In this chapter we will examine in detail how a cash budget is prepared. This is animportant part of your studies, and you will need to be able to prepare a cash budget (orextracts) accurately.

We will start by summarising the source of the main data for a cash budget, andillustrating how a simple cash budget can be prepared for a new business. We will seehow this document links with other financial documents, in particular the budgetedStatement of Financial Position. We will also revise how to prepare a statement thatreconciles profit with cash movement.

From there we will move on to examining the specific issues that can cause difficultywhen preparing a cash budget, and which will need to be mastered. Specifically we willlearn how to deal with units and prices, split receipts, discounts, irrecoverable debts,bank account interest, accruals, prepayments and depreciation.

We will then see how our techniques can be applied to an existing business as well asa new business, and illustrate this with more complex case study.

We will also deal with the calculation of closing trade receivables and trade payables andalso show how amounts paid or received in connection with non-current assets can beworked out. Finally, we will examine the calculation of tax payments, and the impact ofinventory levels on payments for materials.

The activities at the end of the chapter are particularly important because the techniquescovered can only be perfected with thorough practice.

Preparing cashbudgets

3

this chapter covers...

p r e p a r i n g c a s h b u d g e t s 7 5

P R E PA R I N G A C A S H B U D G E T f o R A N E w B U S I N E S S

In this chapter we will build up a cash budget using the format that we lookedat at the end of Chapter 1.

We will start by looking at the cash budget for a new trading organisation, sothat we can get a clear idea of the main principles. We will also see how thecash budget fits in with the budgeted Statement of Profit or Loss andStatement of Financial Position. Later on we will see how we can build onour technique to develop cash budgets for existing businesses byincorporating data from the opening Statement of Financial Position.

r o u n d i n gThroughout the calculations for figures in our cash budgets in this book wewill be rounding amounts to the nearest where necessary. It would nevermake sense to use figures in a cash budget that were any more accurate thanthis. Some organisations may prepare cash budgets rounded to largeramounts (for example the nearest thousand pounds) if this suits their needsbetter.

t h e b a s i c p r o c e s s l i n k i n g w i t h o t h e r b u d g e t sThe data that we use to create all our budgets must be consistent so that allour budgets are based on the same assumptions. We will find that much ofthe data for a cash budget can be found in a budgeted Statement of Profitor Loss, if this has already been prepared. However, the key to accurate cashbudgets is to remember that receipts and payments are based on when thereceipts and payments occur, and therefore most of the figures in thisstatement will need analysing or modifying.

When we receive or pay cash at a different time to the recording of the sale,purchase or expense, this is known as lagging. It is these lagged figures based on the time of receipt or payment that we will use in our cash budget.For example, if credit sales of 10,000 were made in January, on twomonths credit, then the money would be received in March. Although thesale would be recorded in the Statement of Profit or Loss in January, it mustappear in the March column in the cash budget.

A cash budget will not show any non-cash items that appear in the budgetedStatement of Profit or Loss the most common example of this isdepreciation. There are also items that will appear in the cash budget, but

are not shown in the budgeted Statement of Profit or Loss. These are capitalitems (purchase or disposal of non-current (fixed) assets), disbursements likedrawings and tax, and exceptional items like financing (funds from equity orloans). These were discussed in Chapter 1.

The diagram below shows how the data in a simple cash budget links withthe data used in other budgets.

7 6 m a n a g i n g c a s h t u t o r i a l

CASH BUDGET

all data based on the time that cashis received or paid

receipts from sales

payments for purchases

payments for cash-based expenses

payments for purchase of non-current assets

payments for non-current assetsacquired under finance leases

payments for drawings/dividends

payments for other disbursements

receipts or payments relating toexceptional items

BUDGETED STATEmENT ofPRofIT oR LoSS

all data based on accrualsaccounting

sales

cost of sales

expenses

CAPITAL BUDGET

acquisition of non-current assets

oTHER BUDGETS

drawings/dividends

other disbursements, eg tax

exceptional items, eg financing

t h e s o u r c e o f d a t a f o r t h e c a s h b u d g e t

We will now use a Case Study to show how a simple cash budget can beproduced for a new business, using the sources of data shown in the diagramon the previous page. We will also demonstrate how a budgeted Statement ofFinancial Position can be prepared for the end of the period.

