CASH BUDGETING

Is arrived at through a projection of future cash receipts and cash disbursements of the firm over various intervals of time. It reveals the timing and amount of expected cash inflows and outflows over the period studied.*

PREPARATION OF THE CASH BUDGET

1.) Receipts
The key to the accuracy of most cash budgets is the forecast of sales. This forecast can be based on an internal analysis, an external one, or both. Internal approach - sales representatives are asked to project sales for the forthcoming period - the product sales manager screen these estimates and consolidate them into sales estimates for product lines - the estimates for the various product lines then are combined into an overall sales estimate for the firm - internal approach can be myopic*

PREPARATION OF THE CASH BUDGET (Receipts)

External approach - economic analysts make forecasts of the economy and of industry sales for several years to come - they may use regression analysis to estimate the association between industry sales and the economy in general - after these basic predictions of business conditions and industry sales, the next step is to estimate market share by individual products, prices that are likely to prevail, and the expected reception of new products*

PREPARATION OF THE CASH BUDGET (Receipts)

Sales to Cash Receipts for cash sales, cash is received at the time of the sale for credit sales, receipts do not come until later the time will depend on the billing terms given, the type of customer, and the credit and collection policies of the firm.

Example: The Continental Sheetmetal Company offers terms of net 30, meaning that payment is due within 30 days after the invoice date. In the company's experience, 90 percent of receivables are collected, on the average, 1 month from the date of the sale, and 10 percent are collected 2 months from the date of the sale, with no bad-debt losses. Moreover, on the average, 10 percent of total sales are cash sales.

Schedule of Sales Receipts (The Continental Sheetmetal Company )

Nov.
Total Sales Credit Sales Collections, 1 month Collections, 2 months Total Collections
270

Dec.
315,000 243,000

Jan.
225,000 283,500 27,000

Feb.
180,000 202,500 31,500

Mar.
225,000 162,000 22,500

Apr.
270,000 202,500 18,000

May
315,000 243,000 22,500

June
342,000 283,500 27,000

$300,000 $350,000 $250,000 $200,000

$250,000 $300,000 $350,000 $380,000

$310,500 $234,000 25,000 20,000

$184,500 $220,500 $265,500 $310,500 25,000 30,000 35,000 38,000

Cash Sales Total sales receipts

$335,500 $254,000

$209,500 $250,500 $300,500 $348,500

If the sales forecasts are those shown in the first line of the table shown above, we can compute a schedule of the expected sales receipts based on the foregoing assumptions. * From this example, it is easy to see the effect of a variation in sales on the magnitude and timing of cash receipts, all other things being held constant.*

PREPARATION OF THE CASH BUDGET (Receipts)

Other Receipts
In addition to the collection of sales from a product or service, cash receipts may arise from the sale of assets, from sale of stock, from a debt issue, from a tax refund, and from fee income. Things of this sort are planned in advance and are predictable for purposes of cash budgeting.*
Nov.
Total Sales Credit Sales Collections, 1 month Collections, 2 months Total Collections Cash Sales Total sales receipts
270

Dec.
315,000 243,000

Jan.
225,000 283,500 27,000

Feb.
180,000 202,500 31,500

Mar.
225,000 162,000 22,500

Apr.
270,000 202,500 18,000

May
315,000 243,000 22,500

June
342,000 283,500 27,000

$300,000 $350,000 $250,000 $200,000 $250,000 $300,000 $350,000 $380,000

$310,500 $234,000 $184,500 $220,500 $265,500 $310,500 25,000 20,000 25,000 30,000 35,000 38,000

$335,500 $254,000 $209,500 $250,500 $300,500 $348,500

$40,000
used equipment

$294,000

PREPARATION OF THE CASH BUDGET

2.) Receivable Collection Period
Nov.
Total Sales Credit Sales Collections, 1 month Collections, 2 months

Dec.

Jan.
$250,000 225,000 283,500 27,000 $310,500 25,000

Feb.
$200,000 180,000 202,500 31,500 $234,000 20,000

Mar.
$250,000 225,000 162,000 22,500 $184,500 25,000

Apr.
$300,000 270,000 202,500 18,000 $220,500 30,000

May
$350,000 315,000 243,000 22,500 $265,500 35,000

June
$380,000 342,000 283,500 27,000 $310,500 38,000

$300,000 $350,000 270 315,000 243,000

Total Collections Cash Sales

Total sales receipts

$335,500

$254,000

$209,500

$250,500 $300,500

$348,500

PREPARATION OF THE CASH BUDGET

3.) Forecasting Disbursements
Given the sale forecast, management may choose to gear production closely to seasonal sales, to produce at a relatively constant rate over time, or to have a mixed production strategy. Once a production schedule has been established, estimates can be made of the needs in materials, labor, and additional fixed assets. As with receivables, there is a lag between the time a purchase is made and the time of actual cash payment. If suppliers give average billing terms of net 30 and the companys policy is to pay its bills at the end of this period, there is approximately a 1-month lag between a purchase and the payment.*

Schedule of Disbursements for Purchases and Expenses (Continental Sheetmetal Company )

Dec.
Purchases $100,000

Jan.
$80,000 100,000 80,000 50,000

Feb.

