1. Cash Budget

2. Budgets A budget is a short term financial plan A budget is a short term financial plan CIMA defines a budget as a “plan expressed in money” CIMA defines a budget as a “plan expressed in money” Budget are prepared in advance Budget are prepared in advance They concern what is forecast and planned for the period of the budget They concern what is forecast and planned for the period of the budget A cash flow forecast is budget dealing with planned inflow and outflow of cash A cash flow forecast is budget dealing with planned inflow and outflow of cash

3. Cash flow forecast Cash flow refers to the movement of cash into and out of a business Cash flow refers to the movement of cash into and out of a business Cash budgets Cash budgets –Seek to predict the flow of cash into and out of the business –Are forecasts enabling businesses to manage cash flow –Are an essential part of the planning process

4. Internal and external use Banks and other lenders will insist on a cash budget before granting a loan Banks and other lenders will insist on a cash budget before granting a loan The potential creditor will seek assurance that net cash inflows will be sufficient to repay the loan with interest The potential creditor will seek assurance that net cash inflows will be sufficient to repay the loan with interest But even if the business is not seeking a loan it is still important to construct a cash budget But even if the business is not seeking a loan it is still important to construct a cash budget This is to ensure that the business will be able to meet its obligations as they arise and, equally important, to take advantage of any surplus cash This is to ensure that the business will be able to meet its obligations as they arise and, equally important, to take advantage of any surplus cash

5. The purpose of a cash budget To know in advance what the likely cash balance at the end of each month To know in advance what the likely cash balance at the end of each month To increase management awareness of potential shortages and surpluses of cash To increase management awareness of potential shortages and surpluses of cash To avoid problems associated with lack of cash to pay debts To avoid problems associated with lack of cash to pay debts To fine tune operations to ensure adequate cash is available To fine tune operations to ensure adequate cash is available To arrange financing to cover a period of cash shortage To arrange financing to cover a period of cash shortage To provide information to make decisions on the use of cash surplus To provide information to make decisions on the use of cash surplus

6. Compare with other accounting statements Profit and loss account Deals with sales revenue, associated costs and profit rather than cash flow Balance sheet Deals with assets, liabilities and capital Cash flow statement Concerns inflow and outflow of cash Cash budget or cash flow forecast Concerns forecast inflow and outflow of cash Unlike the other three, this is drawn up in advance rather than after the event Also, it is an internal document only shown to external stakeholders (potential creditors) when seeking a loan

7. Comparisons of Cash & P&L Budgets Budget profit and loss account Forecasts sales revenue, associated costs and profit Forecasts sales revenue, associated costs and profit Includes all forecast sales and associated spending for the year- whether or not cash flows Includes all forecast sales and associated spending for the year- whether or not cash flows Depreciation is a negative item Depreciation is a negative item Does not include planned capital expenditure or raising finance Does not include planned capital expenditure or raising finance Cash budget Forecasts inflow and outflow of cash Forecasts inflow and outflow of cash Only includes transactions where cash flows Only includes transactions where cash flows Depreciation is ignored as a non-cash item Depreciation is ignored as a non-cash item Includes everything where cash moves in or out of the business Includes everything where cash moves in or out of the business

8. If it moves count it! Accounting is characterised by rules about how items are treated - the rules behind accounting have their own logic even though outsiders can find them baffling. Accounting is characterised by rules about how items are treated - the rules behind accounting have their own logic even though outsiders can find them baffling. Cash budgeting on the other hand is based on a few very simple rules: Cash budgeting on the other hand is based on a few very simple rules: If it leads to a cash flow (into or out of the business) count it If it leads to a cash flow (into or out of the business) count it If there is no cash flow then ignore it If there is no cash flow then ignore it If cash flows in, it is a positive item If cash flows in, it is a positive item If cash flows out, it is a negative item If cash flows out, it is a negative item

9. Constructing a cash budget

10. Importance of Spreadsheets Cash budgets are best produced using a spreadsheet Cash budgets are best produced using a spreadsheet Each column represents a month of the year whereas each row across represents various categories of inflow and outflow Each column represents a month of the year whereas each row across represents various categories of inflow and outflow The use of a spreadsheet not only improves presentation and but also makes it easier to make amendments where necessary The use of a spreadsheet not only improves presentation and but also makes it easier to make amendments where necessary The planned inflows and outflows are recorded in the cells of the spreadsheet - so we have a record of not just how much but also when the cash is expected to flow The planned inflows and outflows are recorded in the cells of the spreadsheet - so we have a record of not just how much but also when the cash is expected to flow

