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Budgeting The cash budget The cash budget is a report designed to show future movements of cash into and

out of a business. The purpose of a cash budget is to plan and control future cash movements. The cash budget may indicate shortages of cash, in which case the business may:

arrange additional finance postpone intended spending on non-current assets delay payment of outstanding debts attempt to improve debt collection change the price at which goods and services are sold

The cash budget also indicates excess cash. This enables the business to make decisions such as:

early repayment of debts to reduce interest expense investment in longer term projects offering better interest rates in preference to holding the cash in the bank a reduction in owner's equity, improving return on investment

Example Cash budget for the month ending 31 May Bank balance 1 May + estimated cash receipts Cash sales Debtors Capital Loan (received) Sale of equipment 2 100 4 000 5 000 2 500 3 000 1 000 15 500 17 600 - estimated cash payments Cash purchases 2 400

Expenses (paid) Drawings Loan (repaid) Vehicles Bank balance 31 May Budgeting requirements

3 600 2 000 1 000 6 000 15 000 2 600

When separating cash and profit it is important to recognise what is:

a receipt but not revenue revenue but not a receipt a payment but not an expense an expense but not a payment

Reasons for having shorter budget periods include:

to provide more accurate information in the budget for the business to act on to better identify periods of cash shortage leading to decisions to improve cash flow to better identify cash surplus maximising the return on excess funds to enable quicker reaction to previously unforeseen events to have better planning and control as a response to reviews of the budget with actual results

Debtors (accounts receiveable) ageing analysis

Relates to budgeting in that it is a process designed to enable a business to more accurately predict receipt of funds from individual debtors.

Information debtors (accounts receivable) ageing analysis provides

it shows for how long each individual accounts receivable has owed money to the business individual accounts receivable may be matched against the terms offered to see how they are responding when matched against discount offered the analysis reveals that accounts receivable (debtors) are eligible for discount over time the analysis provides a history of each accounts receivable, which may be matched against the cost of carrying and collecting those debts further analysis into special groups may help decision-making enables comparison with previous periods to assess performance enables estimate of cash flow into the business for cash budget purposes enables estimate of future bad debts for Profit and Loss budget purposes

What strategies can a business employ to improve debt collection?

What is more important than the actions stated above is to carefully monitor potential credit customers to avoid 'credit risk'. Having a good relationship with credit customers may help to minimise the need for the less pleasant strategies listed above. Calculating receipts from debtors All sales on credit are collected as follows:

50% in the month following sale 30% in the second month 20% in the third month

Complete the table showing cash received in the months of October, November and December. Month August September Credit sales 30 000 40 000 October November December 8 000

October November December Total

60 000 50 000 70 000

View the text document for solution to calculating receipts from debtors. A budgeting problem - Fun Run Enterprises

Fun Run enterprises commenced business in 2002. The following budgeted information for the year ending 30.6.2003 has been provided. Sales

total sales for the year is expected to be $400 000 40% of sales are for cash staff are expected to be paid $60 000 in salaries sales returns are anticipated at $3000

Goods sold

cost of goods sold is to be set at 60% of (gross) sales. All goods are bought on credit creditors are paid stock loss is expected to be $2400 stock on hand at 30.6.2003 is anticipated to be $34 000

Anticipated payments

advertising $16 000 cleaning $6000 drawings $45 000 loan repayment $10 000

Other items

discount expense $500 bad debts $2000

Balance sheet 1.7.2002 $ 11 000 32 000 1 500 52 000 80 000 (4 000) 20 000 4 400 100 000 ? ? 30.6.2003 $ ? 34 000 2 000 55 000 80 000 (12 000) 22 000 4 100 6 500 90 000

Assets Bank Stock Prepaid advertising Debtors Machinery less Accumulated depreciation Liabilities Creditors Accrued salaries Accrued interest Loan Owner's equity Capital Required

prepare a cash budget prepare a Profit and Loss statement (budgeted) - functional classification not required prepare a classified balance sheet

View the text document for solution to the Fun Run Enterprises budgeting problem. Annual sales - Fun Run Enterprises

Annual sales Fund Run

Enterprises Using variance analysis to assist in the understanding of accounting information. A variance report is used to show the difference between budgeted and actual figures. In doing so this may reflect on the performance of the firm. The variance report may be used for the cash budget, Profit and Loss statement and balance sheet. Management may seek to explain the reasons for the difference between the budgeted and actual report. There may be valid reasons for the differences that serve to excuse the person responsible for that particular area. These reasons should be offered. You should firstly indicate whether the actual figures are favourable or unfavourable when compared with the budgeted figures. A favourable result is when the result is better than expected by management. For instance, if cash sales are $40 000 in actual amount when they were expected to be only $35 000. It would be an unfavourable result if an expense is actually $2000 more than budgeted for. This does create some problems in reality. For instance, if the expense above was sales commission the business concerned may be quite happy if this expense was $2000 above budget as it may indicate that sales were also above budget. Budget variances may be linked to the responsibility given to a person or department and their performance compared with this budget. It may also be a means of control. For instance, the budget may include expenses and the business may be using the budget to set spending limits on those expenses. Cash variance analysis
A variance report shows the difference between actual figures and budgeted figures for a period of time. Variance reports may be applied to any type of financial report. The cash variance report brings together the statement of receipts and payments and the cash budget.




