Afm Notes 4 Presentation

8/4/2019 Afm Notes 4 Presentation

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What Does Cash BudgetMean?An estimation of the cash inflows and outflows for a business orindividual for a specific period of time. Cash budgets are oftenused to assess whether the entity has sufficient cash to fulfill

regular operations and/or whether too much cash is being left inunproductive capacities.

Investopedia explains Cash BudgetA cash budget is extremely important, especially for smallbusinesses, because it allows a company to determine how muchcredit it can extend to customers before it begins to have liquidity

problems.

For individuals, creating a cash budget is a good method fordetermining where their cash is regularly being spent. Thisawareness can be beneficial because knowing the value ofcertain expenditures can yield opportunities for additional savingsby cutting unnecessary costs.

For example, without setting a cash budget, spending a dollar aday on a cup of coffee seems fairly unimpressive. However, uponsetting a cash budget to account for regular annual cashexpenditures, this seemingly small daily expenditure comes out toan annual total of $365, which may be better spent on otherthings. If you frequently visit specialty coffee shops, your annualexpenditure will be substantially more.

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1Y8KrZYAf
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A forecastof estimated cash

receiptsanddisbursements for a specifiedperiod of time.

Cash Budget | Cash Budgeting:

Learning Objectives:

1.Define and explain a cash budget.2.What is the purpose of a cash budget3.How to prepare a cash budget.

Definition and Explanation:

Cash budget is a detailed plan showing how cash resourceswill be acquired and used over some specific time period.

Cash budget is composed of four major sections.

1.The receipts section.2.The disbursements section3.The cash excess or deficiency section
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4.The financing section

The cash receipts section consists of a listing of all of the

cash inflows, except forfinancing, expected during

the budgeting period. Generally, the major source ofreceipts will be from sales. The disbursementsection consists of all cash payment that are planned forthe budgeted period. These payments will include rawmaterialspurchases,direct labor payments, manufacturing

overhead costs, and so on as contained in their respectivebudgets. In addition, other cash disbursements suchas equipment purchase, dividends, and other cash

withdrawals by owners are listed.

The cash excess or deficiency section is computed asfollows:

Cash balance beginningAdd receipts

Total cash availableLess disbursements

Excess (deficiency) of cash available overdisbursements

XXXXXXXX--------

XXXXXXXX--------XXXX

If there is a cash deficiency during any period, the company

will need to borrow funds. If there is cash excess during any

budgeted period, funds borrowed in previous periods can be

repaid or the excess funds can be invested.

The financing section deals the borrowings andrepayments projected to take place during the budgetperiod. It also include interest payments that will be due on

money borrowed. Generally speaking, the cash
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budget should be broken down into time periods that are asshort as feasible. Considerable fluctuations in cash balancesmay be hidden by looking at a longer time period. While a

monthly cash budget is most common, many firms budgetcash on a weekly or even daily basis.

Example of Cash Budget:

(See explanation of this budget)

Hampton Freeze Inc.Cash Budget

For the Year Ended December 31, 2009Quarter

Otherbudget

ref.1 2 3 4 Year

Cash balance,beginning

$42,500

$40,000

$40,000

40,500 42,500

Add receipts:

Collections fromcustomers

Seesales

budget 230,00

0480,00

0740,00

0520,00

01,970,0

00

------------

------------

------------

------------

------------

Total cashavailable

272,500

520,000

780,000

560,500

2,012,500

------------

------------

------------

------------

------------

Lessdisbursements:

Direct materialsmaterialbudget

49,50072,300100,05

079,350301,200

Direct laborLaborbudget

84,000192,00

0216,00

0114,00

0606,000
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Manufacturingoverhead

Overhead

budget 68,00096,800

103,200

76,000344,000

Selling andAdministrative

sell. &

adm.budget

93,000130,900 184,750 129,150 537,800

Equipment purchases

50,00040,00020,00020,000130,000

Dividends 8,000 8,000 8,000 8,000 32,000----------

-----------

-------------

-----------

-------------

--Total

disbursements

352,50

0

540,00

0

632,00

0

426,50

0

1,951,0

00----------

-----------

-------------

-----------

-------------

--Excess/deficiency of cashavailable overdisbursements

(80,000)

(20,000)

148,000

134,000

61,500

Financing:Borrowings (atbeginning)*

120,000

60,000 - - 180,000

Payments (atbeginning)

- -(100,00

0)(80,00

0)(180,00

0)

Interest** - - (7,500)(65,00)(14,000

)----------

--

---------

---

----------

--

---------

---

----------

--Total financing

1200,000

(60,000)

(107,500)

(86,500)

(14,000)

------------

------------

------------

------------

------------

Cash balance, $40,00 $40,00 $40,50 $47,50$47,500
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ending 0 0 0 0=====

======

======

======

=======

*The company requires a minimum cash balance of$40,000. Therefore, borrowing must be sufficient tocover the cash deficiencies of $80,000 in quarter 1 andto provide for the minimum cash balance of $40,000. All

borrowings and repayments of principal are in round$1,000 amount.

