5 Budgets & Cash Flow Forecast

Question 1

Budget

Answer 1

A financial plan for future period based on analysing financial performance by forecasting revenue and expenditure, for any given time period. Key financial indicator, used to support funding applications.

Question 2

Income Budget

Answer 2

Sets out agreed expenditure for a future time period. Helps a firm to plan its workforce/operations/allocate resources. Allows planning for staffing/order levels needed to meet demands/requirements.

Question 3

Expenditure Budget

Answer 3

Sets out agreed expenditure for a future time period including a range of expenditure -raw materials/staff/marketing/administration/rents and rates/asset purchases/insurance.

Question 4

Profit Budget

Answer 4

Sets out agreed profit for a future time period, important to ensure the firm makes a profit, based on projected income/expenditure, should be viewed within a full year to remove seasonality changes in demand.

Question 5

Purpose of Budgets

Answer 5

Gaining investment from financiers/potential investors to know their investment is secure.
Financial control - rectifying areas of underperformance by putting actions in place.
Establish priorities depending on objectives.
Improving staff performance and delegate responsibility/motivation/develop skillset.

Question 6

Problems with Constructing Budgets

Answer 6

Difficult to forecast revenue accurately/based on estimates.
Unforeseen changes in the external environment are not taken into account.
Staff with extra responsibility are demotivated.
Conflict between departments competing for resources.
Time-consuming to analyse and construct budgets.
Conflict when budgets are imposed - counterproductive.

Question 7

How do businesses benefit from analysing budgeted/actual expenditure figures?

Answer 7

Securing finance from investors.
Analyse whether demand is sustainable - the need to diversify/meet needs.
Ensure not making a loss (expenditure>revenue)
Address overspending to amend future budgets - identify plans related to actual decisions.

Question 8

What business decision may arise as a result of analysing revenue data?

Answer 8

Whether to invest in increasing capacity (if demand is sustainable) such as hiring new staff/purchasing new warehouses/machinery.
Adding value/USP to meet customer needs.
Adapt marketing mix - new competitors/unexpected external shocks.

Question 9

Variance Analysis Purpose

Answer 9

Enables managers to monitor performance.
Find reasons for negative/adverse differences.
Making informed decisions to deal with setbacks, direct toward aims/objectives.

Question 10

Variance Analysis Equation

Answer 10

Budgeted Figure - Actual Figure

Question 11

What to do when sales revenue is adverse?

Answer 11

Cut prices (if demand is elastic).
Improve company image - PR donations to charities.
Increase advertising/promotions.
Update/extend product range (diversify).
Seek new markets at home or overseas.

Question 12

Actions to take when there are adverse production (cost) variances?

Answer 12

Cut wages or increase labour productivity - increase output.
Seek cheaper raw materials - purchase overseas/in bulk.
Reduce wastage - use fewer raw materials and produce fewer faulty goods (lean production/JIT)

Question 13

Favourable Variance

Answer 13

When revenue>budget OR costs are lower than budgeted - when more profit is made than expected.

Question 14

Adverse Variance

Answer 14

Actual expenditure being higher than budgeted for OR actual revenue being lower than budgeted - less profit is made than expected.

Question 15

Causes of Favourable Variances

Answer 15

Wage rises lower than expected.
Economic boom leads to higher than expected sales.
Rising value of the £ makes imported raw materials cheaper.
Lower interest rates lead to higher spending and therefore higher sales
Predicted costs paid back on loans is lower.
Bad publicity for competitor boosts sales revenue above budgeted target.

Question 16

Causes of Adverse Variances

Answer 16

Competitors introduce new products - extra sales that have a negative impact on revenue.
Government increases taxes/business rates by an unexpected amount.
Fuel prices rise as price of oil rises.
Staff efficiency falls, higher wage costs for each unit produced.
Rent increases forced through by property owner.

Question 17

Forecasted Cash Inflows

Answer 17

Owner’s investment/sources of finance.
Cash sales estimated from sales forecast (over/underestimated).
Debtor payments determined by credit terms - whether they are paid on time (how good is a firm’s credit control).

Question 18

Factors to Consider

Answer 18

Expertise/skillset of entrepreneur.
Whether estimates are accurate.
Is the product innovative?
How will competitors react?