Favourable (F)/Unfavourable (UF)

$ Bank balance - 1 Jan. + Cash receipts 4 000

$ 4 000

Cash sales Debtors Capital Total cash received - Cash payments Advertising Sales commission Vehicles Wages Creditors Drawings Loan Rent Total cash payments Bank balance - 31 Dec.

18 800 4 000 11 600 38 400 800 500 10 000 8 000 3 000 5 000 5 000 1 000 33 300 5 100

16 800 7 600 23 000 51 400 300 200 12 000 10 000 2 000 4 000 6 500 1 100 36 100 (15 300)

- 2000 + 3 600 + 11 400 + 13 000 + 500 + 300 - 2 000 - 2 000 + 1 000 + 1 000 - 1 500 - 100 - 2 800 10 200


The preparation of the cash variance report requires the format set out. This is usually provided in the answer booklet in the examination. Many figures are also provided. Reconstruction of accounts may be necessary to determine amounts paid/received, opening or closing balances. You will also have to determine arithmetically the amount of the variance and whether it has been favourable or unfavourable. Marks are hard to get and showing all cash receipts entries correct in all columns may only earn a single mark. Many students lose marks by not showing totals for cash receipts, payments and the bank balance. From the above variance you may be asked:

to comment on liquidity and to suggest strategies to help improve liquidity to explain the deterioration in liquidity to comment on whether the increased spending on vehicles is necessarily unfavourable to link the decline in sales to other expenses and suggest reasons why this occurs

A task on variance analysis The following reports include the budgeted figures for Fun Run. You are now provided with the actual figures and are asked to show the variance and state

whether it is favourable or not. The first step in the process of variance analysis is to state the amount of variance. For instance, if cleaning is budgeted for $6000 and you actually pay $7000 then the variance is $1000. The second step is to state whether this is favourable (F) or unfavourable (UF). This process is 'mechanical' in that it does not allow for subjective opinion. An increase in spending on advertising would be regarded as 'unfavourable' yet it may result in a substantial increase in sales. That would be regarded as favourable. The example for cleaning is shown. The third step is to 'explain' why the variation took place. When making this explanation you may have to consider an interrelationship with other items. Often these items are contained in the relevant ledger accounts. Take the case of debtors. The closing balance in the debtors account will be affected by credit sales. An increase in credit sales has the potential to increase the closing balance. However, cash received from debtors, bad debts and discount reduce the debtors closing balance. An increase in discount should encourage debtors to pay more quickly. Improvement in sales may be related to increases in selling expenses such as sales, salaries and advertising. It may also be due to an increase in non-current assets, in particular new premises, motor vehicles or equipment. In fact if certain expenses or non-current assets increase and sales do not respond you have to challenge why that expenditure was undertaken. Learn to think in opposites. The explanation for debtors given above applies in the same way to creditors. Because we are using the perpetual stock approach you must link creditors to stock control. In a similar way cost of sales, which reduces the stock control balance is linked to sales. Sales may increase as a result of more units being sold, or as a result of increased prices. If more units are sold then we would expect an increase in cost of sales. This leads to changes in stock control and creditors (if the stock is bought on credit). View the text document for solution to the task on variance analysis. Variance reports Advice To complete the variance reports the following steps are necessary. Cash budget 1. Take the opening bank balance and add that to the total of cash receipts.

2. Total cash payments. 3. Deduct item 2 from item 1 to arrive at the closing bank balance. 4. Transfer the closing bank balance to the Balance sheet as the amount for 'Bank'. Profit and Loss statement 1. Determine net profit by deducting the total of expenses from adjusted gross profit. 2. Transfer the net profit to the Owner's equity section of the balance sheet. Balance sheet 1. Total current assets (after the inclusion of bank). 2. Determine the new figure for machinery. 3. Add depreciation from the Profit and Loss statement to accumulated depreciation ($4 000 on 1 July2002) to get the new figure for that item. 4. Total non-current assets. 5. Add current and non-current assets to get total assets. 6. Total current liabilities. 7. Insert net profit. 8. Insert drawings. 9. Determine total equities. In preparing this problem the following accounts had to be reconstructed:

debtors creditors stock control advertising

salaries loan

View the text document for solution to Variance reports.

Comments may also be made as to the best strategy to recover these outstanding debts. It is important to know what the credit policy of the business is, before commenting on the performance of the business in collecting of outstanding debts. In this case if 30 days is given for payment then performance is poor, as only 44% have been collected in that time. Should it be 60 days then performance is much better with 80% collected (44% + 36%). It is very important to watch the pattern emerging in the collection of debts and be wary of any deterioration. Outstanding debts constitute unproductive funds and it is in the interest of the business to collect these debts as soon as possible.