**The interest payment relate only to the the principle

being repaid at the time it is repaid. For example, theinterest in quarter 3 relates only to the interest due on

the $100,000 principle being repaid from quarter 1borrowing:

$100,000 10% per year 3/4 year = $7,500

The interest paid in quarter 4 is computed as follows:

$20,000 10% per year 1 year $2,000$60,000 10% per year 3/4 year 4,500

---------Total interest paid $6,500

======

Explanation of cash budget for Hampton Freeze Inc.

Cash budget builds on the other budgets ( salesbudget,material budget, Labor budget, Overhead

budget,sell. & adm. budget) and on some additional datathat are provided below:

The beginning cash balance is $42,500
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Managementplans to spend $130,000 duringthe year on equipment purchases: $50,000 in the firstquarter; $40,000 in the second quarter; $20,000 in the

third quarter; $20,000 in the fourth quarter.

The board of directors has approved cash dividends of$8,000 per quarter.

Management would like to have a cash balance of at

least $40,000 at the beginning of each quarter forcontingencies.

Assume Hampton Freeze will be able to get agreement

from a bank for an open line of credit. This wouldenable the company to borrow at an interest rate of10% per year. All borrowings and repayments would bein round $1,000 amount. All borrowings would occur at

the beginning of the quarters and all repayments are

made and only on the amount of principal that isrepaid.

The cash budgetis prepared one quarter at a time, startingwith the first quarter. Management began the cash

budget by entering the beginning balance of cash for thefirst quarter of $42,500--a number that is given above.

Receipts--in this case, just the $230,000 in cash collectionfrom customers--are added to the beginning balance toarrive at the total cash available of $272,500. Since the

total disbursements are $352,500 and the total cashavailable is only $272,500, there is short fall of $80,000.

Since management would like to have a beginning cashbalance of at lease $40,000 for the second quarter, thecompany would need to borrow $120,000.

Required borrowing at the end of the first quarterDesired ending cash balance $40,000
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Plus deficiency of cash available over disbursements 80,000----------

Required borrowings $120,000======

The second quarter of cash budget is handled similarly.

Note that the ending cash balance of the first quarter isbrought forward as the beginning cash balance for the

second quarter. Also note that additional borrowingis required in the second quarter because of the continuedcash shortfall.

Required borrowing at the end of the second quarterDesired ending cash balance $40,000Plus deficiency of cash available over disbursements 20,000

------------Required borrowings $60,000

======

In third quarter, the cash flow situation improves

dramatically and the excess of cash available overdisbursement is $148,000. This makes it possible for the

company to repay part of its loan from the bank, which nowtotals $180,000. How much can be repaid? The totalamount of the principle and interest that can be repaid isdetermined as follows:

Total maximum feasible loan payments at the end of the third

quarterExcess of cash available over disbursement $148,000Less desired ending cash balance 40,000

-------------Maximum feasible principle and interest payment $108,000

======


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The next step--figuring out the exact amount of

loan payment--is tricky since interest must be paid on the

principle amount that is repaid. In this example, the

principle amount that is repaid must be less than $108,000,so we know that we would be paying of part of the loan that

was taken out at the beginning of the first quarter. Sincethe repayment would be made at the end of the thirdquarter, interest would have accrued for three quarters. So

the interest owed would be 3/4 of 10% or 7.5%. Either atrial and error or an algebraic approach will lead to theconclusion that the maximum principle repayment that can

be made is $100,000. The interest payment would be 7.5%of this amount, or $7,500--making thetotalpayment $107,500.

In the fourth quarter, all of the loan and accumulatedinterest are paid off. If all loans are not repaid at the end ofthe year and budgeted financial statements are prepared,then interest must be accrued on the unpaid loans. This

interest will not appear on the cash budget (since it has notyet been paid), but it will appear as interest expense on thebudgeted income statement and as a liability on thebudgeted balance sheet.

As with theproduction budget andraw materials budget,the amounts under the year column in the cash budget are

not always the sum of the amounts for the four quarters. In

particular, the beginning cash balance for the year is thesame as the beginning cash balance for the first quarter and

the ending cash balance for the year is the same as theending cash balance for the fourth quarter.
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Burlington Northern Fe (BNSF) operates the second largestrailroad in the United States. The company's senior vice

president, CFO, and treasure is Tom Hunt, who reports that"as a general theme, we have become very cash-floworiented." After the manager of the Burlington Northern andSanta Fe railroads, the company went through a number of

years in which they were investing heavily andconsequently had negative cash flow. To keep on top of the

company's cash position, Hunt has a cash forecast prepared

every month. "Everything falls like dominoes from free cashflows," Hunt says. "It provides us with alternatives." Right

now, the alternative of choice is buying back our ownstock...[b]ut it could be increasing dividends or making

acquisitions. All those things are not even on the radarscreen if you don't have free cash flow."

