Cash Flow Forecast And Budgeting

Question 1

What are the used of cash flow forecast?

Answer 1

Identify timing of cash shortages and surpluses, application for funding and monitor cash flow

Question 2

How does cash flow forecast identify timings of cash shortages and surpluses?

Answer 2

If the cash flow forecast identifies periods of high negative cash flows, the management can make plans to reduce the negative balance. This can be done by reducing purchase of materials, machinery, tightening its credit sales policy (eg do not give too much credit) and applying for credit facilities in advance (eg bank overdraft/st bank loan). OTOH, if the cash flow forecast shows high positive cash flows in specific period, the management could begin making investment plans. It could plan to buy equipment, purchase materials in bulk to take advantage of discounts or repay bank loans early. This is because having excess funds carries an opportunity cost and poor use of money.

Question 3

How does cash flow forecast make application for funding?

Answer 3

When a business approaches banks or financial institutions for funding, they will be keen to look at the cash flow forecasts at regular intervals because the cash flow forecast reveals the ability of the business to repay loans.

Question 4

How does cash flow forecast monitor cash flow?

Answer 4

The cash flow forecast ensures that the business can afford to pay its suppliers and employees as the consequence would be dire if they are not paid. Suppliers -> may take legal action due to repeated default of payments + Ensure continuous credit from suppliers
Employees -> may leave/panic

Question 5

What are the limitations of cash flow forecast?

Answer 5

Nature of cash inflows, nature of cash outflows, accuracy of data, unexpected events, personal bias, actions of competitors and interest rate

Question 6

How does nature of cash inflows make the cash flow forecast less accurate?

Answer 6

• Owner’s capital injection: owner’s direct control -> cannot predict
• cash sales: depends on demand and market conditions -> very volatile (eg tastes and preferences may vary)
• receipts from trade receivables: depends on the volume of credit sales and timing of when customers actually pay -> can fluctuate

Question 7

How does nature of cash outflows limits the accuracy of cash flow forecast?

Answer 7

• lease: a predetermined agreed amount -> when the lease ends, the new changed amount is unpredictable
• rent: fixed and agreed for a certain time period -> need to renegotiate after the rent period -> change (volatile)
• materials: vary with demand
• labour: based largely on demand if workers are paid by piece rate or per hour rate

Question 8

How does accuracy of data limit cash flow forecast?

Answer 8

The management depends on market intelligence to prepare cash flow forecast. However, information from some of the sources, both secondary and primary, may be inaccurate. For example, sales executive May over forecast higher receipts from customers to please their manager. As such, the management may be misled into thinking there will be positive cash balance in the future months. The production department may forecast unrealistic higher level of purchases in the future months that will translate into higher cash outflows causing negative cash balance. Thus, the management will be misled into applying for credit facility or bank loan to tide over the potential negative cash balance and incur unnecessary interest expense.

Question 9

How does unexpected events limit the accuracy of cash flow forecast?

Answer 9

An experienced finance manager or employee may draw up an accurate sales forecast after meticulous research. However, an unexpected chain of events such as a sudden major closure of a customer, a surge in oil prices, political or civil unrest can totally nullify a meticulously prepared cash flow forecast.

Question 10

How does personal bias limit the accuracy of cash flow forecast?

Answer 10

Cash flow forecasts are drawn up based on assumptions of a stable economy and good relationships with customers and suppliers. However, these assumptions may be incorrect due to personal biasness, which would render the cash flow forecast inaccurate.

Question 11

How does behaviour of competitors limit the accuracy of cash flow forecast?

Answer 11

The actions of competitors have a direct impact on the performance of the business. In today’s highly competitive market where competitors can entice customers with social media promotions and e-commerce apps, a business will find it difficult to forecast its cash flow, especially its cash receipts. The ease of entry into the market also makes it difficult for a business to track its competitors and its strategies. Hence, businesses would have to think of Creative and innovative ways of promoting products to compete.

