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One situation which can be problematic is if you are required to analyse an opening statement of financial position to decide how many outstanding receivables will pay what they owe in the first few months of the cash budget period, and how many outstanding payables must be paid.

For example, suppose that a statement of financial position as at 31 December 20X4 shows that a company has the following receivables and payables.

Receivables $150,000

Trade payables $ 60,000

You are informed of the following.

(a) Customers are allowed two months to pay.

(b) 1½ months' credit is taken from trade suppliers.

(c) Sales and materials purchases were both made at an even monthly rate throughout 20X4.

Required

Determine in which months of 20X5 the customers will eventually pay and the suppliers will be paid.

(a) Since customers take two months to pay, the $150,000 of receivables in the statement of

financial position represent credit sales in November and December 20X4, who will pay in January and February 20X5 respectively. Since sales in 20X4 were at an equal monthly rate, the cash budget should plan for receipts of $75,000 each month in January and February from the receivables in the opening statement of financial position.

(b) Similarly, since suppliers are paid after 1½ months, the statement of financial position payables will be paid in January and the first half of February 20X5, which means that budgeted payments will be as follows.

$ In January (purchases in second half of November and first half of

December 20X4) 40,000

In February (purchases in second half of December 20X4) 20,000 Total payables in the statement of financial position 60,000 Solution

Example: receivables and payables

(The payables in the statement of financial position of $60,000 represent 1½ months' purchases, so that purchases in 20X4 must be $40,000 per month, which is $20,000 per half month.)

Now you have some idea as to the underlying principles, let us put these to work. From the following information which relates to George and Zola, prepare a month by month cash budget for the second half of 20X5 and make brief comments as you consider might be helpful to management.

(a) The company's only product, a leather bag, sells at $40 and has a variable cost of $26 made up as follows.

Material $20

Labour $4

Variable overhead $2

(b) Fixed costs of $6,000 per month are paid on the 28th of each month.

(c) Quantities sold/to be sold on credit

May June July Aug Sept Oct Nov Dec 1,000 1,200 1,400 1,600 1,800 2,000 2,200 2,600 (d) Production quantities

May June July Aug Sept Oct Nov Dec 1,200 1,400 1,600 2,000 2,400 2,600 2,400 2,200 (e) Cash sales at a discount of 5% are expected to average 100 units a month.

(f) Customers are expected to settle their accounts by the end of the second month following sale.

(g) Suppliers of material are paid two months after the material is used in production.

(h) Wages are paid in the same month as they are incurred.

(i) 70% of the variable overhead is paid in the month of production, the remainder in the following month.

(j) Company tax of $18,000 is to be paid in October.

(k) A new delivery vehicle was bought in June, the cost of which, $8,000 is to be paid in August. The old vehicle was sold for $600, the buyer undertaking to pay in July.

(l) The company is expected to be $3,000 overdrawn at the bank at 30 June 20X5.

(m) The opening and closing inventories of raw materials, work in progress and finished goods are budgeted to be the same.

Example: a month-by-month cash budget in detail

CASH BUDGET FOR 1 JULY TO 31 DECEMBER 20X5

(a) There will be a small overdraft at the end of August but a much larger one at the end of October. It may be possible to delay payments to suppliers for longer than two months or to reduce purchases of materials or reduce the volume of production by running down existing inventory levels.

(b) If none of these courses is possible, the company may need to negotiate overdraft facilities with its bank.

(c) The cash deficit is only temporary and by the end of December there will be a comfortable surplus.

The use to which this cash will be put should ideally be planned in advance.

Learning outcome E1(c)

Tom Ward has worked for some years as a sales representative, but has recently been made redundant.

He intends to start up in business on his own account, using $15,000 which he currently has invested.

Tom maintains a bank account showing a small credit balance, and he plans to approach his bank for the necessary additional finance. Tom asks you for advice and provides the following additional information.

(a) Arrangements have been made to purchase non-current assets costing $8,000. 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.

Question 2.3 Cash forecast

Solution

(b) Inventories costing $5,000 will be acquired on 28 September and subsequent monthly purchases will be at a level sufficient to replace forecast sales for the month.

(c) Forecast monthly sales are $3,000 for October, $6,000 for November and December, and

$10,500 from January 20X7 onwards.

(d) Selling price is fixed at the cost of inventory plus 50%.

(e) Two months' credit will be allowed to customers but only 1 month's credit will be received from suppliers of goods.

(f) Running expenses, including rent, are estimated at $1,600 per month, all paid in cash.

(g) Tom intends to make monthly cash drawings of $1,000.

Required

Prepare a forecast cash budget for the 6 months October 20X6 to March 20X7.

Learning outcome E1(a)

You are presented with the following budgeted data for your organisation for the period November 20X1 to June 20X2. It has been extracted from functional budgets that have already been prepared.

Nov X1 Dec X1 Jan X2 Feb X2 Mar X2 Apr X2 May X2 June X2

$ $ $ $ $ $ $ $ Sales 80,000 100,000 110,000 130,000 140,000 150,000 160,000 180,000 Purchases 40,000 60,000 80,000 90,000 110,000 130,000 140,000 150,000

Wages 10,000 12,000 16,000 20,000 24,000 28,000 32,000 36,000

Overheads 10,000 10,000 15,000 15,000 15,000 20,000 20,000 20,000

Dividends 20,000 40,000

Capital expenditure 30,000 40,000

You are also told the following.

(a) Sales are 40% cash, 60% credit. Credit sales are paid two months after the month of sales.

(b) Purchases are paid the month following purchase.

(c) 75% of wages are paid in the current month and 25% the following month.

(d) Overheads are paid the month after they are incurred.

(e) Dividends are paid three months after they are declared.

(f) Capital expenditure is paid two months after it is incurred.

(g) The opening cash balance on 1 January 20X2 is $15,000.

The managing director is pleased with the above figures as they show sales will have increased by more than 100% in the period under review. In order to achieve this he has arranged a bank overdraft with a ceiling of $50,000 to accommodate the increased inventory levels and wage bill for overtime worked.

Required

(a) Prepare a cash budget for the six month period January to June 20X2.

(b) Comment upon your results in the light of your managing director's comments and offer advice.

(c) If you have access to a computer spreadsheet package and you know how to use it, try setting up the cash budget on it. Then make a copy of the budget and try making changes to the estimates to see their effect on cash flow.

Question 2.4 Cash budget

Section summary

Cash budgets are prepared by taking operational budgets and converting them into forecasts as to when receipts and payments occur. The forecast should indicate the highest and lowest cash balance in a period as well as the balance at the end.