Budget and Budgetting 1(2)

7/31/2019 Budget and Budgetting 1(2)

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Cash

It is essential to sustain a business.

It is important for trading purposes, buy stock,

pay workers salaries, bills etc

Profitable business can fail due to lack of cash.

It is also possible for business trade for many

years without making any profit.


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Harriet sets up a specialist mountain bikebusiness. She rents a shop for $1,000/- amonth- the first payment is due one month

after taking up the lease. She buys 10 bikes onone months credit. Each bike cost $1,000/-and is sold for $1,300/-. She sells all the bikeswithin the first 2 weeks, generating income of$13,000/- (and an initial profit of $3,000/-)

Cash= ? Profit=? Stock=?


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Towards the end of the 1stmonth she uses the$3,000/- profit to buy 3 more bikes, hoping tosell them quickly. Unfortunately, a competitor

reduces its prices and Harriet finds that shecannot sell her bikes

Cash = ?

Profit = ?

Stock = ?


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At the end of the month, Harriet is faced with 2 bills.She pays her supplier $10,000/- but no longer hasthe cash to pay her landlord.

Cash=? Profit=? Stock=?

She has still (on paper) made $3,000/- profit. Thisprofit is tied up in stock (the bikes) that she cannot

sell. Unless the landlord is generous or she can findthe rental money from elsewhere, then despite beingprofitable, Harriet has a cash flow crisis on herhands.


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Cash flow statement

A summary of the cash that has come into and out of the business over a period of

time, showing:

Where cash has come from (cash receipts)

How it has been used (cash payments)

Details what has happened, rather than what might happen in the future. Limitedcompanies are required to publish cash flow statements with their annual accounts.

It also include information about investing & financing activities of a company over a

period of time.

Helps users of financial statements evaluate a companys ability to have sufficient

cash- both on a short run and on a long run basis. The statement of cash flows is

useful to virtually everyone interested in the companys financial health: short-and

long-term creditors, investors, management- and both current and prospective

competitors


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ALLISON CORPORATION

Statement of Cash Flow

For the year ended December 31, 2005

Cash flows from operating activities:

Cash received from customers $870,000

Interest and dividends received $ 10,000

Cash provided by operating activities $880,000

Cash paid to suppliers and employees $(764,000)

Interest paid $ (28,000)Income taxes paid $ (38,000)

Cash disbursed for operating activities $(830,000)

Net cash flows from operating activities $ 50,000

Cash flows from investing activities:

Purchases of marketable securities $(65,000)Proceeds from sales of marketable securities $ 40,000

Loans made to borrowers $(17,000)

Collections on loans $ 12,000

Purchases of plants assets $(160,000)

Proceeds from sales of plant assets $ 75,000

Net cash flows from investing activities $(115,000)


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Cash flows from financing activities:

Proceeds from short-term borrowing $ 45,000

Payments to settle short-term debts $(55,000)

Proceeds from issuing bonds payable $100,000

Proceeds from issuing capital stock $ 50,000

Dividends paid $ (40,000)

Net cash flows from financing activities $100,000

Net increase (decreases) in cash $ 35,000

Cash and cash equivalents, Jan. 1 $ 20,000

Cash and cash equivalents, Dec 31 $ 55,000


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The cash flows shown in the statement are grouped into 3 major

categories:

1) Operating activities

2) Investing activities

3) Financing activities

Operating activities

The operating activities section shows the cash effects of revenue and

expense transactions.

The operating activities section of the statement of cash flows include thecash effects of those transactions reported in the income statement.

Receipts and payments of interest are classified as operating activities.


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Cash flows from operating activities include:

Cash receipt Cash payments

Collections from customers for Payments to suppliers of

sales of goods and services merchandise and services, including

payments to employeesInterest and dividends received

Payments of interest

Other receipts from operations;

i.e: proceeds from settlement of Payments of income taxes

litigation

Other expenditures relating to

operations; i.e: payments in

settlement of litigation


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Investing Activities

Cash flows relating to investing activities present the cash effects oftransactions involving plant assets, intangible assets, and investment. They

include:

Cash receipts Cash payments

Cash proceeds from selling Payments to acquire investments

Investments and plant assets and plant assets

Cash proceeds from collecting Amounts advanced to borrowers

principal amounts on loans


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Financing activities

Cash flows classified as financing activities include the following items thatresult from debt and equity financing transactions:

Cash receipts Cash payments

Proceeds from both short- Repayment of amounts borrowedterm and long-term borrowing (excluding interest payments)-

Refer to repayment of loans

Cash received from owners Payments to owners, such as cash

(i.e: from issuing stock) dividends


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Cash and Cash Equivalents

Cash is defined as including both cash and cash equivalents.

Cash Equivalents: Short-term, highly liquid investments, such as moneymarket funds, commercial paper, and treasury bills.

Preparing cash flow statement.

It is easier to prepare by examining income statement and the changesduring the period in all of the balance sheet accounts except for cash.


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Cash Flow forecast

A way of constantly monitoring cash flow position. A plan of the expected

movements of cash into and out of the business in the year ahead.

