status and financial prospects of the business and should be used whenever the prime purpose is to make sure that the business will run on a basis that is financially sound.
The truth is that all successful plans for business should contemplate both prospective income and expenditure and prospective receipts and disbursements, and that emphasis as to which of the two is more important depends to a considerable extent upon the business. In all cases except those in which income and expenditure and receipts and disbursements are practically identical, there should be two separate budgets. The income and expenditure budget should be for the guidance of all the operating officials of the company; it should show in some detail the amounts that may be expended and the results that are expected in each department. This is the budget that serves the purpose of facilitating control.
The receipts and disbursements budget may be only for the private information and guidance of the treasurer, or of those who are responsible for the financial management of the company. It will indicate just where the actual cash receipts of each month are to come from and through what channels the cash is to flow out.
The budget of cash receipts and expenditures may itself be divided into two parts, the first part including only those transactions which have to do with current operations, and the second part including only capital transactions. By combining the two parts the financial management may look ahead and make certain that ample bank balances will be maintained; calculate to what extent they will be dependent upon bank and other loans; determine exactly how far they should go in taking advantage of cash discounts; and otherwise guide the financial course of the company with skill and accuracy.