F I R S T T R A D E :S I M P L E C A S H B U D G E TJim First is planning to start a trading business. He has prepared the followingbudgeted Statement of Profit or Loss for the initial four months trading.

Jim first: Budgeted Statement of Profit or Loss

Sales 22,000less cost of sales:Opening inventory 0Purchases 21,000less closing inventory (7,000)

14,000Gross profit 8,000less:Cash expenses 4,000Depreciation 1,000

5,000Net profit 3,000

Jim also provides you with the following information regarding his plans:

Sales are to be made on two months credit. The sales figures in the budgetedStatement of Profit or Loss are based on monthly sales as follows:

Month 1 4,000Month 2 6,000Month 3 5,000Month 4 7,000Total sales 22,000

Purchases made in the first month must be paid for immediately. Subsequentpurchases will be on one months credit. The purchases figure in the budgetedStatement of Profit or Loss is made up as follows:

p r e p a r i n g c a s h b u d g e t s 7 7

CaseStudy

Month 1 6,000Month 2 6,000Month 3 4,000Month 4 5,000Total purchases 21,000

Cash expenses are based on paying out 1,000 in each of the first fourmonths of the business.

Equipment is to be bought for 15,000 in the first month of the business. Thedepreciation shown in the budgeted Statement of Profit or Loss is based ondepreciating these non-current assets at 20% per year on a straight-line basis.

Jim has 25,000 to invest in the business in month 1. The business has noopening cash balance.

Jim wishes to withdraw 2,000 from the business in month 4.

r e q u i r e d Prepare a cash budget in receipts and payments format for the first four

months trading of First Trade. Prepare a budgeted Statement of Financial Position as at the end of the four

month period.

s o l u t i o nThe cash budget is prepared in the following way. The capital invested is entered as a receipt in month 1. The receipts from sales are entered on the appropriate line, taking account of

the two months credit by lagging the receipts by two months, ie sales formonths 1 and 2 are received in months 3 and 4. Note that the sales made inmonths 3 and 4 do not appear on this cash budget as the money will not bereceived until months 5 and 6.

The payments for purchases and expenses are entered into the appropriatelines, using the data on payment terms. Remember that the first monthspurchases are paid for in month 1 and subsequent purchases are given onemonths credit.

The payments for non-current assets and drawings are entered asappropriate.

The receipts and payments totals are completed, and each months cash flowis calculated (ie total receipts minus total payments).

The bank balance brought forward for month 1 is inserted (here it is zero). The carried forward bank balance for each month is calculated in turn. This is

based on the calculation for each month using the formula:

7 8 m a n a g i n g c a s h t u t o r i a l

fIRST TRADE CASH BUDGET foR moNTHS 1 To 4

month 1 month 2 month 3 month 4000 000 000 000

Receipts:

Initial Investment 25

Receipts from Sales - - 4 6

Total Receipts 25 - 4 6

Payments:

Purchases 6 - 6 4

Expenses 1 1 1 1

Non-current Assets 15 - - -

Drawings - - - 2

Total Payments 22 1 7 7

Cash Flow for Month 3 (1) (3) (1)

Bank Balance brought forward 0 3 2 (1)

Bank Balance carried forward 3 2 (1) (2)

p r e p a r i n g c a s h b u d g e t s 7 9

cash flow for month + bank balance brought forward = bank balance carriedforward

The closing bank balance (bank balance carried forward) for one month is thenentered as the opening bank balance for the following month (bank balancebrought forward). Negative figures are shown in brackets.

We can see from the cash budget that if everything goes according to plan, Jimsbusiness bank balance will be 3,000 in credit at the end of month 1, but will fall to anoverdrawn balance of 2,000 by the end of month 4. Jim would therefore need to arrange suitable finance if he wishes to follow this budget. He should also consider the impact of things not going according to plan. For examplesales may be lower than forecast and expenses may be higher. This what-if planningprocess is called sensitivity analysis, and in Chapter 4 w