Learning Objective

• Guide the participants on how to prepare the cash budget

• Cash Budget

What to include in a cash budget

A cash budget is prepared to show the expected receipts of cash and payments of cash during a budget period.

Receipt of cash may come from one or more of the following

• Cash sales.
• Payment of debtors (credit sales).
• The sale of fixed assets.
• The issue of new shares or loan stock.
• Receipt of interest and dividends from investments outside the business.

Remember not all these cash transactions will appear in the Profit and Loss Account, some are recorded straight to the Balance Sheet. For example issue of shares and disposal of assets. Payments of cash may be for one or more of the following.

• Purchase of stock.
• Payroll costs or other expenses.
• Purchase of capital items.
• Payment of interest, dividends and taxation.

It should be obvious that the Profit or Loss made by an organization during an accounting period does not reflect its cash flow position for the following reasons.

1. Not all cash receipt affects profit and loss account income.
2. Not all cash payments affect profit and loss account expenditure.
3. Some costs in the profit and loss account such as profit or loss on sale of fixed assets or depreciation are not cash items but are costs derived from accounting conventions.
4. The timing of cash receipts and payments may not coincide with the recording of profit and loss account transactions. For example dividend may be declared in 2003 and shown in profit and loss account for that year but the payment can be made in 2004.

Example of Cash Budget

James Banda has been working as a Transport Manager for GDC Ltd and has retired. He intends to start up in business on his own account, using K150, 000 which he has invested at New Building Society. James maintains an account with National Bank with a minimal balance but intends to approach the bank for the necessary additional finance.

Peter asks you for advice and provides the following additional information.

1. Arrangements have been made to purchase fixed assets costing K80,000. These will be paid for at the end of September and are expected to have a five year life, at the end of which they will possess a nil residual value.
2. Stocks costing K50,000 will be acquired on 28 September and subsequently monthly purchases will be at a level sufficient to replace forecast sales for the month.
3. Forecast monthly sales are K30,000 for October, K60,000 for November and December, and K105,000 from January 2004 on wards.
4. Selling price is fixed at the cost of stocks plus 50%.
5. Two month’s credit will be allowed to customers but one month’s credit will be received from suppliers of stock.
6. Running expenses, including rent but excluding depreciation of fixed assets are estimated at K16,000 per month.
7. James intends to make monthly cash drawings of K10,000.

Prepare a cash budget for six months to 31 March 2004.

SOLUTION

The opening cash balance at 1 October will consist of James initial K150,000 less the K80,000 expended on fixed assets purchased in September. In other words, the opening balance is K70,000. Cash receipts from credit customers arise in two months after the relevant sales.

Payments to suppliers are a little trickier. We are told that cost of sales is 100/150* sales. Thus for October cost of sales is 100/150* K30,000 = K20,000. These goods will be purchased in October but not paid until November. Similar calculations can be made for the later months. The initial stocks of K50, 000 is purchased in September and consequently paid for in October.

Depreciation is not a cash flow and so is not included in a cash budget.

The cash budget can now be prepared as follows:

Cash budget for the six month ending 31 March 2004

Cash budget analysis

As stated above Cash budget assist the managers to forecast their future cash requirements and therefore make necessary arrangements before hand. As in the above case it shows that the maximum cash deficit which the business is going to face is K121,000.

Some of the remedies include:

• Postponing purchase of fixed assets or use finance lease to acquire the assets thereby releasing cash.
• Negotiate a quicker payment period for customers or negotiate for more credit days with the suppliers.
• Obtain a bank short loan, or negotiate a bank overdraft.
• Reduce the level of monthly drawings if possible.