Preparing Cash Budgets John Ogivie, author of the CIMA Study System Finance, gives some usefu tips on this popuar examination topic. The management of cash resources hods a centra position in the area of short-term financing decisions. Resuts of investment decisions are estimated in cash terms and the vaue of a company to a sharehoder ies in its abiity to add to their command over resources over time, which means to add to the sharehoder s command over cash. Cash management is part of the wider task of treasury management, which covers not ony the management of the company s cash in the norma course of business making sure the company aways has enough cash on hand to meet its bis and expenses, and investing any surpus cash but aso other things too. Exampes incude foreign exchange deaings when the company either imports or exports goods, arranging suitabe mixes of short-, medium- and ong-term borrowing, and deaing on the foreign currency markets and the Eurocurrency market to maximise investment opportunities or to borrow funds on the most advantageous terms. However, hoding cash carries with it a cost the opportunity cost of the profits which coud be made if the cash was either used in the company or invested esewhere. Therefore, a company has to baance the advantages of iquidity against profitabiity: cash shoud be hed unti the margina vaue of the iquidity it gives is equa to the vaue of the interest ost. Cash management is therefore concerned with optimising the amount of cash avaiabe to the company and maximising the interest on any spare funds not required immediatey by the company. It is vita for organisations to identify their cash requirements, so as to optimise the method of financing. It is equay important, therefore, for organisations to budget for future financing needs so that the funding process can be panned and achieved as smoothy and efficienty as possibe. Cash budgets are vita to the management of cash. They show, over periods varying between a singe day, a week, a month, a year or even onger, the expected infows and outfows of cash through the company. They hep to show cash surpuses and cash shortages. Management can therefore use cash budgets to pan ahead to meet those eventuaities arranging borrowing when a deficit is forecast, or buying short-term securities during times of excess cash. The accuracy of the budget depends on the forecasts on which it is based, principay the forecast of future saes. This affects not ony the amount of cash that wi come into the company but aso the timing of the receipts: credit saes wi mean that payment for goods is deayed a month or two, whie seasona saes wi mean that the company wi have some months of arge cash infows and some of much smaer ones. This causes probems because, generay, cash outfows associated with production and day-to-day operations do not vary as much. The company may thus face cash shortages at times during the budget period and these wi have to be made up somehow. CIMA 2002 1
Deviations from budgeted figures are amost inevitabe and so some organisations wi prepare severa budgets based on possibe future situations: an optimistic budget which assumes that the company achieves aboveforecast growth; a pessimistic budget, which assumes beow-forecast growth; a target budget, which assumes forecast growth is achieved. Computer spreadsheets are amost essentia to modern organisations, as they aow managers to change their origina specifications to present aternative versions of the future. Four distinct stages are invoved in the preparation of cash budgets: 1. Forecast the anticipated cash receipts. The main source of cash is ikey to be saes and the saes forecast wi therefore be the primary data source. Saes can be divided into cash saes and credit saes, the cash fow arising from the atter depending on the agreed credit terms. Thus, for exampe, the saes forecast for January woud appear in the cash budget in Apri if a saes were on credit terms of 90 days. Other cash receipts woud incude income on investments, cash from saes of fixed assets, etc. 2. Forecast the anticipated cash payments. The principa payment is generay the payment of trade purchases. Once again, the credit period taken must be aowed for. Other cash payments incude wages and saaries, administrative costs, taxation, capita expenditure and dividends. 3. Compare the anticipated cash payments and receipts to determine the net cash fow for each period. 4. Cacuate the cumuative cash fow for each period by adding the opening cash baance to the net cash fow for the period. Remember that there wi be differences between the cash budget for a period and the forecast profit and oss account for that period. This is because the cash budget is concerned with cash payments and cash receipts, whie the profit and oss account is concerned with income earned and expenses consumed in a period. Areas where the two statements may show different amounts are: the cash budget wi record budgeted cash receipts from customers, whie the profit and oss account wi show forecast saes for the period; the cash budget wi record budgeted cash payments to suppiers, whie the profit and oss account wi show forecast cost of saes, which wi refect opening stock, pus purchases, ess cosing stock; CIMA 2002 2
