Chapter 2:Cash Budget

Cash Budget

Definition Detailed forecast of cash inflows and outflows for a future time period, incorporating revenue and capital items and other cash flow items.

PurposeProvide an early warning of liquidity problems and funding needs.

OBJECTIVES

To provide early warning of liquidity problem. So, that we can:

1. Estimate and plan future cash shortage or surplus.

2. As reference point to monitoring cash flows.

3. Set borrowing limits and min cost of funds.4. Max interest earnings5. Liquidity management

CORRECTIVE ACTION• Sales of short term investment• Short term borrowing• Defer some cash spending such as capital

expenditure• Improve collections of outstanding debts• Ask major suppliers to agree on more credit terms• Improve cash flows by cutting day-to-day

expenditure

TYPES OF CASH BUDGET

There are two types of cash budget:

1. Receipts and payments budget

2. Balance sheet forecast

BALANCE SHEET FORECAST

Forecast future balance sheet at the specific forecast date.What may require:

1. Of non-current assets (acquisition & disposal)

2. Future inventory 3. Future receivables Level4. Future payables5. in shared capital and long term funding6. in retained profit

BALANCE SHEET FORECAST

Apple Co. has the following balance sheet as at 30 May 2012:

Non Current Assets RM RMPlant and Machinery 192,000

Current assetsInventory 16,000Receivables 80,000Bank 2,000 98,000Total assets 290,000

Issured share capital 216,000Accumulated profits 34,000

250,000

Shareholders fundsCurrent liabilities Dividend payable 10,000 Trade Payable 30,000 40,000Total Equity and liabilities 290,000

The company expects to acquire further plant and machinery costing RM 8,000 during the year to 30 June 2012.

a. The levels of inventory and trade receivables are expected to increase by 5% and 10% respectively by 30 June 2012 due to business growth.

b. Trade payables and dividend liabilities are expected to be the same at 30 June 2012.

c. No share issue is planned, and accumulated profits for the year to 30 June 2012 are expected to be RM 42,000.

d. Plant and Machinery is depreciated on a reducing balance basis at the rate of 20% per annum for all assets held at balance sheet date.

Produce balance sheet forecast as at 30 June 2012 and predict what the cash balance or bank overdraft will be at that date.

Let’s Calculate:

CASH BUDGET IN RECEIPTS AND PAYMENTS FORMAT1. Forecast timing and amount of cash receipts and

payments.2. Can divided into shorter time period quarter,

monthly, weeks or days.3. Budget shows:a. Opening balanceb. Expected cash receipts and paymentc. Net cash flow*d. Closing balance

Example of Cash Budget Format

January February March AprilCash receipts RM RM RM RMCash from receivables 54,000 63,000 58,000 54,000Cash Sales 3,000 4,000 2,000 1,000Cash sales for non current assets - 1,000 - 500Total receipts 57,000 68,000 60,000 55,500

Cash PaymentsPayments to suppliers 24,000 29,000 24,000 27,000Payments of wages and salaries 26,000 28,000 26,000 28,000Payment for non current assets 4,000 14,000 - 3,000PurchasesPayment of dividend - 5,000 - -Total payments 54,000 76,000 50,000 58,000

Net cash flow 3,000 -8,000 10,000 -2,500Opening cash balance 6,000 9,000 1,000 11,000Closing cash balance 9,000 1,000 11,000 8,500

Cash Budget for (period)

PREPARING A CASH BUDGET

It is based on receipts and payments. The most complex calculations is receipts from sales and payments to suppliers.

RECEIPTS FROM SALES

Business might have some cash sales, but mostly on credit. To prepare cash budget, assumptions:• When customers will pay• The level of bad (irrecoverable) debts

ExampleEstimated 10% of its sales will be cash sales, and the remainder credit sales. Also 50% of credit customers will pay in the month following sale, 30% two months after sale, 15% three months after sale and bad debts will be 5% of credit sales.

Total sales figures are as follows:Month RMOctober 80,000November 60,000December 40,000January 50,000February 60,000March 90,000

Required:

Prepare a month by month budget of cash receipts from sales for the months January to March.

SolutionCash receipts

Cash receipts

Cash receipts

Sales month Total sales January February March

RM RM RM

October 80,000 10,800 - -

November 60,000 16,200 8,100 -

December 40,000 18,000 10,800 5,400

January 50,000 5,000 22,500 13,500

February 60,000 - 6,000 27,000

March 90,000 - - 9,000

Total Receipts

50,000 47,400 54,900

Let’s calculate Activity One

Page 23 together.