Allowing managers to:

Ensure enough cash is available to meet outgoings

Plan how to finance any anticipated shortages of cash

Cash flow forecast list:

Cash inflows

(Money coming in from sales and other source)

Cash outflows

(money being used to pay bills and other expenses)

Net cash flow

The effect on net cash flow (inflow-outflow) on the businesss cash balances


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SEPT OCT NOV DEC JAN FEB TOTAL

Cash inflows

Sales Revenue 1500 1600 1750 2000 1500 1100 9450

Total cash in 1500 1600 1750 2000 1500 1100 9450

Cash outflows

Water - - 100 - - 100 200

Electricity - - 100 - - 100 200

Raw Materials 750 800 875 1000 750 550 4725

Wages 100 100 100 200 100 100 700

Advertising - 50 500 1000 - - 1550

Maintenance - - 30 50 10 10 100

Office Equipment 50 - 100 - - - 150

Premises rent 250 250 250 250 250 250 1500

Misc. expenses 10 10 100 200 10 10 340

Total cash out 1160 1210 2155 2700 1120 1120 9465

Net cash flow (+/-) 340 390 (405) (700) 380 (20) (15)

Opening balance 0 340 730 325 (375) 5 -

Closing balance 340 730 325 (375) 5 (15) -


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May June July

Cash inflows

Start-up capital 5,000

Sales revenue 1,000 ?

Total Receipts ? 1,000 1,200

Cash outflows

Payments

Insurance 100 100 100

Stock purchases 0 650 780

Miscellaneous 50 50 50

Rent 1,000 1,000 1,000Electricity 100

Telephone 75

Marketing costs 20 24

Shop fittings ?

Water 150

Total payments 3,150 ? 2,279

Total receipts 5,000 1,000 1,200

Total payments 3,150 ? 2,279

Net cash flow ? ? ?

Opening balance 1,850 1,030

Closing balance 1,850 ? ?


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Using the figures provided, complete 12-month cash flow forecast for Wolf Clothing Stores.

Note: The first month will be a non-trading month (no-sales will be made, but all other

relevant costs will still be incurred).

Capital introduced: $15,000/- is invested in the business by the owners.

Sales : Sales are estimated at $1,000/- in the first month , increasing by 35%

each month thereafter.

Insurance : $1,200/- is paid in equal instalments.Stock : Cost of purchase is 65% of sales. Loyalty discounts after 6 months will

reduce this to 55% (i.e: from the 7th trading month)

Miscellaneous : $25/- per month

Rent : $1,000/- per month. The lat above the shop is rented out bringing in

$450 per month additional income.

Accountants Fee : $1,000/- annual fee, paid in first month .

Electricity : $100/- per quarter (July, October, January, April)

Telephone : $75/- per quarter (July, October, January, April)

Vehicle costs : $200/- in the 1stmonth, $75/- per month thereafter.


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Marketing costs : 2% of sales for 1st6 month increasing to 6% from the 7th trading month

Water : $100 per quarter (July, October, January, April)

Salaries : Since Wolf are operating as a partnership, they do not intend to pay

themselves for the 1st3 months . After this time, salaries will be equal

7% of sales.

Shopfittings : $2,000/- in the 1stmonth


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USEFULNESS LIMITATIONS

Cash flow forecasts enable businesses toidentify cash shortages. If a business identifies acash shortage, it can plan to avoid or manage

situation.

Cash flow forecasts are only estimates. Salesmay be lower than forecast or cost may behigher. A wide range of factors will affect the

accuracy of the forecast.

Banks require cash flow forecasts to beprepared before they grant a business loan. Thisensures that the business will be able to payback the loan and that it understands the

importance of cash flow management.

It is impossible to forecast every item ofexpenditure.

Using a cash flow forecasts, a business can planexpenditure based on a future cash surplus, ordelay expenditure to avoid a cash shortage.

The cash flow statement may reveal a problembut may give little indication of the underlyingcauses (although, at least, management will beaware of the problem)

By completing a cash flow forecast , using aspreadsheet, the business can consider whatifs. The spreadsheet will automatically work outthe cash implications of, for instance, offeringcustomer longer credit period.

Management must use cash flow forecasts as aworking tool. Once a cash flow forecasts hasbeen prepared, it should be monitored regularlyand updated to take into account changingeconomic circumstances.


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Cash forms a large part of working capital.

Working Capital:

Amount of money available to fund the day-to-dayrunning of a business.

It is calculated by comparing what a business ownswith what it owes.

Working Capital= Current Assets- Current Liabilities


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A business needs to have more currentassets than current liabilities to ensure thatits short-term debts can be meet.

A lack of working capital causes the sameproblems as lack of cash (remembering thatcash is just one part of working capital). A

business will be unable to meet its short-term debts (i.e: paying for stock, or payingstaff) and will face financial crisis.


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Investing too much in fixed asset

Holding to much stock

Overtrading Seasonal fluctuations

Giving too much credit

Using too much credit Unexpected events


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Chase debtors Cut cash outflow

Debt factoring

Delay payments Increase cash flow

Overdraft

Bank Loan

Sale and leaseback

Sell unused assets


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Williams, J.R, Haka S.F, Bettner, M.S &Carcellon, J. V.2008. Financial&ManagerialAccounting

Thompson, R. and Machin, D. (2003). AsBusiness Studies

Documents

Budget and Budgetting 1(2)