Cash Budget | Cash Budgeting:
Learning Objectives:
- Define and explain a cash budget.
- What is the purpose of a cash budget
- How to prepare a cash budget.
Definition and Explanation:
Cash budget is a detailed plan showing how
cash resources will be acquired and used over some specific time period.
Cash budget is composed of four major sections.
-
The receipts section.
-
The disbursements section
-
The cash excess or deficiency section
-
The financing section
The cash receipts section consists of a listing of all of the cash inflows,
except for financing, expected during the budgeting period. Generally, the major
source of receipts will be from sales. The disbursement section consists of all cash payment that are planned for
the budgeted period. These payments will include
raw materials purchases,
direct
labor payments, manufacturing overhead costs, and so on as contained in their
respective budgets. In addition, other cash disbursements such as equipment
purchase, dividends, and other cash withdrawals by owners are listed.
The cash excess or deficiency section is computed as follows:
Cash balance beginning
Add receiptsTotal cash available
Less disbursements
Excess (deficiency) of cash available over disbursements
|
XXXX
XXXX
--------
XXXX
XXXX
--------
XXXX |
If there is a cash deficiency during any period, the company will need to
borrow funds. If there is cash excess during any budgeted period, funds borrowed
in previous periods can be repaid or the excess funds can be invested.
The financing section deals the borrowings and repayments projected to take
place during the budget period. It also include interest payments that will be
due on money borrowed. Generally speaking, the cash budget should be broken down
into time periods that are as short as feasible. Considerable fluctuations in
cash balances may be hidden by looking at a longer time period. While a monthly
cash budget is most common, many firms budget cash on a weekly or even daily
basis.
Example of Cash Budget:
(See
explanation of this budget)
Hampton
Freeze Inc.
Cash Budget
For the Year Ended December 31, 2009 |
|
|
Quarter |
|
|
Other budget ref. |
1 |
2 |
3 |
4 |
Year |
Cash
balance, beginning |
|
$42,500 |
$40,000 |
$40,000 |
40,500 |
42,500 |
Add
receipts: |
Collections from customers |
See sales budget |
230,000 |
480,000 |
740,000 |
520,000 |
1,970,000 |
|
|
------------ |
------------ |
------------ |
------------ |
------------ |
Total cash
available |
|
272,500 |
520,000 |
780,000 |
560,500 |
2,012,500 |
|
|
------------ |
------------ |
------------ |
------------ |
------------ |
Less
disbursements: |
|
|
|
|
|
|
Direct
materials |
material budget |
49,500 |
72,300 |
100,050 |
79,350 |
301,200 |
Direct
labor |
Labor budget |
84,000 |
192,000 |
216,000 |
114,000 |
606,000 |
Manufacturing overhead |
Overhead budget |
68,000 |
96,800 |
103,200 |
76,000 |
344,000 |
Selling
and Administrative |
sell. & adm. budget |
93,000 |
130,900 |
184,750 |
129,150 |
537,800 |
Equipment
purchases |
|
50,000 |
40,000 |
20,000 |
20,000 |
130,000 |
Dividends |
|
8,000 |
8,000 |
8,000 |
8,000 |
32,000 |
|
|
------------ |
------------ |
------------ |
------------ |
------------ |
Total
disbursements |
|
352,500 |
540,000 |
632,000 |
426,500 |
1,951,000 |
|
|
------------ |
------------ |
------------ |
------------ |
------------ |
Excess/deficiency of cash available over disbursements |
|
(80,000) |
(20,000) |
148,000 |
134,000 |
61,500 |
|
|
|
|
|
|
|
Financing: |
Borrowings
(at beginning)* |
|
120,000 |
60,000 |
- |
- |
180,000 |
Payments
(at beginning) |
|
- |
- |
(100,000) |
(80,000) |
(180,000) |
Interest** |
|
- |
- |
(7,500) |
(65,00) |
(14,000) |
|
|
------------ |
------------ |
------------ |
------------ |
------------ |
Total
financing |
|
1200,000 |
(60,000) |
(107,500) |
(86,500) |
(14,000) |
|
|
------------ |
------------ |
------------ |
------------ |
------------ |
Cash
balance, ending |
|
$40,000 |
$40,000 |
$40,500 |
$47,500 |
$47,500 |
|
|
====== |
====== |
====== |
====== |
====== |
*The company requires a minimum cash balance
of $40,000. Therefore, borrowing must be sufficient to cover the cash
deficiencies of $80,000 in quarter 1 and to provide for the minimum cash
balance of $40,000. All borrowings and repayments of principal are in
round $1,000 amount.
