Sec. 54, Cost-Volume-Profit Analysis; Sec. 55, Contribution Margin Analysis; and Sec. 107, Operating Leverage.
11. Using Budgeting to Control Cash
Introduction
The cash budget presents the amount and timing of the expected cash inflows and out flows for a specified time period. It is a tool for cash planning and control and should be detailed enough that you know how much is required to run your business. If you can estimate cash flows reliably, you will be able to keep cash balances near a target level using fewer transactions.
The cash budget should be prepared for the shortest time period for which reliable financial information can be obtained. In the case of many businesses, this may be one week. However, it is also possible to predict major cash receipts and cash payments for a specific day.
How is it prepared?
The cash budget usually consists of four major sections:
1.The receipts sections, which is the beginning cash balance, cash collections from customers, and other receipts
2.The disbursements sections, which comprises all cash payments that are expected for the budgeting period
3.The cash surplus or deficit section, which shows the difference between the cash receipts section and the cash disbursements section
4.The financing section, which provides a detailed account of the borrowings and repayments anticipated during the budgeting period
If further financing is needed, the cash budget projections allow adequate lead-time for the necessary arrangements to be made.
Cash budgets are often prepared monthly, but there are no general, it should be long enough to show the effects of your business policies, yet short enough so that estimates can be made with reasonable accuracy. Table 11.1 shows the major elements of a cash budget.
The basis for predicting cash receipts is sales, whether from cash sales or collections from customer balances. An incorrect sales estimate will result in erroneous cash estimates. The sales prediction also influences the projected cash outlays for manufacturing cost, since production is tied to sales. The projection of operating expenses may be tied to the supplier’s payment terms.
Table 11.1: Important Components of a Cash Budget
| Cash inflows | |
| Operating: | Cash sales, collections from customer on account |
| Non-operating: | Investment income (dividend income, interest income), rental income, sales of assets, amount received from debt incurrence, royalty income |
| Cash outflows | |
| Operating: | Salaries expense, rent expense, purchase of materials and supplies, payments to vendors utilities expense |
| Non-operating: | Purchases of fixed assets, repayments of loans, tax expense, purchases of stock and bonds in other companies |
Example
| FRED’S SPORTS CENTER | |
| Cash BudgetJanuary 20×8 | |
| Cash balance, Jan. 1 | $50,000 |
| Add: Cash receipts from customers | 150,000 |
| Cash available | $ 200,000 |
| Less: Cash payments | |
| For inventory | $ 40,000 |
| Rent | 10,000 |
| Insurance | 5,000 |
| Utilities | 3,000 |
| Purchase of equipment | 2,000 |
| Salaries | 12,000 |
| Taxes | 10,000 |
| Total cash payments Cash balance, Jan. 31 | $ 90,000$ 110,000 |
How is it used and applied?
The cash budget allows you to review future cash receipts and cash payments to identify possible patterns of cash flows. In this way, you can examine your collection and disbursement efforts to ascertain if you are maximizing your net cash flows. Further, the cash budget reveals when and how much to borrow and when you will be able to pay the money back. For instance, if your cash budget indicates that a large cash outlay will be needed to purchase assets such as store fixtures, you may have to borrow money and determine a debt repayment schedule. In order to obtain a credit line lenders usually required you to submit a cash budget, among with your financial statements.
Comparing estimated and actual cash figures allows you to study the reasons for any major discrepancies and to take any corrective action. Variance analysis gives you an idea of your cash position and provides insight in improving cash estimates in the next budgeting period. It also aids in the periodic revision of projections. This updating usually occurs at the beginning of each budget segment (e.g., the first day of a quarter, or the first day of a month). Budgets should be modified immediately for significant changes. Table 11.2 shows a format that may be used for variance analysis.
Variance analysis is important for a business, whether it be a retailer, wholesaler, manufacturer, or service concern. Evaluation of cash variances may be performed yearly, quarterly, monthly, or daily. If theft is suspected, variance analysis should be done frequently. After all, cash is the easiest asset to steal.
Table 11.2: Variance Analysis Report for Cash Budgeting
12. Forecasting Cash Collections
Introduction
A forecast of cash collections and potential bad debts is an essential part of cash budgeting. The critical step in making such a forecast is estimating the cash collection and bad debt percentages and applying them to sales or accounts receivable balances.
How is it computed?
The historical trend in cash collections relative to sales should be examined for the past three years. An example illustrates the technique.
Example 1
Assume that an analysis by Mr. Jones, the owner of a clothing store, of collection experience for August sales revealed the following collection data:
| Description | Percent of total credit sales | |
| Collected in | August | 2.3 |
| September | 80.2 | |
| October | 9.9 | |
| November | 5.1 | |
| December | 0.5 | |
| Cash discounts | 1.0 | |
| Bad debt losses | 1.0 | |
| Total | 100.0 |
If next year’s August sales are expected to fall into the same pattern, then the calculated percentage for August credit sales can be used to determine the probable monthly distribution of collections. The same analysis applied to each month of the year will give a reasonably reliable basis for collection forecasting.