Source: Randy Myers, "Cash Crop: The 2000 working

capital survey," CFO, August 2000, pp. 59-82.

You may al

Cash budget: a cash plan for a defined period of time. Itsummarises monthly receipts and payments. Hence, it highlightsmonthly surpluses and deficits of actual cash. Its main uses are:

to maintain control over a firm's cash requirements, e.g. stockand debtors

to enable a firm to take precautionary measures and arrange in

advance for investment and loan facilities whenever cashsurpluses or deficits arises

to show the feasibility of management's plans in cash terms

to illustrate the financial impact of changes in managementpolicy, e.g. change of credit terms offered to customers.


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Receipts of cash may come from one of the following:

cash sales payments by debtors

the sale of fixed assets the issue of new shares the receipt of interest and dividends from investments.

Payments of cash may be for one or more of the following:

purchase of stocks payments of wages or other expenses

purchase of capital items payment of interest, dividends or taxation.

Steps in preparing a cash budget

i) Step 1: set out a pro forma cash budget month by month. Belowis a suggested layout.

Month 1Month 2Month 3

$ $ $Cash receipts

Receipts from debtors

Sales of capital items

Loans received

Proceeds from share issues

Any other cash receipts

Cash paymentsPayments to creditors

Wages and salaries

Loan repayments

Capital expenditure


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Taxation

Dividends

Any other cash expenditure

Receipts less paymentsOpening cash balance b/f W X Y

Closing cash balance c/f X Y Z

ii) Step 2: sort out cash receipts from debtors

iii) Step 3: other income

iv) Step 4: sort out cash payments to suppliers

v) Step 5: establish other cash payments in the month

Figure 4.1 shows the composition of a master budget analysis.

Figure 4.1 Composition of a master budget

OPERATING BUDGETFINANCIAL BUDGET

consists of:- consists of

Budget P/L acc: get: Cash budget

Production budget Balance sheet

Materials budget Funds statement

Labour budget

Admin. Budget

Stocks budget

f) Other budgets:These include budgets for:

administration research and development selling and distribution expenses


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capital expenditures working capital (debtors and creditors).

The master budget (figure 4.1) illustrates this. Now attempt

exercise 4.1.

Exercise 4.1 Budgeting I

Different

The cash budgetcontains an itemization of the projectedsources and uses of cash in a future period. The inputs tothe cash budget come from several other budgets. The

results of the cash budget are used in the financingbudget, which itemizesinvestments, debt, andboth interestincome and interest expense.

The cash budget is comprised of two main areas, whichare Sources of Cash and Uses of Cash. The Sources of

Cash section contains the beginning cash balance, as wellas cash receipts from cash sales, accounts

receivable collections, and the sale ofassets. The Uses ofCash section contains all planned cashexpenditures,which comes from the Direct Materials Budget,DirectLabor Budget,Manufacturing Overhead Budget,

and Selling and Administrative Expensebudget. It mayalso contain line items for fixed assetpurchasesand dividends to shareholders.

If there are any unusually large cash balances indicatedin the cash budget, these balances are dealt with in the

financing budget, where suitable investments areindicated for them. Similarly, if there are any negativebalances in the cash budget, the financing budget
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indicates the timing and amount of any debtorequityneeded to offset these balances.

Example of the Cash Budget

Here is an example of the cash budget, showing thesources and uses of cash by week:

Everson ManufacturingCash Budget

Week 1 Week 2 Week 3 Week 4

Beginning cash $25,000 $55,000 -$24,000 -$63,000

Sources of Cash+ Cash sales +10,000 +12,000 +15,000 +18,000

+ Accounts receivablecollected

+180,000 +185,000 +180,000 +192,000

+ Asset sales +30,000 0 +10,000 +25,000

= Total cash available $245,000 $252,000 $181,000 $172,000

Uses of Cash

- Direct materials -$87,000 -$91,000 -$99,000 -$107,000

- Direct labor -19,000 -20,000 -23,000 -25,000- Manufacturingoverhead

-29,000 -30,000 -34,000 -37,000

- Selling &administrative

-35,000 -35,000 -38,000 -38,000

- Asset purchases -20,000 0 -50,000 0

- Dividend payments 0 -100,000 0 0

= Total uses of cash -$190,000 -$276,000 -$244,000 -$207,000

Net Cash Position $55,000 -$24,000 -$63,000 -$35,000

The example shows that an inordinately large dividendpayment in the second week of the cash budget, coupledwith a large asset purchase in the following week, places
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the company in a negative cash position. Paying out sucha large dividend can be a problem for lenders, who do

not like to issue loans so that companies can use thefunds to pay their shareholders and thereby weaken theirability to pay back the loans. Thus, it may be wiser forthe company to consider a small dividend payment and

avoid a negative cash position.

