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Cash Flow Management: Budgeting and
Controlling Costs
If there is anything more
important to the successful financial management of a business than the
thorough, thoughtful preparation of Pro Forma Income Statements, it is the
preparation of the Cash Flow Statement, sometimes called the Cash Flow
Budget.
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The Cash Flow Statement
The Cash Flow Statement identifies when cash is expected to be
received and when it must be spent to pay bills and debts. It shows
how much cash will be needed to pay expenses and when it will be
needed. It also allows the manager to identify where the necessary
cash will come from.
For example, will it be internally generated from sales and the
collection of accounts receivable--or must it be borrowed? (The Cash
Flow Projection deals only with actual cash transactions;
depreciation and amortization of good will or other non-cash expense
items are not considered in this Pro Forma.) |
The Cash Flow Statement identifies
when cash is expected to be received and when it must be spent to pay
bills and debts. It shows how much cash will be needed to pay expenses and
when it will be needed. It also allows the manager to identify where the
necessary cash will come from. For example, will it be internally
generated from sales and the collection of accounts receivable--or must it
be borrowed? (The Cash Flow Projection deals only with actual cash
transactions; depreciation and amortization of good will or other non-cash
expense items are not considered in this Pro Forma.)
The Cash Flow Statement, based on management estimates of sales and
obligations, identifies when money will be flowing into and out of the
business. It enables management to plan for shortfalls in cash resources
so short term working capital loans may be arranged in advance. It allows
management to schedule purchases and payments in a way that enables the
business to borrow as little as possible. Because all sales are not cash
sales management must be able to forecast when accounts receivable will
become "cash in the bank" and when expenses--whether regular or
seasonal--must be paid so cash shortfalls will not interrupt normal
business operations.
The Cash Flow Statement may also be used as a Budget, permitting the
manager increased control of the business through continuous comparison of
actual receipts and disbursements against forecast amounts. This
comparison helps the small business owner identify areas for timely
improvement in financial management.
By closely watching the timing of cash receipts and disbursements, cash
balance on hand, and loan balances, management can readily identify such
things as deficiencies in collecting receivables, unrealistic trade credit
or loan repayment schedules. Surplus cash that may be invested on a
short-term basis or used to reduce debt and interest expenses temporarily
can be recognized. In short, it is the most valuable tool management has
at its disposal to refine the day-to-day operation of a business. It is an
important financial tool bank lenders evaluate when a business needs a
loan, for it demonstrates not only how large a loan is required but also
when and how it can be repaid.
A Cash Flow Statement or Budget can be prepared for any period of time.
However, a one-year budget matching the fiscal year of your business is
recommended. As in the preparation and use of the Pro Forma Statement of
Income, the projected Cash Flow Statement should be prepared on a monthly
basis for the next year. It should be revised not less than quarterly to
reflect actual performance in the preceding three months of operations to
check its projections.
In preparing the Cash Flow Statement or Budget start with the sales
budget. Other budgets are related directly or indirectly to this budget.
The following is a sales forecast in units:
Sales Budget--Units For the Year Ended December 31, 19__
Territory
Total 1st
2nd 3rd 4th
Qtr Qtr
Qtr Qtr
East.................... 26,000 5,000 6,000
7,000 8,000
West....................11,000 2,000 2,500
3,000 3,500
37,000 7,000 8,500 10,000 11,500
Assume you sell a single product and the sales price for it is $10. Your
sales budget in terms of dollars would look like this:
Sales Budget--Dollars For the Year Ended December 31, 20__
Territory
Total
1st 2nd
3rd 4th
Quarter Quarter Quarter
Quarter
East...................... $260,000 $50,000
$80,000 $ 70,000 $ 80,000
West...................... 110,000 20,000
25,000 30,000
35,000
$370,000 $70,000 $85,000 $100,000
$115,000
Say the estimated per unit cost of the product is $1.50 for direct
material, $2.50 for direct labor, and $1.00 for manufacturing overhead. By
applying unit costs to the sales budget in units, you would come out with
this budget:
Cost of Goods Sold Budget For the Year Ended December 31, 20__
Total 1st
2nd 3rd
4th
Quarter Quarter Quarter
Quarter
Direct material..... .$ 55,500 $10,500 $12,750
$15,000 $17,250
Direct labor......... 92,500
17,500 21,250 25,000
28,750
Mfg. overhead........ 37,000
7,000 8,500
10,000 11,500
$185,000 $35,000 $42,500 $50,000
$57,500
Later on, before a cash budget can be compiled, you will need to know the
estimated cash requirements for selling expenses. Therefore, you prepare a
budget for selling expenses and another for cash expenditures for selling
expenses (total selling expenses less depreciation):
Selling Expenses Budget For the Year Ended December 31 20__
Total
1st 2nd
3rd 4th
Quarter Quarter Quarter
Quarter
Commissions............. $46,500 $ 8,750
$10,625 $12,500 $14,375
Rent....................
