ACCOUNTING UNIT 1 & 2

Chapter 10 – Cash Budgets

Budgeting

Budgeting is the process of preparing reports that estimate or predict the financial consequences of likely future transactions.

These reports look almost exactly the same as the reports we have already prepared, but have two key differences: Budgets report future events rather than

historical events; they focus on what might happen rather than what has already happened.

As a consequence, budgets use estimates or predictions rather than actual, verifiable data.

The Purpose of Budgeting

Like all accounting reports, budgets have a role in both planning and decision-making:

Budgets assist planning by predicting what is likely to occur in the future.

Budgets aid decision-making by providing a standard against which actual performance can be measured.

Review Questions

Complete Review Questions 10.1

The Budgeting Process

The information presented in the budgeted reports should be based on the historical data, but allowances must be made for changes and the effect of new business decisions.

(Obviously, a brand new business will not have any historical data on which to rely – this makes budgeting harder for new businesses)

Review Questions

Complete Review Questions 10.2

Expected Cash Receipts

Typical cash receipts a service firm could expect to see in its Cash Budget might include:

cash fees GST received GST refund other revenue received (such as interest or

commission revenue) cash contributions by the owner loans received cash received from the sale of a non-current

asset.

Expected Cash Payments

Typical cash payments a service firm could expect to see in its Cash Budget might include:

expenses paid (such as wages, rent or advertising)

GST paid GST settlement cash drawings by the owner loan repayments cash paid for non-current assets.

Figure 10.2

The most obvious thing to note about this Cash Budget is its similarity to the Statement of Receipts and Payments.

The only differences are those outlined earlier: rather than actual historical data, the Cash Budget uses estimates of future transactions.

The only actual figure in the Cash Budget is the Bank balance at start, as this figure is already known before the budget is prepared.

Consecutive Budgets

Figure 10.2 relates only to one month taken in isolation, but it would be wise for a business to prepare budgets for consecutive months to show the effect of monthly variations.

That is, separate budgets for October, November and December could be prepared and presented side-by-side to show trends in receipts and payments from month to month.

Such a budget may appear as is shown in Figure 10.3 below:

Figure 10.3

The budget shows that the planned purchase of the company car for $35 000 will drive the bank account into an overdraft (of $13 260) in December.

Armed with this information, the owner can decide to defer the purchase of the car, contribute additional funds of his own, or perhaps fund the purchase using a loan or other finance.

Review Questions & Exercises Complete Review Questions 10.3 Complete Exercises 10.1, 10.2, 10.3

Uses of the Cash Budget

Planning: The Cash Budget statement aids planning

by allowing the owner to prepare in advance for an expected cash surplus or cash deficit.

This forewarning is particularly important if a cash deficit is predicted, because the owner can take steps to address the cash shortage before it occurs.

Planning

Should the budget predict an overall cash deficit, the owner might prepare for this by: deferring the purchase of non-current assets,

or using credit facilities or a loan for their purchase

deferring loan repayments taking less cash drawings making a cash capital contribution organising (or extending) an overdraft facility

Planning

Should the budget predict an overall cash surplus, the owner might plan to use the extra cash to:

purchase more/newer non-current assets

increase loan repayments increase cash drawings expand operating activities by

increasing advertising, employing more staff etc.

Decision-Making

In addition, the Cash Budget aids decision-making because it sets a benchmark for the assessment of the firm’s actual cash performance by comparing budgeted and actual cash flows, the owner can identify problems areas, and then act to correct the situation.

Problems identified by the budget may lead to: strategies to increase cash fees (via promotions,

greater advertising, discounting prices) strategies to decrease cash paid for expenses.

Cash Variance Report

A Cash Variance Report compares actual and budgeted cash figures, highlighting any differences (which are known as ‘variances’), so that problems can be identified and corrected.

In appearance, it is very similar to a Cash

Budget, but is has additional columns for actual figures, and the calculation of the variance.

It is prepared once the actual figures are available, but before the next budget.

Cash Variance Report

A variance is simply the difference between the budgeted figure and actual figure.

Whether it is ‘favourable’ or ‘unfavourable’ depends on its effect on Bank.

A variance is favourable (F) if it means Bank will be higher than expected in the budget.

A variance is unfavourable (U) if it means Bank will be lower than expected in the budget.

Cash Variance Report

In relation to cash receipts: If actual cash received is greater than

budgeted, the variance is favourable, as the closing Bank balance will increase more than expected.

If actual cash received is less than budgeted, the variance is unfavourable, as the closing Bank balance will increase less than expected.

Cash Variance Report

The opposite applies to cash payments:

If actual cash paid is greater than budgeted, the variance is unfavourable, as the closing Bank balance will decrease more than expected.

If actual cash paid is less than budgeted, the variance is favourable, as the closing Bank balance will decrease less than expected.

Figure 10.4

In the Cash Variance Report, variances are assessed from a cash perspective only. For example, less cash has been paid off the Loan principal than expected.

Even though the liability of the loan will be higher than expected (and this may be considered to be unfavourable), it means more cash on hand, so it is classified as a favourable variance.

Uses of the Cash Variance Report Assuming the variances are not caused by

poor estimates, then the Cash Variance Report is a valuable aid to decision-making.

The unfavourable variances should be investigated, and their cause(s) identified.

This will allow the owner to take corrective action. In this example, the actual bank balance was $4035 lower than was budgeted: why did this occur?

Uses of the Cash Variance Report For a start, Cash fees was $3000 lower than

budgeted, and the favourable variance in Wages is likely to be a direct consequence.

After all, if less photography is done, not as many hours are required. Perhaps the lack of fees was caused by the lower than expected payment for Advertising. This problem requires corrective action from the owner.

Uses of the Cash Variance Report Even though Cash fees was lower than

budgeted, payments for Photographic supplies was higher: does this mean supplies were wasted, or more expensive to buy, or is there some other explanation?

It also appears that the full amount was paid for Camera equipment, rather than just the deposit, whereas less of the Loan principal was repaid.

Review Questions & Exercises Compete Review Questions 10.5 Complete Exercises 10.6 &10.7