cash budget would be incomplete if it were based on only one set of estimated cash inflows and cash outflows. These figures may well be expected cash flows or even most likely estimates, but we need to consider the possibility of errors or variability in cash flow estimates. Table 13.2 lists the principal known and uncertain cash flows.
The variability in cash flows can be handled by ‘what-if” analysis or by optimistic/ pessimistic forecasts. For example, what if your cash sales were, say, 10 percent higher, or lower, than originally expected? A cash budget prepared for a worst-case scenario might be quite useful. It may also allow you to plan better for difficult times.
Table 13.1: Certain and Uncertain Cash Flows
| Known cash flow | Uncertain cash flow |
| Interest receipts | Cash sales |
| Rent | Collections |
| Payroll | Payable payments |
| Tax Payments | |
| Interest Payments | |
| Loan repayments | |
| Purchase of long-term assets |
14. Budget Accuracy Ratios
Introduction
The accuracy of a budget may be evaluated by comparing budget figures to actual figures. The closer the actual amounts are to the estimates, the better is the budget process and the greater is the reliance that may be placed on future projections.
How is it computed?
Example
An owner budgeted profit for $800,000, but the business actually earned $1,000,000. The reasons for this favorable result might be one or more of the following:
How is it used and applied?
There is no assurance that a plan designed to increase earnings will in fact do so. However, if actual profits exceeds budgeted profits, the owner has achieved the profit goal. This may arise because of greater revenue than expected, or better control over costs than anticipated.
By comparing actual to budgeted amounts, the owner can determine whether the business plans are sound. If not, improvements in the planning process are needed. Perhaps the planning is over-optimistic or unrealistic. On the other hand, the problem may lie with an inclination to overspend and/or waste. The expense deviation should be related to that of sales. Perhaps all that has happened is simply that expenses went up because sales revenue increased. In that case, the result is expected and no negative sign exists.
15. Projecting Financing Needs
Introduction
Forecasts of the future sales and their related expenses provide the firm with the information needed to project its future needs for financing. Percentage of sales is the most widely used method for projecting a company’s financing needs. This method involves estimating the various expenses, assets, and liabilities for a future period as a percent of the sales forecast and then using these percentages, together with the projected sales, to construct pro-forma balance sheets.
How is it computed?
The basic steps involved in projecting financing needs are as follows:
1.Project the first firm’s sales. The sales forecast is the most important initial step. Most other forecasts (budgets) follow the sales forecast.
2.Project additional variables such as expenses.
3.Estimate the level of investment in current and fixed assets required to support the projected sales.
4.Calculate the firm’s financing needs.
The following example illustrates ,how to develop a pro-forma balance sheet and determine the amount of external financing needed.
Example
Assume that sales for 20×7=$20, projected sales for 20×8 = $24, net income = 5 percent of sales, and the dividend payout ratio = 40 percent. The steps for the computations are outlined as follows, with the results shown in Exhibit 15.1:
Step 1: Express those balance sheet items that vary directly with sales as a percentage of sales. Any item such as long term debt that does not vary directly with sales is designed “n.a.,” or “not applicable.”
Step 2: Multiply these percentages by the 20×8 projected sales = $24 to obtain the projected amounts as shown in the last column.
Step 3: Insert figures for long-term debt, common stock, and paid-in-capital from the 20×1 balance sheet.
Step 4: Compute 20×8 retained earnings as shown in Note b.
Step 5: Sum the asset accounts, obtaining total projected assets of 47.2, and also add projected liabilities and equity to obtain $7.12, the total financing provided. Since there is a short fall of $0.08 “external financing needed.” Any external financing needed may be raised by issuing notes payable, bonds, stocks, or any combination of these financing sources.
Figure 15.1: Pro Forma Balance Sheet in Millions of Dollars
20×8 retained earnings = 20×7 retained earnings + projected net income − cash dividends paid = $1.2 + 5%($24) - 40%[5%($24)] = $1.2 + $1.2 - $0.48 = $2.4 - $0.48 = $1.92
External financing needed projected total assets - (projected total liabilities + projected equity) = $7.2 - ($4.9 + $2.22) = $7.2 - $7.12 = $0.08
How is it used and applied?
Financial officers and business owners need to determine the portion of the next year’s funding requirements that has to be raised externally. By doing so, they can get a head start in arranging a least-cost financing plan.
The