9,250 1,750
2,125 2,500
2,875
Advertising.............
9,250 1,750
2,125 2,500
2,875
Telephone............... 4,625
875 1,062
1,250 1,437
Depreciation--office.... 900
225 225
225 225
Other...................
22,250 4,150
5,088 6,025
6,983
$92,500 $17,500 $ 21,250 $25,000
$28,750
Selling Expenses Budget--Cash Requirements For the Year Ended December 31,
20__
Total 1st
2nd 3rd
4th
Quarter Quarter Quarter
Quarter
Total selling expenses.. $92,500
$17,500 $21,250 $25,000
$28,750
Less: depreciation......
expense--office.........
900 225
225 225
225
Cash requirements....... $91,600
$17,275 $21,025 $24,775
$28,525
Basic information for an estimate of administrative expenses for the
coming year is easily compiled. Again, from that budget you can estimate
cash requirements for those expenses to be used subsequently in preparing
the cash budget.
Administrative Expenses Budget For the Year Ended December 31, 20___
Total 1st
2nd 3rd
4th
Quarter Quarter Quarter
Quarter
Salaries................ $22,200 $4,200
$5,100 $ 6,000 $ 6,900
Insurance................ 1,850
350 425
500 575
Telephone................ 1,850
350 425
500 575
Supplies................. 3,700
700 850
1,000 1,150
Bad debt expenses.....3,700
700 850
1,000 1,150
Other expenses.......... 3,700
700 850
1,000 1,150
$37,000 $7,000 $8,500 $10,000
$11,500
Administrative Expenses Budget--Cash Requirements For the Year Ended
December 31, 20___
Total 1st
2nd 3rd
4th
Quarter Quarter Quarter Quarter
Estimated adm. expenses... $37,000 $7,000
$8,500 $10,000 $11,500
Less: bad debt expenses... 3,700
700 850
1,000 1,150
Cash requirements......... $33.300
$6,500 $7,650 $ 9,000 $10,350
Now, from the information budgeted so far, you can proceed to prepare the
budget income statement. Assume you plan to borrow $10,000 at the end of
the first quarter. Although payable at maturity of the note, the interest
appears in the last three quarters of the year. The statement will
resemble the following:
Budgeted Income Statement For the Year Ended December 31, 20___
Total 1st
2nd 3rd
4th
Quarter Quarter Quarter
Quarter
Sales.................. .$370,000
$70,000 $85,000 $100,000 $115,000
Cost of goods sold...... 185,000 35,000
42,500 50,000
57,500
Gross Margin............ $185,000 $35,000 $42,500
$ 50,000 $ 57,500
Operating expenses:
Selling................ $ 92,500
$17,500 $21,250 $ 25,000 $
28,750
Administrative......... 37,000
7,000 8,500
10,000 $ 11,500
Total...............
.$129,500 $24,500 $29,750
$ 35,000 $ 40,250
Net income
from operations....... .$ 55,500 $10,500
$12,750 $ 15,000 $ 17,250
Interest expense.......
450 150
150 150
Net income before
Income taxes........... $ 55,050 $10,500
$12,600 $ 14,850 $ 17,100
Federal income tax..... 27,525
5,250 6,300
7,425 8,550
Net income.............. $ 27,525 $ 5,250
$ 6,300 $ 7,425 $ 8,550
Estimating that 90 percent of your account sales is collected in the
quarter in which they are made, that 9 percent is collected in the quarter
following the quarter in which the sales were made, and that 1 percent of
account sales is uncollectible, your accounts receivable budget of
collections would look like this:
Budget of Collections of Accounts Receivable For the Year Ended December
31, 20___
Total 1st
2nd 3rd
4th
(net) Quarter Quarter
Quarter Quarter
4th Quarter Sales 20-0... $ 6,000 $ 6,000
1st Quarter Sales 20-1... 69,300 63,000
$ 6,300
2nd Quarter Sales 20-1... 84,150
76,500 $ 7,650
3rd Quarter Sales 20-1... 99,000
90,000 $ 9,000
4th Quarter Sales 20-1... 103,500
103,500
$361,950 $69,000 $82,800 $97,650 $112,500
Going back to the sales budget in units, now prepare a production budget
in units. Assume you have 2,000 units in the opening inventory and want to
have on hand at the end of each quarter the following quantities: 1st
quarter, 3,000 units; 2nd quarter, 3,500 units; 3rd quarter, 4,000 units;
and 4th quarter, 4,500 units.