Question 19

Forecasted Cash Outflows

Answer 19

Payment of fixed costs - easy to estimate on monthly basis, time delay between estimates.
Payment of variable costs - when sales are difficult to forecast, so are direct costs.
Unforeseen Expenses - one-off unexpected payments.
Payment terms - when a supplier changes terms and wants payments sooner/demands money back.

Question 20

Net Cash Flow

Answer 20

Total Inflows - Total Outflows

Question 21

Closing Balance

Answer 21

Opening Balance + Net Cash Flow

Question 22

Receivables

Answer 22

When a business is owed money from customers - credit terms offered to customers. Aappear in month of cash receipt.

Question 23

Payables

Answer 23

When a business owes money to suppliers. Credit payments appear in month of cash outflow.

Question 24

Use of Cash Flow Forecasts

Answer 24

To identify timing/significance of potential shortfalls.
Identify possible corrective action.
Help secure finance from potential investors/financiers.
Give confidence to shareholders about short-term survival.
Provide a guide which to measure actual cash flow.

Question 25

Benefits of Cash Flow Forecasts

Answer 25

Identify potential problems before they arise - planning.
Identify opportunities for the use of excess cash.
Control spending/avoid overspending.
Help to raise finance.
Negotiate trade credit.
Plan to meet day-to-day expenses.
Where necessary take corrective action.
Set cash flow targets.

Question 26

Limitations of Cash Flow Forecast

Answer 26

Needs to be monitored/reviewed.
Based on forecasts so is likely to be inaccurate.
Does not ensure survival.
May lose customers if too concerned about timings of cash inflows.
May increase costs if too concerned about timing of cash outflows.

Question 27

What may happen if cash inflows are too slow?

Answer 27

A firm may try to speed up cash inflows, may include offering a discount for early payments or penalties for late payments. They may need to chase payments (credit control).

Question 28

Why might a business be willing to offer a customer long payment terms?

Answer 28

May encourage people to purchase as opposed to a competitor (marketing tool).
Confirm sale immediately.
More competitive.
Better placed to assess the customer’s credit worthiness than a bank.

Question 29

What may happen if cash outflows are too quick?

Answer 29

A firm will try to slow down cash outflows, which may include negotiating longer payment terms from suppliers (agree longer trade credit period). If you do not pay on time, may develop a negative reputation and suppliers drop you. The time to find new suppliers, you are forgoing potential sales.

Question 30

What is cash used for?

Answer 30

Buying inventory
Paying wages
Utility bills

Question 31

What may insufficient liquid cash funds mean?

Answer 31

Inability to meet short term debts - bank overdraft/trade payables.
Missed opportunities.

Question 32

Causes of Cash Flow Problems`

Answer 32

Credit Sales - poor credit control and long payment terms.
Overtrading, where inflows>outflows - additional overhead/day-to-day expenses or increased capital expenditure.
Internal Management - stock control/relationship with suppliers/inaccurate planning.
Seasonality
Unexpected Events - covid/conflict/trading issues/logistic issues/external changes.

Question 33

Improving Cash Flows INFLOWS

Answer 33

Using financiers (banks)
Overdraft - arrangement with bank to allow business to withdraw more than amount available.
Short Term Loan - an arrangement to lend money for a set period of time.
Debt factoring - the process of selling a business’ debts to a factor house at a reduced amount in order to receive immediate payment.
Cash payments from customers - reducing credit terms (the amount of time a customer is given to pay back).
Offering a discount for immediate/quick payment.
Credit Control - the process of chasing payments from debtors (people who have bought from you on credit).

Question 34

Improving Cash Flow OUTFLOWS

Answer 34

Delaying payments to suppliers - negotiating longer payment terms, may incur penalties, need to maintain +ve relationship.
Stock Management - JIT, Inventory Management - reduce money tied up in stock, reliable supply deliveries.
Reduce Overhead Spending - cut unnecessary expenditure without an impact on productivity.

Question 35

Difficulties with Improving Cash Flow

Answer 35

Damage to firm’s reputation
Potential loss of customers if payment terms affect competitiveness.
Administrative costs and time.
Loss of discounts or need to offer discounts.
May affect profitability - only receive parts of debts or more expensive to leave assets in longer run.