Other Cash Budget Issues

Cash balances may fluctuate considerably within a single

accounting period, thereby masking cash shortfalls that

can put a company in serious jeopardy. To spot theseissues, it is quite common to create and maintain cash

forecasts on a weekly basis. Though these short-termbudgets are reasonably accurate for perhaps a month,

the precision of forecasting declines rapidly thereafter, somany companies then switch to budgeting on a monthlybasis. In essence, a weekly cash budget begins to lose its

relevance after one month, and is largely inaccurate after

two months.

Related Topics

Different

Cash Budgeting and How to Use it:

Within the broad category of business budgeting, the owner of the smallbusiness may want to do some specialized budgeting with regard tocashflow. One type of budget that is practically necessary to the survival ofthe business firm is cash budgeting.

Short-term financial planning
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The cash budget is one of the primary tools used in short-term financialplanning in order to plan for cash flow. It is often developed on a month-by-month basis. A good cash budget allows the owner to see short-termfinancial needs and opportunities for the business. One month, the firm

may have extra cash and may be able to save some money in a moneymarket fund or take advantage of a bargain in the marketplace. Anothermonth, the firm may have a shortfall and have to withdraw some moneyfrom savings or even apply for a short-term bank loan to cover its needs.

You can see by looking atthis explanation of a cash budgethow ownersstate their expected cash inflows (sales revenues) and outflows(expenditures) on a month-by-month basis in order to calculate their

excess cash or cash shortage at the end of each month. This is anextraordinarily helpful short-term planning tool for the small businessowner.Financial Forecasting

Cash budgeting is the second step in the firm's financial forecasting

process.

Different

Cash is the gasoline that makes your business run.Cash flowcan bedefined as the way money moves into and out of your business; it is thedifference between just being able to open a business and being able tostay in business. A cash flow analysis is a method of checking up onyour firms financial health. It is the study of the movement of cash

through your business, called a cash budget, to determine patterns of

how you take in and pay out money. The goal is to maintain sufficientcash for firm operations from month to month. This type of cash flowanalysis is called developing thecash budget.

Difficulty: Average

Time Required: 3 hours
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Here's How:

1.This type of cash flow analysis is called cash budgeting analysis. It ispart of your firm'sfinancial forecasting plan. Determine the amount

of cash that will flow into your firm during the month. If you are juststarting your business, you should include the beginning balance incash that you want to have available every month. There would alsobe the amount of sales you have during the first month. Sales wouldinclude both cash sales and sales that you make to your customerswho pay on credit. Here's anexampleyou can follow to develop yourSchedule of Cash Receipts (Sales Receipts).

2.Determine the amount of cash that will flow out of your firm duringthe month. You will have expenses. You will probably have to buyoffice supplies. Other monthly expenses may include advertising,vehicle expenses, payroll expenses, just to name a few. You willhave some quarterly expenses, such as taxes. You may haveexpenses that just occur occasionally, like purchases of computerequipment, vehicles, or other larger expenses. Here is anexampleof aSchedule of Cash Payments that is the second step of the cashbudget.

3.You want the cash that will flow into your firm (Step 1) to be greater

than the cash that will flow out of your firm (Step 2). This means thatyour monthly cash inflow needs to be greater than your monthly cashoutflow so you will have sufficient cash to operate your firm. Here'sablank worksheetyou can use to calculate your cash inflow or cashreceipts and anotherblank worksheetyou can use to calculate yourcash payments.

4.Your ending balance for the first month becomes the beginningbalance for the second month. You do the same type of analysis.

Each month, you may have to add more items to your cash flowanalysis as your business grows. You need to decide what theminimum ending cash balance is that you find acceptable for yourfirm and aim toward that figure each month.
http://bizfinance.about.com/od/forecasting/a/fin_forecast.htmhttp://bizfinance.about.com/od/forecasting/a/fin_forecast.htmhttp://bizfinance.about.com/library/Schedule_of_Cash_Receipts.pdfhttp://bizfinance.about.com/library/Schedule_of_Cash_Receipts.pdfhttp://bizfinance.about.com/library/Sch_Cash_Pmts_Exp.pdfhttp://bizfinance.about.com/library/Sch_Cash_Pmts_Exp.pdfhttp://bizfinance.about.com/library/Statement_Cash_Receipts_Wksheet.pdfhttp://bizfinance.about.com/library/Statement_Cash_Receipts_Wksheet.pdfhttp://bizfinance.about.com/library/Statement_Cash_Receipts_Wksheet.pdfhttp://bizfinance.about.com/library/Statement_Cash_Payments_Worksheet.pdfhttp://bizfinance.about.com/library/Statement_Cash_Payments_Worksheet.pdfhttp://bizfinance.about.com/library/Statement_Cash_Payments_Worksheet.pdfhttp://bizfinance.about.com/library/Statement_Cash_Receipts_Wksheet.pdfhttp://bizfinance.about.com/library/Sch_Cash_Pmts_Exp.pdfhttp://bizfinance.about.com/library/Schedule_of_Cash_Receipts.pdfhttp://bizfinance.about.com/od/forecasting/a/fin_forecast.htm


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5. If your cash flow turns negative for any one month, you will have toborrow money for that month from family or friends, investors, orfrom a bank or other financial institutions. Then, if your cash flow ispositive the next month, you can repay that loan.