PAYMENTS TO SUPPLIERS FOR WAGES AND SALARIES Similar way of calculating to the cash receipts, need to figures for:

• Purchases in each time period.• Estimates amount of credit taken from suppliers.

Three types of payment is:

1. Payment for material purchases2. Payment of wages and salaries3. Payments for overheads expenses

EXAMPLE: PAYMENTS FOR MATERIAL PURCHASESA manufacturing business makes and sell widgets. Each widgets requires two units of raw materials, which cost RM 3 each. Production and sales quantities of widgets each month are as follows:

In the past, the business has maintained its inventory of raw material at 100,000 units. However, it plans to increase raw material inventory to 110,000 units at the end of January and 120,000 units at the end of February. The business takes one month’s credit from it’s suppliers.

Required:Calculate the budgeted payments to suppliers each month for raw material purchases.

Month Sales and production

Units

December (actual) 50,000

January (budget) 55,000

February (budget) 60,000

March (budget) 65,000

SolutionUnit

Produced

December

January February March

Units Units Units Units

December 50,000 100,000

January 55,000 110,000

February 60,000 120,000

March 65,000 130,000

Increase in inventory

- 10,000 10,000 -

Total purchase quantities

100,000 120,000 390,000 130,000

Purchase cost

300,000 360,000 390,000 130,000

So budget payments to suppliers:

January February March

RM RM RM

Payments to suppliers

300,000 360,000 390,000

Example of Overhead PaymentsA manufacturing company makes product APPLE, for which the variable overhead cost is RM 2 per unit. Fixed costs are budgeted at RM 450,000 for the year, of which RM 130,000 are depreciation charges. The remaining fixed costs are incurred at a constant rate every month, with the exception of factory rental costs, which are RM 80,000 each year, payable 50% in December and 50% in June.

With exception of rental cost, 10% of overhead expenses are paid for in the month they occur and the remaining are paid in following month.

The budgeted production quantities of product APPLE are:Months Units

September 40,000

October 60,000

November 50,000

December 30,000

Solution

Fixed Overhead

Annual fixed overheads 450,000(-) Depreciation 130,000

Cash Expenses 320,000(-) Annual factory rental 80,000

Monthly Cash expenses for the year 20,000

Variable Overheads

Units Variable Overhead

Cost

Payment in

October November

December

$ $ $ $

September

40,000 80,000 72,000 - -

October 60,000 120,000 12,000 108,000 -

November

50,000 100,000 - 10,000 90,000

December

30,000 60,000 - - 6,000

Total Payments

84,000 118,000 96,000

Overhead Cash Payments

October November December

$ $ $

Variable Overheads

84,000 118,000 96,000

Fixed Overheads

20,000 20,000 60,000

Total Payments

104,000 138,000 156,000

Sensitivity Analysis• Is a modeling and risk assessment procedure in

which changes are made to significant variables in order to determine the effect of these changes on the planned outcome.

• Test the ‘responsiveness’ of a forecast to see how sensitive they are to changes in inputs.

Sensitivity Analysis

WHY

Budgets are prepared based on assumption and Estimates.

So, it can be

inaccurate

Items for Sensitivity Analysis• Sales- January 2012 the company expects to have $ 15,000 in the bank. Revenue

in Jan expected to be $ 25,000 and growth rate 1.25% p/month is predicted during forecast period.

• Operating Expenses- Buys inventory 1 month in advance and pay in cash. All sales are on credit.

No bad debt.

• Accounts Receivables Days- Payment received from customers, 60% (1 months) and 40% (2 months).

• Accounts Payable Days- Purchases of capital equipment ($200,000- Feb) & payment of tax

($30,000- Mar) & dividends ($ 40,000 – Apr).

• COS & Gross Profit Margin- COS is 65% of revenue. Overhead cost expected to be & 6,500 p/month

and rising by 5% at start of each new calendar year.

• Interest Rate- Loans officer has advice the company that the interest rate of bank overdraft is 1.65% p/month.

Alternative Methods• Preparing a series of different forecast-different

scenario.• Preparing cash forecasts as a range of possible

outcomes.• Using probability analysis.

Forecasting with Inflation

Inflation : Process the price of commodities rises over time. Inflation usually measured as percentage. Example, rate of inflation is 20% a year, purchases worth $ 10,000 last year and this year it will cost $ 12,000. So at the same inflation rate next year it will cost $ 14,400.

Index number: rate of change of variable specified time to another. There are two types of index:1. Price relative - changes in price of items over the time.2. Quantity relative – changes in quantity over the time.

Cleared Funds

Definitions:

Sums that have been transferred through a payment clearing system, debited to the originator of the transfer, credited to the recipient and are available to earn interest.