Cash Budget
Areas to be covered:
➢ INTRODUCTION
➢ OBJECTIVE OF CASHBUDGET
➢ STATISTICAL TECHNIQUE FOR CASH FORECAST INCLUDING MOVING
AVERAGES AND ALLOWANCE OF INLFATION
➢ PREPARATION OF CASHBUDGET
➢ PREPEARTION OF CASHFORECAST
MEANING OF CASH BUDGET
A detailed forecast of the anticipated cash inflows and outflows
over a period of time is known as cash budget. It includes:
1. Timing and amount of receipts expected by an organisation during
the budgeted period.
2. Timing and amount of payments that
organisation during the budgeted period.
may
be
made
by
an
3. Net cash flow and changes in the cash balance at various
intervals e.g. a monthly cash budget will show changes in cash
balance on a weekly basis.
OBJECTIVES OF CASH BUDGET
The cash budget provides a forecast of the amount and duration during
which the organisation will either have a cash surplus or a cash deficit.
1. To maximise income from other sources: Cash budgets predict the
amount and duration of surplus funds available with an organisation.
A treasury manager can use these predictions to invest surplus funds.
2.
For managing its liquidity position: Cash budgets indicate the
liquidity problems that an organisation may face. The cash deficit
prediction allows an organisation to make arrangements with the
various providers of finance to either close or at least narrow the
gap between its cash inflows and its cash outflows.
3. To minimise the cost of funds: A treasury manager needs some time
to identify the appropriate borrowing facilities and the cheapest
source of finance available to an organisation. An early prediction of
the liquidity crisis that the organisation may face gives enough time
to the treasury manager to ensure that the organisation is able to
obtain adequate funds and/or borrowing limits from various financial
institutions. This allows the organisation to avert the expected
liquidity crisis.
4. To manage foreign currency risk: The cash budgets allow the treasury
department to predict the amount and timing of the cash flows in
various currencies. This allows the treasury department to plan
whether it must match a cash flow with opposite cash flow in the
same currency or it must hedge a cash flow in the foreign market.
5. To implement financial
the mismatch between
actual time that will be
allows an organisation
and avoid bad debts.
6.
controls: Cash budgets are used to forecast
the credit period given to a customer and
taken by the customer to clear his dues. This
to effectively manage its trade receivables
To prepare and monitor long term plans: Organisations use cash
budgets for planning and preparing long term objectives and
strategies. They monitor the long term plans by comparing estimated
cash flows with the actual cash flows.
7. For appraising projects: cash budgets allow an organisation to know
whether the cash flows generated by a project are sufficient enough
to finance the capital and revenue (operational) expenses incurred
by a project.
8. To manage working capital: the concept of
be linked to ‘just-in-time’ payments to the
management. The cash flow estimates can
the basis of:
• Raw material ordered,
• Payment made for raw material received
• Inventory of finished goods.
‘just-in-time delivery can
trade payables and cash
be regularly updated on
and consumed and
9. To identify weakness in cash management: The management can
identify the weakness in cash management by comparing the actual
cash flows with the budgeted cash flows e.g. poor policy for
ordering raw materials. A review of the cash budget allows the
management to decide whether it will need to borrow cash in the
future or not.
Float
The term float refers to unclear funds. A float occurs when there is a
difference between the bank balance according to the cash book
and cleared funds available with an organisation. Funds do not leave
the bank account of an organisation as soon as the organisation
authorises its bank to disperse funds due to the following reasons:
1. For the cheques send through postal mail: there is difference of
time between the posting of cheque by the trade receivables and
the receipt of cheque by the trade payables. Also known as
receivable or collection float.
2. Delay by trade payables: the payables may not deposit the cheque
received into his bank account on the day on which the cheque
was issued. Also known as Deposite or payable float.
3. Bank’s clearing system: usually the clearing system of a bank takes
three days to process a payment. Also known as bank clearance or
availability float.
CASH BUDGET AS MECHANISM OF MONITORY AND CONTROL.
Difference between forecasted and actual cash flows: The management
can take corrective action by comparing forecasted cash flows with
actual flows. A cash budget helps the management to achieve its
goals for cash management e.g. avoiding borrowings, keeping
borrowing within certain limits, maintaining desired cash balance,
investing cash surplus in appropriate securities etc. The cash flows
forecasted by the management may differ due to the following
reasons:
• The management may have over estimated sales.