6.Keep on doing this each month for your forecasting period. Try tokeep your borrowing to a minimum and your cash inflow greaterthan your outflows. Remember that this cash budget is a financialforecasting document but try to follow it as closely as possible. Hereis anexampleof a completed Cash Budget, based on the schedulesalready completed, that you can look at. Here is ablankworksheetyou can use for your own company.

Different

Small business owners can't just assume that just because they can showa forecasted profit for their business that all is well. Profit is not thesame as cash in the till. Cash on hand is necessary to operate day to dayoperations. As a result, small business owners also must develop aprojected cash budget in order to assure that they will have adequatecash in the future to operate their firm.

Cash budgetsare usually done on a monthly basis. Cash receipts orinflows, which are usually sales revenue, are projected based on thesales projections from the projected income statement. Cashexpenditures or outflows are similarly projected. The difference betweenthem is thenet cash flow. The business owner has to take intoconsideration whether or not he allows customers to pay on credit andcontrol for that when calculating when cash inflows are received.

Each month, the small business owner then calculates if there will beenough cash to meet the minimum cash balance and the firm's cashneeds for the month. If not, the owner will have to borrow. If there isexcess cash, the owner can repay past loans. In this way, the businessowner can keep a good handle on the cash position of the firm.
http://bizfinance.about.com/library/Cash_Budget_Example.pdfhttp://bizfinance.about.com/library/Cash_Budget_Example.pdfhttp://bizfinance.about.com/library/Cash_Budget_Example.pdfhttp://bizfinance.about.com/library/Cash_Budget_Worksheet.pdfhttp://bizfinance.about.com/library/Cash_Budget_Worksheet.pdfhttp://bizfinance.about.com/library/Cash_Budget_Worksheet.pdfhttp://bizfinance.about.com/library/Cash_Budget_Worksheet.pdfhttp://bizfinance.about.com/od/forecasting/a/%5bhttp:/bizfinance.about.com/od/cashmanagement/qt/Cash_Budget_vs_Cash_Flow_Statement.htmhttp://bizfinance.about.com/od/forecasting/a/%5bhttp:/bizfinance.about.com/od/cashmanagement/qt/Cash_Budget_vs_Cash_Flow_Statement.htmhttp://bizfinance.about.com/od/cashflowanalysis/f/net-cash-flow.htmhttp://bizfinance.about.com/od/cashflowanalysis/f/net-cash-flow.htmhttp://bizfinance.about.com/od/cashflowanalysis/f/net-cash-flow.htmhttp://bizfinance.about.com/od/cashflowanalysis/f/net-cash-flow.htmhttp://bizfinance.about.com/od/forecasting/a/%5bhttp:/bizfinance.about.com/od/cashmanagement/qt/Cash_Budget_vs_Cash_Flow_Statement.htmhttp://bizfinance.about.com/library/Cash_Budget_Worksheet.pdfhttp://bizfinance.about.com/library/Cash_Budget_Worksheet.pdfhttp://bizfinance.about.com/library/Cash_Budget_Example.pdf


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The Purpose of a Cash Budget

At its most basic level, a budget is a plan. It is a plan for owners and

managers to achieve their


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goals for the company during a specific time period.

The preparation of a cash budget is an important management task.

While some small businesses may be able to survive for a time without

budgeting, savvy business owners will realize its importance.

A cash budget can protect a company from being unprepared for

seasonal fluctuations in cash flow or prepare a company to take

advantage of unexpected quantity discounts from suppliers.

While there are other types of budgets that can be prepared, such as

projected or pro forma

financial statements, a cash budget is a management plan for the most

important factor of a

companys viabilityits cash position. A companys cash position

determines how suppliers will be paid, how a banker will respond to a

loan request, how fast a company can grow, as well as directly

influencing dividends, increases to owners equity, and profitability.

Many small businesses find it helpful to prepare monthly cash budgets

and to analyze any

variances between the budgeted and actual amounts on a monthly

basis. This enables small business owners and managers to stay on top

of any unexpected cash uses.

The creation of a cash budget requires you to make estimates (or best

guesses) about many


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different aspects of your company and the environment in which it

operates. Future sales will be contingent on many things, such as

competition, the local economic climate, and your own internal

operations and capacity. In addition, after sales are estimated,potential costs must also be derived.

The important thing to keep in mind while arriving at these figures is

that past experience is important, but so is intuition. The estimates you

will need to develop must be based in reality and yet contain a dose of

creativity and, if warranted, optimism.

