Chapter 9 - Cash Budgeting And Resources Ratios Flashcards
Purpose of a cash budget
A cash budget details the forecast bank receipts and payments in order to show the forecast bank balance at the end of each month.
The cash budget focuses on the liquidity of a business. Without liquidity a business will run out of money to pay its suppliers, wages and expenses.
From the cash budget the managers of a business can decide what action to take when a surplus of cash is shown to be available or when a bank overdraft needs to be arranged.
Difference between cash and profit
Cash is money on the bank or held as physical cash (money in the till)
Profit is a calculated figure which shows the surplus of income over expenditure for a period
Reasons why a business can be making a profit but its bank balance is reducing
Capital expenditure - the purchase of non current assets reduce cash but profit is affected only by the amount of depreciation of the asset
Increase in trade receivables - if more goods are being sold this should increase profits but until trade receivables pay there is not benefit to the bank balance
Decrease in trade payables - if trade payables are paid earlier than usual there will be no effect on profit but the bank balance will reduce
Layouts of cash budgets
Cash budgets consist of three main sections:
Receipts for the month
Payments for the month
Summary of bank account
Benefits of cash budgets
Monitors cash resources
Plan future expenditure. E.g finance new non current assets
Control costs costs and revenues to ensure a bank overdraft is avoided or a bank loan can be arranged in advance
Reschedule payments to avoid bank borrowing. E.g delay the purchase of non current assets
Forecasting cash receipts and payments
Receipts
Receipts are analysed to show the amount of money expected to be received from: cash sales, trade receivables, disposal of non current assets, capital introduced and loans received.
Payments
Payments show how much money is expected to be paid in respect of:
Cash purchases, trade payables, production costs, acquisition of non current assets, repayment of capital, drawings, loans repaid.
Funding non current assets
Cash purchase - This is where the business has sufficient cash to pay in full. Alternatively, a business might buy an asset on standard commercial credit terms eg 30 days and then make payment for the asset from the bank account before the end of the term.
Part exchange- This is where an old asset is traded in as a part of the purchase price, the balance remaining is either paid in cash or by borrowing
Borrowing - Loans - Method of funding the purchase of non current assets. Ownership of the assst belongs to the business from the start unlike hire purchase.
Borrowing - Hire purchase - A hire purchase agreement from a finance company enables a business to have use of a non current asset on payment of a deposit. The finance company owns the asset and the hirer makes regular instalments. At the end of the hire purchase period ownership of the asset usually passes from the finance company to the business. Often used to finance non current assets.
Inventory holding period (days)
Inventories/ cost of sales x 365
Inventory holding period is the number of days inventories held on average. It is important for a business to keep it’s inventory holding period as short as possible.
Trade receivables collection period (days)
Trade receivables/ revenue x 365
This calculation shows how many days on average trade receivables take to pay for goods sold to them by the business. Most trade receivables should make payment within about 30 days however with international trade it may take longer for the proceeds to be received.
A comparison from year to year of the collection period is a measure of the efficiency at collecting the money that is due. Ideally trade receivables days should be shorter than trade payable days which means money is being received from trade receivables before it is paid out to trade payables.
Trade payables payment period (days)
Trade payables/ cost of sales x 365
Here we are measuring the speed it takes to make payment to trade payables. While trade payables can be a useful source of finance, delaying payment too long may cause problems. We should also be looking for a similar figure for trade payables days from one year to the next which would indicate a stable company.
Working capital cycle (days)
Working capital cycle = inventory days + receivable days - Payable days
The working capital cycle measures the period in time between payment for goods received into inventory and the collection of cash from customers in respect of their sale.
Improving cash flow
When the working capital cycle has been calculated it needs to be compared with the working capital cycle for the previous year or similar business. It will show either a better position - time has been reduced or a worse position - time has been increased
How to improve liquidity
Raise additional finance from the owners in the form of capital
Raise additional debt finance in forms of loans, overdrafts, hire purchase
To improve cash flow of the working capital cycle:
Speed up the rate of debt collection
Slow down the rate of payment to suppliers
Reduce inventory
Offer prompt payment discount to customers
Dispose of non current assets