• The management may have under estimated expenses.
• The trade receivables may not have acted according to the
historic / expected trend.
• Themanagementmayhavemadeunrealisticassumptionsabouttheavail
abilityofcredite.g.loans, bank overdraft, suppliers credit, etc.
CASH FLOW CONTROL REPORTS
The cash flow control report consists of the actual and estimated
receipts, payments and cash balance for a particular period. It
allows the management to compare:
• The actual cash flows against the forecasted cash flows.
• The
currently
forecasted
cash
flows
against
the
originally
forecasted / targeted cash flows.
1. Control over receipts: Needs to monitor & control the following:
• Payment from trade receivables: The management must take action
to correct any deviation from the budgeted sales or credit period
granted to the customers.
• Income from investments: It is the income generated by the
treasury department by investing cash surplus in various securities.
2. Control over payments: Needs to monitor and control the following:
• Routine payments not related with activity level e.g. office rent.
• Routine payments related with activity level e.g. payment for
material.
• Non-recurring payments e.g. major capital investments, legal fees,
etc.
Ways to control short-term cash deficit
• Liquidity can be improved by selling short-term investments that are held by the
organisation.
• Short-term loans can be obtained at the cheapest interest rate.
• Overdrafts limits can be renegotiated with the bankers of the organisation.
• Inventory held by the organisation can be reduced to free the money invested in the
finished goods and work-in-progress.
• By using leading and lagging techniques (discussed later in this Learning Outcome).
Ways to control long-term cash deficit
• By postponing routine capital expenditure e.g. replacing office furniture after five years
instead of three years.
• By selling long term investments e.g. paintings, treasury bonds, shares and/or debentures of
other organisations.
• By selling non-current assets of the business e.g. land, office building, machinery, etc.
• By issuing long term securities e.g. debentures, preference shares and equity shares.
• Renegotiating cash outflows with long term trade payables e.g. suppliers of non-fixed assets
(lessor), debenture holders and banks.
• By reducing the amount of dividend distributed among the equity shareholders.
Revision of cash budget: The management can take right decisions by
comparing the actual cash flow with meaningful estimates. Hence, at
regular interval either the cash budget must be revised or a new
cash budget must be drawn. The revised /= new cash budget must
consider the actual cash flows and their effect on the estimated
cash flows. It allows the management to plan in an effective manner
for achieving its goals /objectives.
Rolling forecast: A rolling forecast refers to a forecast that is
continually updated e.g. the organisation may prepare a monthly
cash budget and decide to update it after every week. A new week
will be added every seven days and the estimates for the remaining
three weeks may be revised, if necessary.
Leading and lagging: Leading is the payment of an obligation before
the due date while lagging is delaying the payment of an obligation
past the due date.
Example: The estimated sales for an organization are as follows:
May
June July
August
$
$
$
$
Sales
6,000 8,000 4,000 5,000
10% sales are on cash. The receivables tend to pay in the following
pattern:
The following month of sales
50% (Entitled for 2% discount)
And after two months
40%
Irrecoverable debts
10%
Required:
a) Calculate the total forecast cash receipt in August.
b) Calculate the forecast cash receipt from receivables in August.
Solution:
Example: Z plc is currently preparing its cash budget for the year to 31
March 2018. An extract from its sales budget for the same year shows
the following sales values.
$
March
80,000
April
70,000
May
60,000
June
50,000
20% of its sales are expected to be for cash. Of its credit sales, 60%
are expected to pay in the month after sale and take a 2% discount;
35% are expected to pay in the second month after the sale, and the
remaining 5% are expected to be bad debts. The value of sales
receipts to be shown in the cash budget for May 2017 is
.
Solution: Solve
Example: A business has estimated that 30% of its sales will be cash
sales and the reminder credit sales. It is also estimated that 70% of
credit customers will pay in the following month of sales and are
entitled of 2% discount 20% two months after sales and bad
(irrecoverable) debts will be 10% is expected. Total sales figures are
as follows:
Months
$
Dec
60,000
Jan
70,000
Feb
80,000
Mar
90,000
What is the budgeted cash collection from credit sales for March?