Production Budget--Units For the Year Ended December 31, 20___
1st 2nd
3rd 4th
Quarter Quarter Quarter Quarter
Sales requirements........... 7,000 8,500
10,000 11,500
Add: ending
inventory requirements...... 3,000 3,500
4,000 4,500
Total requirements.......... 10,000 12,500
14,000 16,000
Less: beginning
inventory...................
2,000 3,000 3,500
4,000
Production
requirements............... 8,000
9,000 10,500 112,000
Next, based on the production budget, prepare a budget to show the
purchases needed during each of the four quarters. Expressed in terms of
dollars, you do this by taking the production and inventory fires and
multiplying them by the cost of material (previously estimated at $1.50
per
unit). You could prepare a similar budget expressed in units.
Budget of Direct Materials Purchases For the Year Ended December 31, 20___
1st 2nd
3rd 4th
Quarter Quarter Quarter
Quarter
Required for production........ $12,000 $13,500
$15,750 $18,000
Required for ending inventory.. 4,500
52,250 6,000
6,750
Total........................
$16,500 $18,750 $21,750 $24,750
Less: beginning inventory......
3,000 4,500
5,250 6,000
Required purchases............. $13,500
$14,250 $16,500 $18,750
Now suppose you pay 50 percent of your accounts in the quarter of the
purchase and 50 percent in the following quarter. Carryover payables from
last year were $5,000. Further, you always take the purchase discounts as
a matter of good business policy. Since net purchases (less discount) were
figured into the $1.50 cost estimate, purchase discounts do not appear in
the budgets. Thus your payment on purchases budget will come out like
this:
Payment on Purchases Budget For the Year Ended December 31, 20___
Total 1st
2nd 3rd
4th
Quarter Quarter Quarter
Quarter
4th Quarter Sales 20-0... $ 5,000 $ 5,000
1st Quarter Sales 20-1... 13,500
6,750 $ 6,750
2nd Quarter Sales 20-1... 14,250
7,125 $ 7.125
3rd Quarter Sales 20-1... 16,500
8,250 $ 8,250
4th Quarter Sales 20-1... 9,375
9,375
Payments by Quarters $58,625
$11,750 $13,875 $15,375 $17,625
Taking the data for quantities produced from the production budget in
units, calculate the direct labor requirements on the basis of units to be
produced. (The number and cost of labor hours necessary to produce a given
quantity can be set forth in supplemental schedules.)
Direct Labor Budget--Cash Requirements For the Year Ended December 31,
20__
Total 1st
2nd 3rd
4th
Quarter Quarter Quarter Quarter
Quantity................
39,500 8,000 9,000
10,500 12,000
Direct labor cost....... $98,750 $20,000 $22,500 $26,250
$30,000
Now outline the items that comprise your factory overhead, and prepare a
budget like the following:
Manufacturing Overhead Budget For the Year Ended December 31, 20___
Total 1st
2nd 3rd
4th
Quarter Quarter Quarter Quarter
Heat and power.......... $10,000 $1,000 $2,500 $ 3,000 $ 3,500
Factory supplies........
5,300 1,000 1,500 1,800
1,000
Property taxes..........
2,000 500 500
500 500
Depreciation............
2,800 700 700
700 700
Rent....................
8,000 2,000 2,000 2,000
2,000
Superintendent..........
9,400 2,800 1,800 2,500
4,300
$39,500 $8,000 $9,000 $10.500 $12,000
Figure the cash payments for manufacturing overhead by subtracting
depreciation, which requires no cash outlay, from the totals above, and
you will have the following breakdown:
Manufacturing Overhead Budget--Cash Requirements For the Year Ended
December 31, 20___
Total 1st
2nd 3rd
4th
Quarter Quarter Quarter Quarter
Productions--units......
