What use is the cash budget?
The metal boxes company now knows that although both the sales forecast and profit margin are healthy during the first three months, in February it will suffer a cash deficit. The company directors can now consider in advance, how this deficit can be financed. In March the company will have quite a substantial cash surplus and the directors will consider investing this cash to maximise the benefit to the company. For example, if the company needed to buy a $60,000 non-current asset during the first three months it would ensure that it could be paid for in March and not February.
The cash budget can also be used to help prepare the budgeted statement of financial position, part of the company’s master budget. We already know that the cash balance is budgeted to be $94,000 at the end of the first quarter’s trading but the metal box company can also calculate the material inventory, trade receivables and trade payables closing balances. A proportion of materials are purchased before they are required for manufacture and therefore there will be a material inventory at the end of March equal to 50% of April’s sales requirements. If April’s sales are forecast to be $700,000 then the material inventory will be $87,500 ($700,000 x 0.25 x 0.50). Receivables at the end of March are expected to be $621,900 ($136,800 still due from February’s sales plus $297,000 and $188,100 due from March sales) the trade payables will be zero as the company pays cash for all of the purchases.
Finally the cash budget can be used to monitor and assess performance. If the metal box company has $780,000 of outstanding receivables at the end of March as compared to the $621,900 that was budgeted, then this would indicate that customers were taking longer to pay than their agreed terms (assuming that the sales revenues were as budgeted) this in turn may indicate that the person responsible for collecting the debt are less efficient than they should be.
Beverley Jay is assessor for Foundations in Accountancy Paper FFM, Foundations in Financial Management