**The interest
payment relate only to the the principle being repaid at the time it is
repaid. For example, the interest in quarter 3 relates only to the
interest due on the $100,000 principle being repaid from quarter 1
borrowing:
$100,000 × 10% per year ×
3/4 year = $7,500
The interest paid in quarter 4 is
computed as follows:
$20,000 × 10% per year × 1 year |
$2,000 |
$60,000 × 10% per year × 3/4 year |
4,500 |
|
--------- |
Total
interest paid |
$6,500 |
|
====== |
|
Cash budget builds on the other
budgets (
sales budget,
material budget,
Labor budget,
Overhead budget,
sell. & adm. budget)
and on some additional data that are provided below:
-
The beginning cash balance is
$42,500
-
Management plans to spend $130,000
during the year on equipment purchases: $50,000 in the first quarter; $40,000 in
the second quarter; $20,000 in the third quarter; $20,000 in the fourth quarter.
-
The board of directors has approved
cash dividends of $8,000 per quarter.
-
Management would like to have a cash
balance of at least $40,000 at the beginning of each quarter for contingencies.
-
Assume Hampton Freeze will be able
to get agreement from a bank for an open line of credit. This would enable the
company to borrow at an interest rate of 10% per year. All borrowings and
repayments would be in round $1,000 amount. All borrowings would occur at the
beginning of the quarters and all repayments are made and only on the amount of
principal that is repaid.
The
cash budget is prepared one
quarter at a time, starting with the first quarter. Management began the cash
budget by entering the beginning balance of cash for the first quarter of
$42,500--a number that is given above. Receipts--in this case, just the $230,000
in cash collection from customers--are added to the beginning balance to arrive
at the total cash available of $272,500. Since the total disbursements are
$352,500 and the total cash available is only $272,500, there is short fall of
$80,000. Since management would like to have a beginning cash balance of at
lease $40,000 for the second quarter, the company would need to borrow $120,000.
Required borrowing at the end of the first quarter |
Desired
ending cash balance |
$40,000 |
Plus
deficiency of cash available over disbursements |
80,000 |
|
---------- |
Required
borrowings |
$120,000 |
|
====== |
The second quarter of cash budget is
handled similarly. Note that the ending cash balance of the first quarter is
brought forward as the beginning cash balance for the second quarter. Also note
that additional borrowing is required in the second quarter because of the
continued cash shortfall.
Required borrowing at the end of the second quarter |
Desired
ending cash balance |
$40,000 |
Plus
deficiency of cash available over disbursements |
20,000 |
|
------------ |
Required
borrowings |
$60,000 |
|
====== |
In third quarter, the cash flow
situation improves dramatically and the excess of cash available over
disbursement is $148,000. This makes it possible for the company to repay part
of its loan from the bank, which now totals $180,000. How much can be repaid?
The total amount of the principle and interest that can be repaid is determined
as follows:
Total
maximum feasible loan payments at the end of the third quarter |
Excess of
cash available over disbursement |
$148,000 |
Less
desired ending cash balance |
40,000 |
|
------------- |
Maximum
feasible principle and interest payment |
$108,000 |
|
====== |
The next step--figuring out the exact amount of
loan payment--is tricky since interest must be paid on the principle amount that
is repaid. In this example, the principle amount that is repaid must be less than
$108,000, so we know that we would be paying of part of the loan that was taken
out at the beginning of the first quarter. Since the repayment would be made at
the end of the third quarter, interest would have accrued for three quarters. So
the interest owed would be 3/4 of 10% or 7.5%. Either a trial and error or an
algebraic approach will lead to the conclusion that the maximum principle
repayment that can be made is $100,000. The interest payment would be 7.5% of
this amount, or $7,500--making the total payment $107,500.
In the fourth quarter, all of the loan and
accumulated interest are paid off. If all loans are not repaid at the end of
the year and budgeted financial statements are prepared, then interest must
be accrued on the unpaid loans. This interest will not appear on the cash
budget (since it has not yet been paid), but it will appear as interest
expense on the budgeted income statement and as a liability on the budgeted
balance sheet. As with the
production
budget and
raw materials budget, the amounts under the year column in the
cash budget are not always the sum of the amounts for the four quarters. In
particular, the beginning cash balance for the year is the same as the
beginning cash balance for the first quarter and the ending cash balance for
the year is the same as the ending cash balance for the fourth quarter.
Burlington Northern Fe
(BNSF) operates the second
largest railroad in the United States. The company's senior vice
president, CFO, and treasure is Tom Hunt, who reports that "as a general
theme, we have become very cash-flow oriented." After the manager of the
Burlington Northern and Santa Fe railroads, the company went through a
number of years in which they were investing heavily and consequently
had negative cash flow. To keep on top of the company's cash position,
Hunt has a cash forecast prepared every month. "Everything falls like
dominoes from free cash flows," Hunt says. "It provides us with
alternatives." Right now, the alternative of choice is buying back our
own stock...[b]ut it could be increasing dividends or making
acquisitions. All those things are not even on the radar screen if you
don't have free cash flow."
Source: Randy Myers, "Cash Crop: The
2000 working capital survey," CFO, August 2000, pp. 59-82. |
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