11. Components of a cash budget Cash inflow Inflow from cash sales, credit sales and from the introduction of capital Cash outflow Outflow resulting from revenue and capital expenditure Net cash flow Cash inflow minus cash outflow Opening balance Cash and money held in bank account at the start of the month Closing balance Opening balance plus net cash flow for the period

12. Cash inflow From sales From sales –Cash from sales. –Cash from credit sales (comes in after a time lag) From owners From owners –Cash from a share issue-capital invested in the business From lenders From lenders –Bank loan Cash from the disposal of unwanted assets Cash from the disposal of unwanted assets –E.g. disposal of fixed assets

13. Forecasting cash inflow This is the greatest problem in constructing the budget This is the greatest problem in constructing the budget For an established business forecast sales will be based on time series analysis (e.g. moving averages). This involves isolating the trend and extrapolating it into the future For an established business forecast sales will be based on time series analysis (e.g. moving averages). This involves isolating the trend and extrapolating it into the future Forecasting is more difficult for start up businesses with no past track record Forecasting is more difficult for start up businesses with no past track record As well as customer demand, the forecast should take the firm’s capacity into account As well as customer demand, the forecast should take the firm’s capacity into account As well as forecasting total sales it is also necessary to forecast timing and the likely balance between cash and credit sales As well as forecasting total sales it is also necessary to forecast timing and the likely balance between cash and credit sales Remember credit sales in January might not result in a cash inflow until February or March Remember credit sales in January might not result in a cash inflow until February or March

14. Types of cash outflows Purchases of stock paid for in cash Purchases of stock paid for in cash Payment to creditors Payment to creditors Payment of wages Payment of wages Payment of rent Payment of rent Payment of insurance premium Payment of insurance premium Expenditure on marketing Expenditure on marketing Purchase of fixed assets Purchase of fixed assets Payment of interest on debt Payment of interest on debt Payment of tax Payment of tax Any purchase on credit will show up in column of the month in which cash flowed out Any purchase on credit will show up in column of the month in which cash flowed out

15. Purchases of stock This will be a major ongoing item in the cash budget This will be a major ongoing item in the cash budget Stocks bought on credit will usually be paid for in a subsequent month. As with cash inflow from sales, purchase of stocks in a cash budget will show up in the month in which the cash flowed out Stocks bought on credit will usually be paid for in a subsequent month. As with cash inflow from sales, purchase of stocks in a cash budget will show up in the month in which the cash flowed out Normally there is a mathematical relationship between sales and purchases. For instance purchases of stock might be one-third of sales revenue Normally there is a mathematical relationship between sales and purchases. For instance purchases of stock might be one-third of sales revenue This relationship will be used when constructing a cash budget This relationship will be used when constructing a cash budget

16. Timing of cash flows is all- important Remember the cash budget does not record when the sale or purchases are expected to be made Remember the cash budget does not record when the sale or purchases are expected to be made Instead it records when cash moved Instead it records when cash moved –When the cash from credit sales is expected to flow into the business –When the cash for credit purchases is expected to flow out of the business

17. Net cash flow Net cash flow is equal to Net cash flow is equal to –Cash inflow for the period (e.g. a month) minus –Cash outflow for the same period Negative cash flow: outflows exceed the inflows Negative cash flow: outflows exceed the inflows Positive cash flow: inflows exceed the outflows Positive cash flow: inflows exceed the outflows

18. Opening balance This refers to the cash position at the start of the month This refers to the cash position at the start of the month Assuming that all money is banked and all payment is made from the firm’s bank account, the opening balance is the state of the firm’s account at the start of the month Assuming that all money is banked and all payment is made from the firm’s bank account, the opening balance is the state of the firm’s account at the start of the month This could be positive or it could be negative This could be positive or it could be negative

19. Closing balance This equals the opening balance plus the net cash flow This equals the opening balance plus the net cash flow Remember that it is possible for opening balance to be negative-similarly the net cash flow could be negative Remember that it is possible for opening balance to be negative-similarly the net cash flow could be negative When you add the opening balance and closing balance together be careful about negative and positive values When you add the opening balance and closing balance together be careful about negative and positive values The closing balance of one month becomes the opening balance of the next The closing balance of one month becomes the opening balance of the next

