The Cash Budget
One of the major functions of corporate finance is to anticipate the need for funds in the company. Although there are several methods for forecasting these needs, the cash budget is the most accurate (and most commonly used) method available. Cash flows through a company like water flows through a pipe. (See the cash flow pipeline.) A cash budget essentially maps out these cash flows and indicates the period in which they will occur. Cash budgeting, at its core, is a very simple procedure that simulates cash flowing through a company.
If we can accurate estimate (1) the amounts and (2) the timing of these cash flows, then we can also estimate whether the company will experience a shortage of cash (or an excess of cash) during any given month. The primary cash inflows for a company consist of (1) cash sales and (2) collection of accounts receivable. An accurate sales forecast is a necessity if we are to construct an accurate cash budget. If we then know the terms that we sell on (2/10, net 30, for example) and the past payment experience of our customers, we can estimate the amount and timing of these collections. The primary cash outflows are generally (1) payments on purchases, (2) labor costs, and (3) capital purchases (i.e., fixed assets). Other large payments may include rent, taxes, and These and other cash outflows must be estimated as to the amount and timing of the payments.
Pro Forma Statements
It is also useful to know what the company’s income statement will look like for the forecasted period and what the balance sheet will look like at the end of the forecasted period. If either of these two statements show weaknesses, we can plan now to take steps that will prevent these deficiencies from occurring. Fortunately, cash budgets and pro forma statements are easily programmed using electronic spreadsheets like Microsoft Excel. This is especially handy since cash budgets involve a large number of relatively simple calculations.
Cash budgets are usually placed on an electronic spreadsheet, where data may be entered and updated frequently. The two spreadsheets below are examples of spreadsheets for 3-month and 12-month planning periods.
Let’s consider a sample cash budgeting problem, with its solution. An explanation of how the numbers are determined may be seen by clicking on the appropriate links in the “Solution” section of this page.
A SAMPLE PROBLEM
Glenda Byers has gathered the data below needed for the preparation of a cash budget for the months of October, November, and December. SALES: (Actual sales for August and September, forecasted sales for October – February) August | $ 45,000 |
September | 54,000 |
October | 65,000 |
November | 75,000 |
December | 93,000 |
January | 71,000 |
February | 55,000 |
Based on the past history and current credit terms offered by her firm, Glenda has estimated the following payment schedule for sales: 25% of total sales will be cash sales; 60% of total sales will be collected in the month following the sale; 15% of total sales will be collected in the second month following the sale . (Note: Notice that since the three above collections total 100%, no bad debts on accounts receivable are anticipated. If we anticipated a 2% bad debt rate, we could change the 15% number above to 13%. We would then be anticipating that we would collect only 98% of the total sales.)
The company’s markup on inventory is two-thirds of the cost (e.g. a $40 profit on an item which cost $60.) In other words, the cost of the merchandise is 60% of the final selling price. The firm purchases enough inventory to cover sales one month in the future. Based on current credit
terms, Glenda expects the following repayment schedule: 12% of purchases are paid for in cash;
78% are paid one month following the purchase, and
10% are paid for two months after the purchase.
EXPENSES (per month, unless otherwise noted):
Mortgage Payment | $ 2,300 |
Wages and Salaries | 3,200 |
Lease Payments | 750 |
Capital purchases (to be purchased in October) | 7,600 |
Property Taxes (to be paid in December) | 11,800 |
Other Expenses (%) | 10% of sales |
* As of October 1st, the firm has $3,000 in its checking account at the bank.
* The firm desires to have a minimum cash balance of $3,000 at all times.
2. Loan Information:
* As of October 1st, the company’s loan balance was $2,000. * The company’s bank requires that interest be paid each month. The interest to be paid is the interest due on the previous month’s loan balance. The interest rate is 1.0% per month on the outstanding balance at the end of the previous month. 3. Fixed Assets: The firm depreciates all capital equipment purchases over a five-year period using the straight line method. 4. Minimum inventory: The firm keeps $30,000 of safety stock on hand at all times.
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