39,500 8,000 9,000
10,500 12,000
Mfg.overhead expenses...
$39,500 $8,000 $9,000 $10,500
$12,000
Less: depreciation......
2,800 700
700 700
700
Cash requirements.......
$36,700 $7,300 $8,300 $ 9,800
$11,300
Now comes the all important cash budget. You put it together by using the
Collection of Accounts Receivable Budget; Selling Expenses Budget--Cash
Requirements; Administrative Expenses Budget--Cash Requirements; Payment
of Purchases Budget; Direct Labor Budget--Cash Requirements; and
Manufacturing Budget--Cash Requirements.
Take $15,000 as the beginning balance, and assume that dividends of
$20,000 are to be paid in the fourth quarter.
Cash Budget For the Year Ended December 31, 20___
Total
1st 2nd
3rd 4th
Quarter Quarter Quarter
Quarter
Beginning cash balance $ 15,000
$15,000 $ 3,850 $ 13,300 $
25,750
Cash collections
361,950 69,000
82,800 97,650
112,500
Total
$376,950 $84,000 $86,650 $110,950
$138,250
Cash payments
Purchases
$ 58,625 $11,750 $13,875 $
15,375 $ 17,625
Direct labor
98,750 20,000
22,500 26,250
30,000
Mfg. overhead
38,700 7,300
8,300 9,800
11,300
Selling expense
91,600 17,275
21,025 24,775
28,525
Adm. expenses
33,300 6,300
7,650 9,000
10,350
Federal income tax
27,525 27,525
Dividends
20,000
20,000
Interest expenses
450
450
Loan repayment
10,000
10,000
Total
$376,950 $90,150 $73,350 $ 85,200
$128,250
Cash deficiency
($ 6,150)
Bad loan received
10,000 10,000
Ending cash balance $
10,000 $ 3,850 $13,300 $ 25,750
$ 10,000
Now you are ready to prepare a budget balance sheet. Take the account
balances of last year and combine them with the transactions reflected in
the various budgets you have compiled. You will come out with a sheet
resembling this:
Budgeted Balance Sheet December 31, 20___
Assets
20___ 20___
Current assets:
Cash
$ 10,000 $ 15,000
Accounts receivable
11,500 6,666
Less: allowance for doubtful accounts (1,150)
(666)
Inventory:
Raw materials
6,750 3,000
Finished goods
22,500 10,000
Total current assets
$ 49,600 34,000
Fixed assets:
Land
$ 50,000 $ 50,000
Building
148,000 148,000
Less: allowance for depreciation
(37,000) (33,000)
Total fixed assets
$161,100 $164,700
Total assets
$210,600 $198,700
Liabilities and Shareholders' Equity
Current liabilities:
Account payable $ 9,375 $ 5,000
Shareholders' equity:
Capital stock (10,000 shares; $10 par value) $100,000 $110,000
Retained earning
s 101,225
93,700
$201,225 $193,700
Total liabilities and shareholders' equity $210,600
$198,700
In order to make the most effective use of your budgets to plan profits,
you will want to establish reporting devices. Throughout the time span you
have set, you need periodic reports and reviews on both efforts and
accomplishments. These let you know whether your budget plan is being
attained and help you keep control throughout the process. It is through
comparing actual performance with budgeted projections that you maintain
control of the operations.
Your company should be structured along functional lines, with well
identified areas of responsibility and authority. Then, depending upon the
size of your company, the budget reports can be prepared to correspond
with the organizational structure of the company.
Two typical budget reports are shown below to demonstrate various forms
these reports may take.
Report of Actual and Budgeted Sales For the Year Ended December 31, 20___
Variations from
budget (under)
Actual sales Budgeted sales Quarterly Cumulative
1st Quarter $ $ $ $
2nd Quarter
3rd Quarter
4th Quarter
Budgeted Report on Selling Expenses For the Year Ended December 31, 20___
Budget Actual Variation Budget
Actual Variations Remarks
This This
This Year to Year to
Year to
Month Month Month
Date Date
Date
Remember, the Cash Flow Statement used as the business's Budget allows the
owner/manager to anticipate problems rather than react to them after they
occur. It permits comparison of actual receipts and disbursements against
projections to identify errors in the forecast. If cash flow is analyzed
monthly, the manager can correct the cause of the error before it harms
profitability.
Cash Flow Article
Copyright Evergreen Publishing
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