There are budgets, other than the cash budget, that are important foryour company. However, the cash budget is a good first step if you are

new to budgeting.

A cash budget cannot be created in a vacuum. Before and during the

budgeting process, business owners must consult with line managers,

suppliers, and key personnel to make the best guess possible about therelationship between the goals for the period and their effect on cash

receipts and cash expenditures.

Why Prepare a Cash Budget?

A cash budget is important for a variety of reasons. For one, it allows

you to make management decisions regarding your cash position (or

cash reserve). Without the type of monitoring imposed by the

budgeting process, you may be unaware of the cash flow through your


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business. At the end of a year or a business cycle, a series of monthly

cash budgets will show you just how much cash is coming into your

company and the way it is being used. Seasonal fluctuations will be

made clear.

A cash budget also allows you to evaluate and plan for your capital

needs. The cash budget will help you assess whether there are periods

during your operations cycle when you might need short-term

borrowing.

It will also help you assess any long-term borrowing needs. Basically, a

cash budget is a planning tool for management decisions.

How to create a cash budget:

There are three main components necessary for creating a cash budget.

Time period

Desired cash position

Estimated sales and expenses how to prepare a cash budget

Here is an example of a cash budget for a small business:

Small Business Cash Budget

For the three months ending March 31, 2000

Beginning Cash Balance

Expected Cash Receipts:


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Cash sales

Collection of accounts receivable

Other income

Total Cash

Expected Cash Payments:

Raw materials (or inventory)

Payroll

Other direct expenses

Advertising

Selling expenses

Administrative expenses

Plant and equipment expenditures

Other payments

Total Cash Expenses

Ending Cash Balance

Time Period

The first decision to make when preparing a cash budget is to decide

the period of time for which your budget will apply.


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That is, are you preparing a budget for the next three months, six

months, twelve months or some other period? In this Business Builder,

we will be preparing a three-month budget. However, the instructions

given are applicable to any time period you might select.

Cash Position

The amount of cash you wish to keep on hand will depend on the

nature of your business, the predictability of accounts receivable, and

the probability of fast-happening opportunities (or unfortunate

occurrences) that may require you to have a significant reserve of cash.

You may want to consider your cash reserve in terms of a certain

number of days sales. Your budgeting process will help you to

determine if, at the end of the period, you have an adequate cash

reserve.

Estimated Sales and Expenses

The fundamental concept of a cash budget is estimating all future cash

receipts and cash expenditures that will take place during the time

period. The most important estimate you will make, however, is an

estimate of sales. Once this is decided, the rest of the cash budget can

fall into place.

For example, if an increase in sales of 10 percent is desired and

expected, various other accounts must be adjusted in your budget. Raw

materials, inventory and the costs of goods sold must be revised toreflect the increase in sales. In addition, you must ask yourself if any

additions need to be made to selling or general and administrative

expenses, or can the increased sales be handled by current excess


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capacity. Also, how will the increase in sales affect payroll and

overtime expenditures?

Instead of increasing every expense item by 10 percent, serious

consideration needs to be given to certain economies of scale that

might develop. In other words, perhaps, a supplier offers a discount if

you increase the quantities in which you buy a certain item; or,

perhaps, the increase in sales can be easily accommodated by the

current sales force. All of these types of considerations must be taken

into account before you start budgeting. Each type of expense (as

shown on your income statement) must be evaluated for its potential

to increase or decrease. Your estimates should be based on your

experience running your business and on your goals for your business

over the time frame for which the budget is being created.

At a minimum, the following categories of expected cash receipts and

expected cash payments

should be considered:


Cash balance

Cash sales

Collections of accounts receivable

Other income

Expected Cash Expenses:

Raw material (inventory)


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Payroll

Other Direct Expenses:

Advertising

Selling expenses

Administrative expense


Other payments


Cash balance - The cash balance is your cash on hand. This includes

what is in your checking accounts, savings accounts, petty cash and any

other cash accounts that you might have.

Cash sales - After arriving at a base figure of cash sales, it must be

adjusted for any trade or other discounts and for possible returns. As

stated previously, the base level of sales (and of accounts receivable)

will be determined by the companys projections, goals and past

experience.

Collections of accounts receivable - After a base level of accounts

receivable is established

(based on sales projections), it must be adjusted to reflect the amount

that will actually be paid

during the time period. Typical adjustments for a small business might

be to assume that 90


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percent of accounts receivable will be collected in the quarter in which

the sales occur, nine

percent will be collected in the following quarter, and one percent will

remain uncollectible. Of

course, past experience will be the most reliable indicator for making

these adjustments.

Other income - Your cash position may be affected positively by

income other than sales.

Perhaps there are investments, dividends, or a loan that will beintroducing cash to the company during the time period. These types of

cash sources are referred to as other income.

Expected Cash Expenses:

Raw materials (inventory) - For small business retailers and

manufacturers, the largest cash expense is usually the amount spent for

inventory or raw materials. Again, past experience will be your bestindicator of future cash outlays. But dont forget to factor in any

necessary increases to keep up with projected sales. You may also want

to consult with your suppliers as to whether any pricing changes are

expected.