Solution: Solve
S TAT I S T I C A L T E C H N I Q U E S F O R C A S H B U D G E T I N G
Time Series Analysis
For example
• Annual cost for last ten years,
• Number of people employed in each last 10 years,
• Output per day of last month,
• Sales per month of last 3 years, etc.
The Four Components of a time series are:
a. Trend: this describes the long term general movement of the data recorded.
b. Seasonal variations: are short term fluctuations in recorded values, a regular variation
around the trend over a fixed time period, usually one year.
c. Cyclical variations: are long term fluctuations in recorded values, economic cycle of
booms and slumps. It takes several years to complete.
d. Random variations: irregular, random fluctuations in the data usually caused by factors
specific to the time series. They are unpredictable.
a. Trends
Long term movement over time in the value of data recorded. For example,
Downward trend
Years
Output/hour(units)
4
5
6
7
8
9
30
24
26
22
21
17
Trend
Upward
trend
Cost/unit
($)
1
1.08
1.20
1.15
1.18
1.25
No clear
movement/static
Number of employees
100
103
96
102
103
98
Finding a trend
One method of finding the trend is by the use of moving
averages. (Take moving averages which covers a cycle)
Moving averages of
Time series of even numbers
Apply two times moving averages
Time series of odd numbers
Apply once moving averages
(Because trend value should relate to a specific period)
Remember that when finding the moving average of an
even number of result, a second moving average has to be
calculated so that values can relate to specific actual
figures. This method attempts to remove seasonal (or
cyclical) variation from a time series by a process of
averaging so as to leave a set of figures representing the
trend. Moving average figure relate to midpoint of overall
period.
Example 1:
(Odd numbers)
Year
Sales units
2000
390
2001
380
2002
460
2003
450
2004
470
2005
440
2006
500
Take a moving average of the annual sales over a period of three years.
Moving average of an even number of results
If the moving average were taken of results in an even number of time periods, the
basic technique would be the same, but the midpoint of the overall period would not
relate to single period. The trend line average figures need to relate to a particular time
period. To overcome this difficulty, take a moving average of the moving average.
Example 2:
Calculate the trend using moving average.
Year
2005
2006
2007
Quarter
1
2
3
4
1
2
3
4
1
2
3
4
Volume of sales (‘000 units)
600
840
420
720
640
860
420
740
670
900
430
760
Solution:
Year
2005
Quarter
Actual volume Moving average of 4
of sales
quarters’ sales
Midpoint of 2 moving
averages trend line
‘000 units
‘000 units
‘000 units
(A)
(B/A)
(C)
1
600
2
840
645
3
420
650
655
4
720
657.50
660
2006
1
640
660
660
Solution:
Year
Quarter
2
Actual volume Moving average of 4
of sales
quarters’ sales
860
Midpoint of 2 moving
averages trend line
662.50
665
3
420
668.75
672.50
4
740
677.50
682.50
2007
1
670
683.75
685
2
900
687.50
690
3
430
4
760
687.50 − 650
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑡𝑟𝑒𝑛𝑑 =
= 5 𝑝𝑒𝑟 𝑞𝑢𝑎𝑟𝑡𝑒𝑟
8−1
b. Seasonal Variation
Short term fluctuations due to change in season. Affect
seasonal businesses like ice-cream manufacturing.
Finding the seasonal variation
There are two models to find out seasonal variations:
• Additive model
• Multiplicative model
Additive model
Seasonal variations are the difference between actual
and trend figures. An average of the seasonal variations for
each time period within the cycle must be determined and
then adjusted so that the total of the seasonal variations
sums to zero.
Seasonal variation = actual sales – trend
So
Time series (actual sales) = trend + seasonal variation
Here Y = T + R + S
Continue Example 2:
Year
2005
2006
2007
Quarter
1
2
3
4
1
2
3
4
1
2
3
4
Actual volume of
sales
‘000 units
600
840
420
720
640
860
420
740
670
900
430
760
‘000 units
Seasonal
variation
‘000 units
650
657.50
660
662.50
668.75
677.50
683.75
687.50
-230
62.50
-20
197.50
-248.75
62.50
-13.75
212.50
Trend
The variation between the actual result for any particular quarter and the trend line
average is not the same from the year to year, but an average of these variations can be
taken.