Mar.

Apr.

May

June

$100,000 $120,000 $140,000 $150,000 $150,000 80,000 80,000 50,000 100,000 90,000 50,000 120,000 90,000 50,000 140,000 95,000 50,000 150,000 100,000 50,000

Cash Payment for purchases

Wages Other expenses Total Cash expenses

$230,000 $210,000 $240,000 $260,000 $285,000 $300,000

There is a 1-month lag between the time of purchase and the payment for the purchase* Wages are assumed to increase with the amount of production Wages are generally more stable over time than are purchases.*

Different lags in the

collections of sales result when the average collections period assumption is changed

Schedule of Cash Disbursements (The Continental Sheetmetal Company ) In addition to cash expenses, we must take into account capital expenditures, dividends, federal income taxes, and any other cash outflows. Because capital expenditures are planned in advance, they usually are predictable for the short-term cash budget. As the forecast becomes more distant, however, prediction of these expenditures becomes less certain. Dividend payments for most companies are stable and are paid on specific dates. Estimation of federal income taxes must be based on projected profits for the period under review. Other cash outlays might consist of the repurchase of stock or payment of long-term debt. *
Jan.
Total cash expenses

Feb.
$210,000 150,000 ______ $360,000

Mar.
$240,000 50,000 20,000 ______ $310,000

Apr.
$260,000

May
$285,000

June
$300,000 20,000 ______ $320,000

$230,000

Capital expenditures
Dividend payments Income taxes Total cash disbursements

30,000 $260,000

30,000 $290,000

______ $285,000

PREPARATION OF THE CASH BUDGET

4.) Net Cash Flow and Cash Balance
Once we are satisfied that we have taken into account all foreseeable cash inflows and outflows, we combine the cash receipts and cash disbursements schedules to obtain the net cash inflow or outflow for each month.
Net Cash Flow and Cash Balance (Continental Sheetmetal Company)
Total cash receipts Total cash disbursements Net cash flow Beginning cash without financing Ending cash without financing

Jan. $335,500 260,000 $75,500 100,000 175,500

Feb. $294,000 360,000 $(66,000) 175,500 109,500

Mar. $209,500 310,000 $(100,500) 109,500 9,000

Apr. $250,500 290,000 $(39,500) 9,000 (30,500)

May $300,500 285,000 $15,500 (30,500) (15,000)

June $348,500 320,000 28,500 (15,000) 13,500

The net cash flow may then be added to beginning cash in January, which is assumed to be $100,000, and the projected cash position computed month by month for the period under review.

Net Cash Flow and Cash Balance (Continental Sheetmetal Company)

Total cash receipts Total cash disbursements Net cash flow Beginning cash without financing Ending cash without financing

Jan. $335,500 260,000 $75,500 100,000 175,500

Feb. $294,000 360,000 $(66,000) 175,500 109,500

Mar. $209,500 310,000 $(100,500) 109,500 9,000

Apr. $250,500 290,000 $(39,500) 9,000 (30,500)

May $300,500 285,000 $15,500 (30,500) (15,000)

June $348,500 320,000 28,500 (15,000) 13,500

The cash budget shown indicates that the company is expected to have a cash deficit in April and May. Its deficit is caused by a decline in collections through March, capital expenditures totaling $200,000 in February and March, and a cash dividend of $20,000 in March. With the increase in collections in May and June, the cash balance without financing rises to $13,500 in June. The cash budget indicates that peak cash requirements occur in April. If the firm has a policy of maintaining a minimum cash balance of $75,000 and of borrowing from its bank to maintain this minimum, it will need to borrow an additional $66,000 in March. Additional borrowings will peak at $105,500 in April, after which they will decline to $61,500 in June, if all goes according to prediction. *

PREPARATION OF THE CASH BUDGET

5.) Deviations from Expected Cash Flows
There is a tendency to place considerable faith in the cash budget simply because it is expressed in numbers. A cash budget represents merely an estimate of future cash flows. Depending on the care devoted to preparing the budget and the volatility of cash flows resulting from the nature of the business, actual cash flows will deviate more or less widely from those that were expected. Analyzing cash flows under only one set of assumptions, as is the case with conventional cash budgeting, results in a faulty perspective of the future. Take into account deviations from expected cash flows, it is desirable to work out additional cash budgets. It can base one cash forecast on the assumption of a maximum probable decline in business and another on the assumption of the maximum probable increase in business.

From the standpoint of internal planning, it is far better to allow for a range of possible outcomes than to rely solely on the expected outcome. This allowance is particularly necessary for firms whose business is relatively unstable. If a company bases its plans on only expected cash flows, it is likely to be caught flatfooted if there is a significant deviation from the expected outcome. An unforeseen deficit in cash may be difficult to finance on short notice. Therefore, it is essential for the firm to be honest with itself and attempt to minimize the costs associated with deviations from expected outcomes. It may do this by taking the steps necessary to ensure accuracy and by preparing additional cash budgets to take into account the range of possible outcomes.