20. Putting it all together - example (£k)JanFebMarch Cash receipts 250260280 Cash payments 340280240 Net cash flow (90)(20)40 Opening balance (120)(210)(230) Closing balance (210)(230)(190)

21. Commentary on the example We start the year with a bank overdraft of £120K We start the year with a bank overdraft of £120K In January cash payments are expected to exceed cash inflow from sales by £90k In January cash payments are expected to exceed cash inflow from sales by £90k With a net cash outflow, the forecast overdraft at the end of the month shows a rise With a net cash outflow, the forecast overdraft at the end of the month shows a rise The closing balance at the end of January becomes the opening balance for February The closing balance at the end of January becomes the opening balance for February Cash inflow is expected to improve in February but a net cash outflow is still expected for the month. As a result the overdraft is forecast to rise Cash inflow is expected to improve in February but a net cash outflow is still expected for the month. As a result the overdraft is forecast to rise In March there is an expected net cash inflow In March there is an expected net cash inflow A reduction in the overdraft is projected and this is the sum that will be taken into April as the opening balance A reduction in the overdraft is projected and this is the sum that will be taken into April as the opening balance

22. Uses of a cash budget

23. The role of a cash budget Highlights when cash balances are expected to be positive so that surplus cash can be invested appropriately Highlights when cash balances are expected to be positive so that surplus cash can be invested appropriately Identifies when outflows might exceed inflow Identifies when outflows might exceed inflow Ensures that the firm has sufficient cash to carry out planned activities Ensures that the firm has sufficient cash to carry out planned activities Ensures that cash balances are sufficient to meet expected payments Ensures that cash balances are sufficient to meet expected payments Justify to lenders that any borrowed funds can and will be repaid Justify to lenders that any borrowed funds can and will be repaid Plan when and how to finance significant items of expenditure Plan when and how to finance significant items of expenditure Plan for any bank overdraft or loan which may become necessary Plan for any bank overdraft or loan which may become necessary Control cash flow by comparing actual events against plans Control cash flow by comparing actual events against plans Optimise the holdings of cash (e.g. invest surplus cash) Optimise the holdings of cash (e.g. invest surplus cash)

24. What if questions Cash budgets produced on a spreadsheet are especially useful in answering “what if” questions Cash budgets produced on a spreadsheet are especially useful in answering “what if” questions What will be the impact on cash flow of What will be the impact on cash flow of –a rise in the cost of stock? –a rise in interest payments or rent? –investment in new fixed assets? –a wage rise? –lower than expected sales? If we change in one cell of the spreadsheet we can rapidly analyse the new scenario If we change in one cell of the spreadsheet we can rapidly analyse the new scenario

25. Cash budgets and new businesses A cash budget is an essential part of a business plan and loan application A cash budget is an essential part of a business plan and loan application The typical start up business will experience negative net cash flow in the early months or even years The typical start up business will experience negative net cash flow in the early months or even years This is because of high start-up costs and slow growth in sales This is because of high start-up costs and slow growth in sales The cash budget helps owners/ managers to plan finance in order to steer the business through this difficult period The cash budget helps owners/ managers to plan finance in order to steer the business through this difficult period

26. Seasonality Although we associate seasonality with Easter eggs, firework, tourism and sun tan lotion the fact is that a large proportion of all businesses experience some seasonal fluctuations in sales Although we associate seasonality with Easter eggs, firework, tourism and sun tan lotion the fact is that a large proportion of all businesses experience some seasonal fluctuations in sales Seasonality will be reflected in the cash budget - there will be periods of net cash outflow caused by low seasonal sales and these will be followed by periods of net cash inflow during the peak season Seasonality will be reflected in the cash budget - there will be periods of net cash outflow caused by low seasonal sales and these will be followed by periods of net cash inflow during the peak season A cash budget enables manager to plan spending to cope with this problem A cash budget enables manager to plan spending to cope with this problem

27. Monitoring and control It is usual to subdivide the column for each month into: It is usual to subdivide the column for each month into: –the budgeted cash receipts/payments forecast for the month –the actual cash receipts/receipts in the month There difference between the two figures is known as a variance There difference between the two figures is known as a variance