2005
2006
2007
Total
Average (divided by 2)
Q1
Q2
-20
-13.75
-33.75
-16.875
197.50
212.50
410
205
Q3
-230
-248.75
Q4
62.50
62.50
-478.75
-239.375
125
62.50
Estimate of the seasonal or quarterly variation is almost done, but there is one
more important step to take. Variations around the basic trend line should cancel
each other out, and add to the ‘zero’. At the moment they do not. Therefore spread
the total of the variations (11.25) across the four quarters (11.25/4) so that the final
total of the variations sum to zero.
Q1
Q2
Q3
Q4
Total
Estimated quarterly variations
-16.875
205
-239.375
62.50
11.25
Adjusted to reduce variations to 0
-2.8125
-2.8125
-2.8125
-2.8125
-11.25
Final estimates of quarterly variations -19.6875
202.1875 -242.1875 59.6875
0
These might be rounded as follows:
= 202
Total = 0
= -20
= -242
= 60
2. Multiplicative model
This model assumes that the components of the series are independent of each
other. In this model, each actual figure is expressed as a proportion of the trend.
So
Seasonal variation = actual sales / trend
Time series Y = T x S x R
The trend component will be same in both models but the seasonal and random
component will vary according to the model. In our example, we assume that random
component is small and so ignore it. So:
Then:
Y=TxS
S = Y/T
Continue Example 2:
Year
2005
2006
2007
Quarter
1
2
3
4
1
2
3
4
1
2
3
4
Actual volume of
sales (Y)
‘000 units
600
840
420
720
640
860
420
740
670
900
430
760
Trend (T)
Seasonal variation
(Y/T)
‘000 units
‘000 units
650
657.50
660
662.50
668.75
677.50
683.75
687.50
0.646
1.095
0.970
1.298
0.628
1.092
0.980
1.309
2005
2006
2007
Total
Average (divided by 2)
Q1
%
Q2
%
0.970
0.980
1.950
0.975
1.298
1.309
2.607
1.3035
Q3
%
0.646
0.628
1.274
0.637
Q4
%
1.095
1.092
2.187
1.0935
Instead of summing to zero, average should sum to 4 or 1 for
each of the four quarters.
Q1
Q2
Q3
Q4
Total
0.975
1.3035
0.637
1.0935
4.009
Adjusted to reduce variations to 4
-0.00225
-0.00225
-0.00225
-0.00225
-0.009
Final estimates of quarterly variations
0.97275
1.30125
0.63475
1.09125
4
= 0.97
= 1.30
= 0.64
= 1.09
Total = 4
Estimated quarterly variations
These might be rounded as follows:
Multiplicative model is better than additive model
Index Number / Indices
Index is a measure of change over time by making some base. It
provides standard way of comparing the values.
Index
Price index
Measure of change in the money
value of a group of items over time
Price Index =
Pn
Po
x 100
Quantity index
Measure of change in the non-monetary
value of a group of items over time
Quantity index =
Qn
Qo
x 100
Index number is calculated
by taking base
Fixed base
Chain base
One base is selected and all
Take the base value of the
subsequent changes are
period immediate.
measured against that fixed
base before.
(use where basic nature of commodity is changed overtime)
Example 3:
Great Ltd sold leather jackets in 20X5 for $20,, in 20X6 they were
$25, in 20X7 $30 and in 20X8 $35. Assuming the base year to be
20X5, the price index numbers for the years 20X6 to 20X8 can be
calculated as follows:
Solution:
20X6 index number =
20X7 index number =
20X8 index number =
Example 4:
Wood Ltd produces and sells high quality furniture in the UK. The
total number of cupboards sold by Teakwood Ltd was 4,000 in
20X5, 6,000 in 20X6, 9,000 in 20X7 and 10,000 in 20X8. Assuming the
base year to be 20X5, the quantity index numbers for the years
20X6 to 20X8 can be calculated as follows:
Solution:
20x6 index number =
20x7 index number =
20x8 index number =
Practice Questions: Home Assignment