Payroll - Salaries are commonly the second largest expense item

during an accounting period.

Dont forget to include estimates for all appropriate local, state, and

federal taxes.

Other Direct Expenses:


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Use this line item for any additional expense that does not fit

conveniently under the other headings. If you are making payments on

a loan, include it here.

Advertising - The role of advertising varies by type of business. If you

are projecting an increase in sales, is there an accompanying marketing

or advertising campaign? These costs must be budgeted. Include any

expenses for print (brochures, mailers, and newspaper ads), radio, or

other advertising services.

Selling expenses - Typical selling expenses include salaries and

commissions for sales personnel and sales office expenses. However,this line item can also include any traveling or other sales-related

expense not covered elsewhere.

Administrative expenses - General office expenses are included here.

This will include your utilities, telephone, copying and day-to-day office

expenses. Unless big changes are underway, past experience will guide

you in evaluating future administrative expenses.

Plant and equipment - Cash payments for equipment loans,

mortgages, repairs, or other upkeep should be included here. Past

experience will, again, be your guide.

Other payments - If there are any cash payments you expect to make

that are not covered in the above listing, include them here. (If they are

repeatable, you may consider adding a separate line item.) However,typically, interest payments and taxes fall here.

How to analyze a cash budget


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The preparation of a cash budget is only the first step toward good

financial management.

The next step is to analyze to see how close the company is performing

to expectations.

Have any unexpected cash outflows occurred? If so, is the companys

financial position

seriously affected?

A simple method for monitoring the cash budget is to prepare a budget

versus actual report of actual and budgeted expenses every month.

This type of report consists of four columns. The first column shows the

budgeted amounts, the second column shows actual company

performance, and the third and fourth columns show the difference in

terms of dollars and percent.

Step 2: If the data is available, construct a budget versus actual report

for your business.

Below is a sample month-end budget versus actual report for the

fictional Turtle Company:

Budget vs. Actual Report

Cash Balance

Cash Receipts:


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Cash sales

Collection of accounts receivable

Other income

Total Cash

Expected Cash Payments:

Raw materials (or inventory)

Payroll

Other direct expenses

Advertising

Selling expense

Administrative expense


Other payments

Total cash expenses

Ending Cash Balance

BUDGET $5,000

20,000

15,000

0

$40,000


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15,000

7,200

500

500

1,500

500

5,000

0

30,200

$9,800

ACTUAL $5,000

22,000

13,500

0

$40,500

15,000

9,400

500

1,000

1,400


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500

7,500

0

35,300

$5,200

% Variance

0%

110%

90%

0%

101%

0%

130%

0%

200%

93%

0%

150%

0%

116%


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53%

As you can see, cash expenses for payroll, advertising and plant andequipment exceeded the budgeted amounts for the Turtle Company.

And because the company analyzes these figures monthly, changes can

be made before the increased expenses become unmanageable. The

use of a budget versus actual report allows owners to pinpoint how

actual cash inflows and outflows vary from expectations and to make

adjustments.

Conclusion

This Business Builder focuses on the creation of a cash budget for your

business. While there are several other types of budgets that can be

prepared, small business owners should pay close attention to their

cash position and create a cash budget for their company. Preparing a

monthly budget versus actual report will give small business owners the

information they need to make important decisions about the cashposition of their company.

checklist

___ When preparing your cash budget, did you remember to make the

ending cash balance the beginning cash balance for the next period?

___ When estimating cash expenses, did you remember to factor any

additional material, labor or other expenses for projected sales?

___ Is your sales goal for the period realistic?


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___ Did you remember to adjust accounts receivable for possible

uncollectible amounts?

___ Do expenditures for payroll include taxes?

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Budgeting Basics

Business Risk Managment

Site Map

Bizcoach, Small Business Ideas.Budgeting Basics

Let's face it- nobody likes budgeting. Most people(especially entrepreneurs) would rather be out doing

something, not sitting around trying to predict what'sgoing to happen to next year's financials.

The truth is that it is not imperative for every company tohave a budget. We have seen many well-run businesseswithout budgets and we're sure you have, too. However,

we do believe that every company (especially growingones) can improve its performance even further with abasic budgeting process. There are two simple reasonsfor this.

First, from a practical point of view, if your business isgrowing then you may soon reach the day when youneed a budget- to apply for a bank loan, buy a new pieceof machinery, raise capital from investors, etc. If that isthe case, then it's far better to start a budget now ratherthan try to pull one together at the last minute.

