topic 19 cash budgets

• Cash budget purposes:

  • to make sure that the business plans ahead so that it has enough cash available to operate and pay bills on time - cash flow problems are the major cause of business failure
  • to alert managers to possible shortages so that they can take action before hand eg. reminding customers to settle debts, delaying payment to suppliers and negotiating a bank overdraft to tide them over
• Difference between a cash budget and financial statements:

  • a cash budget is a forecast, financial statements are historic
  • a cash budget includes both revenue and capital items
  • it is possible to have negative balances in the cash budget if the business is overdrawn at the bank
  • only cash transactions are included - non cash items such as provision for depn do not go in a cash budget
• Receipts and payments are not the same as income and expenditure. When credit transactions occur sales and purchases are not perfectly synchronised with receipts and payments
• Cash flow is based on receipts less payments. Includes revenue and capital items, there is timing differences as cash is not received until customers pay. Includes only cash transactions
• Profit is based on income less expenditure. Only revenue items are included and transactions are recorded when they take place (realisation concept). Also includes credit transactions, accruals/prepayments and non-cash items
• Why a profitable business can have an overdraft:

  • high sales on credit and accrued income but slow paying customers mean high profits but poor cash flow
  • purchasing nca improves long run profitability but means large cash outflow
  • repayment of loans decreases cash but has no effect on profit
• Why an unprofitable business can have a healthy cash balance:

  • purchases on credit and accrued expenses reduce profit but do not affect cash flow
  • not spending money on better quality nca keeps money in the business
  • taking out loans increases cash flow but only the interest on loans affect profit
  • depn of non current assets can be a significant expense which reduces profit but has no effect on cash flow
• Explain how credit sales and purchases should be recorded in a cash budget:

  • credit sales is when goods are sold but payment by the customer will be made in the future
  • credit purchases is when goods are bought but payment will be made in the future
  • receipts from customers are therefore recorded in the month when customers are expected to make payment not when the credit sale is made
  • payments to suppliers is recorded in the month where suppliers are expected to be paid and not when the credit purchase is made