Cash Budget

Areas to be covered:
➢ INTRODUCTION

➢ OBJECTIVE OF CASHBUDGET

➢ PREPARATION OF CASHBUDGET

➢ PREPEARTION OF CASHFORECAST

➢ STATISTICAL TECHNIQUE FOR CASH FORECAST INCLUDING MOVING

AVERAGES AND ALLOWANCE OF INLFATION
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 may be made by an

organisation during the budgeted period.

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 controls: Cash budgets are used to forecast

the mismatch between the credit period given to a customer and
actual time that will be taken by the customer to clear his dues. This
allows an organisation to effectively manage its trade receivables
and avoid bad debts.

6. 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 ‘just-in-time delivery can
be linked to ‘just-in-time’ payments to the trade payables and cash
management. The cash flow estimates can be regularly updated on
the basis of:
• Raw material ordered,
• Payment made for raw material received and consumed and
• Inventory of finished goods.

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 Deposit 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.

• The management may have made unrealistic assumptions about the

availability of credit e.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 overpayments: 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 receipts in August.
b) Calculate the forecast cash receipts 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:
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
STATISTICAL TECHNIQUES FOR CASH BUDGETING

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,

Trend
Downward trend Upward No clear
trend movement/static
Years Output/hour(units) Cost/unit Number of employees
($)
4 30 1 100
5 24 1.08 103
6 26 1.20 96
7 22 1.15 102
8 21 1.18 103
9 17 1.25 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 Time series of odd numbers

Apply two times moving averages 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 Quarter Volume of sales (‘000 units)

2005 1 600
2 840
3 420
4 720
2006 1 640
2 860
3 420
4 740
2007 1 670
2 900
3 430
4 760
Solution:
Actual volume Moving average of 4 Midpoint of 2 moving
Year Quarter
of sales quarters’ sales averages trend line

‘000 units ‘000 units ‘000 units

(A) (B/A) (C)
2005 1 600

2 840
645
3 420 650
655
4 720 657.50
660
2006 1 640 660
660
Solution: Year Quarter
Actual volume Moving average of 4 Midpoint of 2 moving
of sales quarters’ sales averages trend line
2 860 662.50
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
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 + S + R
Continue Example 2:
Actual volume of Seasonal
Year Quarter Trend
sales variation
‘000 units ‘000 units ‘000 units
2005 1 600
2 840
3 420 650 -230
4 720 657.50 62.50
2006 1 640 660 -20
2 860 662.50 197.50
3 420 668.75 -248.75
4 740 677.50 62.50
2007 1 670 683.75 -13.75
2 900 687.50 212.50
3 430
4 760
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.

Q1 Q2 Q3 Q4
2005 -230 62.50
2006 -20 197.50 -248.75 62.50
2007 -13.75 212.50
Total -33.75 410 -478.75 125
Average (divided by 2) -16.875 205 -239.375 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: = -20 = 202 = -242 = 60 Total = 0

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.

Seasonal variation = actual sales / trend

So
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:

Y=TxS
Then:
S = Y/T
Continue Example 2:
Actual volume of Seasonal variation
Year Quarter Trend (T)
sales (Y) (Y/T)
‘000 units ‘000 units ‘000 units
2005 1 600
2 840
3 420 650 0.646
4 720 657.50 1.095
2006 1 640 660 0.970
2 860 662.50 1.298
3 420 668.75 0.628
4 740 677.50 1.092
2007 1 670 683.75 0.980
2 900 687.50 1.309
3 430
4 760
 Q1 Q2 Q3 Q4
% % % %
2005 0.646 1.095
2006 0.970 1.298 0.628 1.092
2007 0.980 1.309 - -
Total 1.950 2.607 1.274 2.187
Average (divided by 2) 0.975 1.3035 0.637 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

Estimated quarterly variations 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

These might be rounded as follows: = 0.97 = 1.30 = 0.64 = 1.09 Total = 4

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 Quantity index

Measure of change in the money Measure of change in the non-monetary
value of a group of items over time value of a group of items over time

Pn Qn
Price Index = x 100 Quantity index = x 100
Po Qo

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