Secondly, a budget is not about predicting the future- it's

about making the future. Once you've made the effort toplan and visualize your company's financial results, thenachieving them becomes that much more realistic. For

more help on your financial planning, use budgetingsoftware that is easy and affordable.
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What is a Budget?Whenever you go on a trip, you fill your bag with the

clothes, food, and money you'll need. That's the origin ofthe concept of budgeting- planning your trip and ensuringthat you'll have enough resources in your bag to make itto your destination. In just the same way, an

organization plans its trips- its strategic objectives- andprepares for the journey with an action plan called abudget.

While the budgeting process can get quite complex inlarge organizations, the starting point for most

companies is to focus on two basic budgets: an operatingbudget and a cash budget. Typically, these budgets aredeveloped to cover a one-year time span.

Operating BudgetThe goal of the operating budget is to provide a blueprint

for how the business is going to operate in the comingyear. As a result, it pulls together information from

functional areas such as design, production, marketing,distribution, and customer service. The end result is a

budgeted income statement that shows how much profitthe business expects to make at the end of the year.

Cash BudgetThe cash budget is not as intuitive as the operatingbudget because it is strictly financial. However, it has a

vital purpose: to ensure that the business has enoughcash to fund its activities throughout the current period.Growing companies often find themselves strapped forcash even though sales are increasing and they are

profitable. The goal of the cash budget is to ensure that


37/40

you don't run out of cash. (For further help, see below-Seven Steps for Preparing a Cash Budget.)

The Key To Success

For example, let's say you are a food manufacturer and

after the first three months of the year you want toevaluate how sales are proceeding. After reviewing the

data, you discover that overall sales are lower thanexpected. Upon further research, you find that one ofyour product lines is 25% below budget due to a special

promotion that your main competitor began offering to

customers. This is where you would concentrate yourcorrective action because customers seem to beresponding to the promotion, buying more product fromyour competitor and less from you.

Six Steps for Preparing an Operating Budget

1) Review prior period data.Use historical data as a starting point. If possible, review

your results for the past two or three years. Unless youare starting a new business or developing a new product(in which case there is no data to review), this will be thebest indication of what's going to happen in the nextyear.

2) Develop reasonable assumptions.

After reviewing the data, you develop assumptions about

the future. Trust your own experience and makeeducated guesses. What will sales growth be? Is themarket for your products or services expanding? How

effective will your marketing program be? What will yourcompetitors do? Most business owners have strong senseof intuition about these things- listen to it, don't


38/40

overanalyze. You can also gather information from tradejournals or by talking with the people in your company

who are close to the scene (members of the sales team,purchasing staff, etc.).

3) Determine expected revenues.Use your prior period data and assumptions to makesales projections. Some companies establish a target thatis realistic and attainable, others prefer a "stretch"

budget that will be difficult, but not impossible, toachieve. However, it is important to keep yourprojections reasonable- within the constraints of

production capacity or a limited sales force on the onehand, and customer demand on the other. Expectedrevenues include not only the number of products youexpect to sell, but also at what price you will sell. If you

plan to increase the price, do you expect customers tocontinue to buy at the higher price, or will sales decreaseby some degree?

4) Calculate the expected cost of goods sold.When calculating the cost of goods sold, be sure to

include all direct and indirect costs: material, labor,packaging, storage, etc. Also, don't forget to takebeginning inventory into account.

5) Calculate expected operating expenses.This includes fixed costs such as rent, salaries, utilities,

office supplies, etc.

6) Calculate expected operating income.Presto, there's your operating budget.


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Seven Steps for Preparing a Cash Budget

1) Determine the beginning cash balance.

Figure out how much cash will be available at thebeginning of the period (year, quarter or month).

2) Add cash receipts.Determine the expected receipts- collections fromcustomers- that will flow into the cash account eachperiod. Cash collections may vary during the budget

period. For example, many retail stores expect to receivemost of their receipts during holiday seasons.

3) Deduct cash disbursements.Based on expected activity, calculate how much cash willbe required to cover disbursements- cash payouts-

during the period. Disbursements could include paymentfor materials, rent, payroll, taxes due, and so on. Someof these expenditures may be evenly distributed

throughout the budget period, but some (such asmaterial costs) may fluctuate as part of the production

process.

5) Calculate the cash excess or deficiency.To calculate the cash excess or deficiency for a period,subtract the disbursement from the sum of the beginning

cash balance and the receipts expected during thatperiod.

6) Determine financing needed for the period.To calculate the cash excess or deficiency for a period,subtract the total disbursements from total cash

available. If, at the end of the period, there is a cashexcess, then financing of operations may be covered bythe available cash. If, on the other hand, there is a cash


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deficiency, then you have to plan on financing theperiods cash needs from other sources, such as a bankloan or additional capital contribution. Note: remember toinclude a stable cash balance beyond the immediate cashneeds. For example, a manufacturer may want tomaintain a $20,000 cash balance at all times to coverunexpected cash demands.

7) Establish the ending cash balance.

The ending cash balance for each period will include thereceipts and loans less the disbursements and financingcosts. The ending cash balance becomes the beginning

cash balance for the next period.

Documents

Afm Notes 4 Presentation