Question 12

How does interest rates limit the accuracy of cash flow forecast?

Answer 12

Banks may change its interest rate periodically and this may impact cash flow forecast. This is because businesses may depend on bank loans to run operations and changes in interest rates affect its cash outflows. The impact will be greater if the business has a large bank loan. Thus, interest rate movements will cause difficulty in forecasting cash flow.

Question 13

What is the importance of budgeting?

Answer 13

Allocation of resources, provides directions and monitor progress

Question 14

How does budgeting allocate resources?

Answer 14

• Ensure limited funds allocated according to priority among departments to meet business goals
• coordinates operations of various departments/divisions

Question 15

How does budgeting provide directions?

Answer 15

• Budget serves as a guide for actions

- inputs from employees in the form of targets and funds required to achieve the target -> improves employee motivation

Question 16

How does budgeting monitor progress?

Answer 16

Budgets allow the management to track its progress such as whether they are meeting budgeted sales target or budgeted costs of production so that corrective action can be quickly taken should adverse variances occur

Question 17

What are the benefits of budgeting?

Answer 17

Planning, effective allocation of resources, realistic target setting, communication and coordination, monitor,control and modify and measuring and assessing performance.

Question 18

How does budgeting carry out planning?

Answer 18

Planning process that forces management to monitor changes in environment eg economic and market conditions to set realistic targets

Question 19

How does budgeting ensure effective allocation of resources?

Answer 19

The management team needs to come together to agree on priorities so that business objectives are met. For example, the operations director and the R&D director have to agree on whether to budget for technological upgrade of production plant or increase in R&D expenditure. The basis of the agreement is based on the strategic objective of the business. Thus, budgeting will achieve the purpose of effective allocation of resources.

Question 20

How does budgeting achieve realistic target setting?

Answer 20

Budgeting provides the opportunity for managers and employees to set realistic targets to aim for. Through that, managers and staff have some degree of accountability for setting and reaching budget levels. This will in tun motivate them to achieve these targets.

Question 21

How does budgeting achieve communication and coordination?

Answer 21

Provides a platform for department heads to discuss resource alloactaion -> promotes effective coordination between departments and provides the opportunity for the entire company to come together to meet business goals.

Question 22

How does budgeting monitor, control and modify?

Answer 22

Managers will monitor regularly to ensure the business is on track to achieve the financial objective. Managers cannot assume that internal and external conditions remain constant. If there is evidence that the budgeted level is unrealistic and objectives cannot be met, then the plan or process must be modified

Question 23

How does budgeting measure and assess performance?

Answer 23

When the budgeted period has ended, variance analysis will be carried out to compare actual performance with the original budget. Managers will be required to explain the differences and this will provide a basis to asses managers’ performance.

Question 24

What are the drawbacks of budgeting?

Answer 24

Time-consuming, lack of flexibility, unnecessary spending, focused on the short-term, quality issues, limited staff cooperation and no direct involvement by managers.

Question 25

What is the importance of variance analysis?

Answer 25

Acts as a controlling or corrective tool and frames future budgets more accurately.

Question 26

What is the formula for variance?

Answer 26

Actual - budgeted figures

Question 27

How does variance analysis acts as a controlling or corrective tool?

Answer 27

When there is a deviation of actual from budgeted figure, manager will be prompted to find out the cause of deviation, especially for adverse variances. For example, if actual profit is below budgeted profit, managers need to determine whether the deviation was due to lower sales revenue or higher costs. If it is due to lower sales, managers will further find out the reasons for the lower sales which could be quality issues. By rectifying the quality issues, the business will be able to regain its competitiveness in the market

Question 28

How does budgeting frame future budgets more accurately?

Answer 28

Through variance analysis, the management will be able to understand the reasons for the deviation from the budgeted figures. For example, if sales revenue is lower than planned due to consumer resistance to higher prices, the management can factor this into account when planning future budgets.