Cash Budget
Cash Budget
Definition
Cash budgets are financial plans that show an organization’s planned
cash inflows and outflows over a period
Purpose
Cash budgets help managers forecast periods of cash deficit (cash
inflow < cash outflow). Examined together with cash reserves, they
indicate when the organization will need more cash. This minimizes
bankruptcy risk.
Operational Budget
The operational budgets are the budgets for the ordinary activities of
the business. For T-Shirt Co, this would be making and selling t-shirts.
Operational Budget vs Cash Budget
Procedure to Prepare Cash Budget
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1. Forecast the cash receipts and payments
Cash receipts would be from sales. Important to note the credit
terms granted to customers for credit sales.
Payments will usually be for the cost of sales and other expenses.
Important to note the credit terms granted by suppliers.
Other cash payments could include wages and salaries,
administrative costs, taxes, capital expenditure, non-current asset
disposals, investment income, and dividends.
2. Calculate net cash flow per period
3. Calculate cumulative cash flow
Cash Budgets and Forecasts
The difference between a cash budget and a forecast is when it is
produced.
Cash budgets are prepared before the relevant period
Cash flow forecasts are prepared in the period.
Forecasts use the same predictive techniques as budgets but within the
period, using actual figures for more accurate predictions.
For example, an organization will know the purchasing prices for
materials by the time a forecast is prepared, compared to estimating
them in a budget.
Forecasts can also allow for changes in economic circumstances, such
as a recession.
Actual performance should still be compared with the budget (the
financial plan) to help understand the variances between budget/target
performance and actual performance.
Calculating Inflation Using Index
Inflation
Inflation is an increase in the prices of goods and services over time
Formula
Current year index = P (current year) / P (base year) × 100
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Change % = Current year index / 100base year
Time Series
Meaning
A time series is a sequence of data points recorded at intervals.
Purpose
It may be helpful to identify past sales and cost patterns to predict
future trends
Assumption
The assumption is that these patterns will continue in the future and
may be used to calculate budget values
Time Series Analyses
Time series analysis identifies patterns in the data. It implements a
statistical model to determine this pattern, which may then be used to
forecast future values.
4 components of Time Series Analyses
Predicting Future Values Formula
Formula
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Average Periodic Increase
Formula
Average periodic increase = Trend (latest value) − Trend
(earliest value) / Number of periods
Seasonal Variation
Steps to calculate the seasonal variation
1. Calculate the trend.
2. Calculate the variation for each season.
3. Average the variation for each season, and normalize (this
step is to ensure any trend effects are removed)
To normalize seasonal variation in the additive model,
ensure the sum of the average variations is zero.
To normalize seasonal variation in the multiplicative model,
ensure the sum of the average variations equals the number
of seasons.
(i.e. if each season is a quarter in the year, the sum of average
variations should be four since there are four quarters in a year).
Formula
S = Y − T (Additive model)
Or
S = Y / T (Multiplicative model)
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Differences between the Additive and Multiplicative Model
Which Model is better?
Usually, the multiplicative model will produce more accurate
future values, as the absolute forecast seasonal variation is
proportional to the trend.
Remember:
Timing of cash flow
Only cash item
EXAM FOCUS POINT
Preparing cash budgets is a vital skill for the exam. Practice as often as you can
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