the cash budget shows the budgeted cash payments for expenses such as wages, eectricity and rates. The profit and oss account wi record the expenditure expected to be consumed in the period which wi refect any accruas or prepayments; the cash budget wi refect the cost of purchasing a fixed asset at the expected date of purchase and the proceeds at the date of sae. The profit and oss account wi record a depreciation charge for the consumption of the asset and a profit or oss on disposa; the cash budget wi show the anticipated payment for tax nine months after the end of the previous accounting period. The profit and oss account wi show the expected tax charge against profits earned in that period. Exercise The foowing information reates to Manse Ltd, a pubishing company. The seing price of a book is 15, and saes are made on credit through a book cub and invoiced on the ast day of the month. Variabe costs of production per book are materias ( 5), abour ( 4), and overhead ( 2). The saes manager has forecast the foowing voumes: Nov Dec Jan Feb Mar Apr May Jun Ju Aug No of books: 1,000 1,000 1,000 1,250 1,500 2,000 1,900 2,200 2,200 2,300 Customers are expected to pay as foows: One month after the sae 40% Two months after the sae 60% The company produces the books two months before they are sod and the creditors for materias are paid two months after production. Variabe overheads are paid in the month foowing production and are expected to increase by 25 per cent in Apri; 75 per cent of wages are paid in the month of production and 25 per cent in the foowing month. A wage increase of 12.5 per cent wi take pace on 1 March. The company is going through a restructuring and wi se one of its freehod properties in May for 25,000, but it is aso panning to buy a new printing press in May for 10,000. Depreciation is currenty 1,000 per month, and wi rise to 1,500 after the purchase of the new machine. The company s corporation tax (of 10,000) is due for payment in March. The company presenty has a cash baance at bank on 31 December 1999, of 1,500. Required Produce a cash budget for the six months from 1 January 2000 to 30 June 2000. Soution CIMA 2002 3
Workings 1. Saes receipts Month Nov Dec Jan Feb Mar Apr May Jun Forecast saes (S) 1,0001,0001,0001,2501,5002,0001,9002,200 S x 15 15,00015,00015,00018,75022,50030,00028,500 33,000 Debtors pay: 1 month 40% 6,0006,0006,0007,5009,00012,00011,400 2 month 60% 9,0009,0009,00011,25013,50018,000 15,00015,00016,50020,25025,50029,400 2. Payment for materias books produced two months before sae Month Nov Dec Jan Feb Mar Apr May Jun Qty produced (Q) 1,0001,2501,5002,0001,9002,2002,2002,300 Materias (Q 5) 5,0006,2507,50010,0009,50011,00011,00011,500 Paid (2 mths after) 5,0006,2507,50010,0009,50011,000 3. Variabe overheads Month Nov Dec Jan Feb Mar Apr May Jun Qty produced (Q) 1,0001,2501,5002,0001,9002,2002,2002,300 Var. overhead (Q 2) 2,000 2,500 3,000 4,000 3,800 Var overhead (Q 2.50) 5,5005,5005,750 Paid one month ater 2,0002,5003,0004,0003,8005,5005,500 4. Wages payments Month Dec Jan Feb Mar Apr May Jun Qty produced (Q) 1,2501,5002,0001,9002,2002,2002,300 Wages Q 4 5,000 6,000 8,000 Wages Q 4.50 8,5509,9009,90010,350 75% this month 3,7504,5006,0006,4137,4257,4257,762 25% next month 1,2501,5002,0002,1372,4752,475 5,7507,5008,4139,5629,90010,237 Cash budget six months ended June Jan Feb Mar Apr May Jun Receipts: Credit saes 15,000 15,000 16,500 20,250 25,500 29,400 Premises disposa 25,000 15,000 15,000 16,500 20,250 50,500 29,400 Payments: Materias 5,000 6,250 7,500 10,000 9,500 11,000 Var overheads 2,500 3,000 4,000 3,800 5,500 5,500 CIMA 2002 4
Wages 5,750 7,500 8,413 9,562 9,900 10,237 Fixed assets 10,000 Corporation tax 10,000 13,250 16,750 29,913 23,362 34,900 26,737 Net cash fow 1,750 (1,750) (13,413) (3,112) 15,600 2,663 Baance b/f 1,500 3,250 1,500 (11,913) (15,025) 575 Cumuative cash fow 3,250 1,500 (11,913) (15,025) 575 3,238 Short-term cash deficits are usuay financed (by defaut) by utiising the company s overdraft faciity. In the exampe above, we are not aware of any overdraft faciity and as such need to identify a suitabe method of financing the deficit that exists in March and Apri. Efficiency improvements arising from prompt banking are unikey to reease sufficient funds to cover a cash requirement of 15,025, so Manse Ltd shoud consider the foowing steps: Deay major items of capita expenditure. The purchase of the new printing press coud be deayed and athough this woud not affect the deficit in March or Apri, deaying the purchase unti, say, June or Juy woud ease the cash drain in a very difficut month particuary if the premises sae did not go through in May. Improve coection period or deay creditor coection period. This was referred to above and there are associated probems (such as ost customers). However, if Manse Ltd coud increase the debtor coection period so that 80 per cent of money was coected one month after the sae and ony 20 per cent two months after the sae, the cash fow woud benefit significanty. Simiary, if payments for materias coud be deayed by another month (athough this woud seem unikey) this woud aso have a beneficia effect. Reduce stock eves. Manse Ltd is effectivey hoding two months stock. Cash fow woud improve if this figure was reduced. Deay non-essentia payments. Deaying the corporation tax coud be probematic: woud the Inand Revenue consider payment by instaments? If none of the above is possibe, then the company must consider approaching a bank to obtain an overdraft faciity or consider some form of factoring, invoice discounting, or sae and easeback. The Study Systems are core texts on the recommended reading ist, and are avaiabe from CIMA Pubishing at 33.00 each. For further information, contact CIMA Pubishing by Phone: +44 (0)20 8849 2229/2277/2270, Fax: +44 (0)20 8849 2465, E-mai: pubishing.saes@cimagoba.com Internet: www.cimapubishing.com CIMA 2002 5
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