28. Favourable and adverse variances A favourable variance is one where the actual figure is better than the budget (or forecast) figure: A favourable variance is one where the actual figure is better than the budget (or forecast) figure: –cash receipts higher than expected –cash payments lower than expected An adverse variance is unfavourable. The actual figure is worse than the budget figure: An adverse variance is unfavourable. The actual figure is worse than the budget figure: –cash receipts lower than expected –cash payments higher than expected

29. Variances - example ItemBudgetActualVariance F or A? Cash inflow 25026010Favourable Cash outflow 340370(30)Adverse Net cash flow (90)(110)(20)Adverse Opening balance (120)(120)0 As expected Closing balance (210)(230)(20)Adverse

30. Variances - questions to ask Variances - questions to ask What was the size of the variance? What was the size of the variance? What was the variance as a percentage of the budget figure? What was the variance as a percentage of the budget figure? Was it favourable or adverse? Was it favourable or adverse? Was the variance within normal tolerance? Was the variance within normal tolerance? What is the explanation for the variance? What is the explanation for the variance? We did not foresee it but was it foreseeable? We did not foresee it but was it foreseeable? What can we do get back on track? What can we do get back on track?

31. Some explanations for variances Incorrect sales forecasts Incorrect sales forecasts Change in the environment leading to reduced sales Change in the environment leading to reduced sales Suppliers insist on payments more rapidly than expected Suppliers insist on payments more rapidly than expected Unexpected rise in costs Unexpected rise in costs Production problems leading to reduced output and sales Production problems leading to reduced output and sales Discounts offered to boost sales Discounts offered to boost sales

32. Cash management

33. Aim – to have the right amount of cash available at the right time Aim – to have the right amount of cash available at the right time There is a trade off between liquidity and opportunity costs There is a trade off between liquidity and opportunity costs –liquidity is needed in order to settle debts as they fall due –but the opportunity cost of holding cash is the loss of earnings from using cash Good cash management requires: Good cash management requires: –accurate cash flow forecasting and monitoring –obtaining short-term borrowing when needed –investing any surplus cash

34. Cash shortages Shortages of cash results in Shortages of cash results in –creditors being unpaid –legal action for recovery of debt –inability to purchase stocks –refusal to supply more credit –disruption to production –resultant loss of sales –labour unrest through inability to pay wages –business failure

35. Surplus cash Surplus cash Cash rich businesses often fail to take advantage of a cash surplus Cash rich businesses often fail to take advantage of a cash surplus Surplus cash can be Surplus cash can be –spent on stock –used to purchase fixed assets –deposited in an interest bearing account –invested in R&D –used to finance acquisitions –invested in new products –lent in tax efficient ways

36. Causes of cash flow problems Over-investment in fixed assets Over-investment in fixed assets Overtrading - rapid expansion with insufficient working capital Overtrading - rapid expansion with insufficient working capital Poor credit control - excessive credit, late payment by debtors, bad debt Poor credit control - excessive credit, late payment by debtors, bad debt Suppliers wanting quick payment Suppliers wanting quick payment Stock piling - excessive investment in stock Stock piling - excessive investment in stock Seasonal variations in sales and cash flow Seasonal variations in sales and cash flow Over borrowing at high interest rates Over borrowing at high interest rates Changing tastes - decline in sales Changing tastes - decline in sales Management error-poor planning Management error-poor planning

37. Solution: increase inflow Sell idle fixed assets Sell idle fixed assets Sale and leaseback Sale and leaseback Stimulate sales by price discount Stimulate sales by price discount Improve debtor control – chase debtors Improve debtor control – chase debtors Discounts for prompt customer payment Discounts for prompt customer payment Tighter credit control Tighter credit control Debt factoring Debt factoring Raise more capital Raise more capital Arrange overdraft facilities Arrange overdraft facilities

38. Solution: reduce outflow Lengthen supplier credit terms Lengthen supplier credit terms Postpone investment Postpone investment Reduce stock holding-adopt lean production techniques (e.g. JIT) Reduce stock holding-adopt lean production techniques (e.g. JIT) Purchase stock on credit Purchase stock on credit Ask trade creditors for extended credit Ask trade creditors for extended credit Spread the cost of purchases - lease or hire purchase Spread the cost of purchases - lease or hire purchase Negotiate rescheduling of debt payments Negotiate rescheduling of debt payments Diversify to avoid seasonal variations in cash flow Diversify to avoid seasonal variations in cash flow Improve planning, monitoring and control Improve planning, monitoring and control