Cash Budget

Learning Outcomes

  • Prepare a cash budget

A flowchart titled “Types of Budgets”. The cash budget is highlighted in yellow. At the top is the sales budget. The sales budget has two arrows pointing to the production budget and the SG&A budget. The production budget has three arrows pointing to the materials budget, labor budget, and manufacturing overhead budget. Those three budgets are all pointing to the cost of goods sold budget. The sales, production, materials, labor, manufacturing overhead, cost of goods sold, and SG&A budget boxes are all blue and there is a bracket labeling those as the operating budget. Below the operating budget is a horizontal line showing the capital expenditures budget in red on the left, and going to the right from there, an arrow pointing to the cash budget, with another arrow pointing to the budgeted income statement, and a final arrow pointing to the budgeted balance sheet. The cash budget, budgeted income statement, and budgeted balance sheet are all green and there is a bracket labeling those as the financial budget. There are also arrows pointing from the cost of goods sold budget and the SG&A budget to the cash budget.

Once the operating budget has been prepared, sufficient information is available to prepare the cash budget and compute the balance in the Cash account for each quarter. Preparing a cash budget requires information about cash receipts and cash disbursements from all the other operating budget schedules.

Schedule of Cash Receipts

We can prepare the cash receipts schedule based on how the company expects to collect on sales. We know, from past experience, how much of our sales are cash sales and how much are credit sales. We also can analyze past accounts receivable to determine when credit sales are typically paid.

GelSoft makes all sales on credit so they do not have any cash sales. For the credit sales, experience shows they collect 60% of sales in the quarter of the sale and the remaining 40% is collected the quarter after the sale. Although in practice, actual collections will be less than 100%, for purposes of this example we’ll assume that all sales are collected. Accounts Receivable at the beginning of the year is $500,000 and is expected to be collected in the 1st Quarter. From this information, GelSoft prepares the following schedule of planned cash receipts:

GelSoft – schedule of cash receipts based on operating budget
Description Q1 Q2 Q3 Q4 Year Q1 YR 2
Budgeted Sales $1,360,000 $1,428,000 $1,499,400 $1,574,370 $5,861,770
Accounts receivable collected Single Line500,000 Single Line Single Line Single Line Single Line500,000 Single Line
60% of current sales collected 816,000 856,800 899,640 944,622 3,517,062
40% of prior quarter sales collected 544,000 571,200 599,760 1,714,960 $629,748
Cash receipts Single Line$1,316,000Double line Single Line$1,400,800Double line Single Line$1,470,840Double line Single Line$1,544,382Double line Single Line$5,732,022Double line Single Line

 

The ending balance of Accounts Receivable is the 40% of 4th Quarter sales that will be collected in the 1st Quarter of the next year ($1574,370 * 0.40 = $629,748).

Notice that Q1 sales of $1,360,000 was collected as follows:

$816,000 in Q1 (60%)

$544,000 in Q2 (40%)

Here is an overview of the sales and collection budget that creates the schedule of cash receipts:

You can view the transcript for “The Cash Budget Part 1, Sales Budget and Collections Budget (Cost Accounting Tutorial #39)” here (opens in new window).

In addition to cash receipts, we also need to understand how we plan to make our cash payments or disbursements.

Schedule of cash disbursements

Companies need cash to pay for purchases, wages, rent, interest, income taxes, cash dividends, and most other expenses. We can obtain the amount of each cash disbursement from other budgets or schedules.

Let’s assume GelSoft makes all purchases on credit, paying 80% in the quarter of purchase and 20% in the quarter after the purchase. Accounts Payable at the beginning of the year is $300,000 and will be paid in the 1st Quarter.

We’ll accumulate all expenditures in this one table. Note that we are going to remove depreciation expense from the calculation since it is not a cash expense (depreciation is the allocation of the cost of fixed assets that have been purchased outside of the operating budget — covered in the capital expenditure budget module).

GelSoft – schedule of cash disbursements based on operating budget
Description Q1 Q2 Q3 Q4 Year Q1 YR 2
Budgeted raw materials purchases $98,560 $297,220 $308,528 $330,253 $1,034,561
Budgeted direct labor costs 370,000 390,000 411,000 415,040 $1,586,040
Budgeted manufacturing overhead 185,000 195,000 205,500 207,520 $793,020
Remove depreciation (non-cash expense) (50,000) (50,000) (50,000) (50,000) (200,000)
Budgeted selling, general, and administrative costs 462,500 462,500 462,500 462,500 $1,850,000
Remove depreciation (non-cash expense) (25,000) (25,000) (25,000) (25,000) (100,000)
Total budgeted cash-related costs Single Line1,041,060 Single Line1,269,720 Single Line1,312,528 Single Line1,340,313 Single Line4,963,621
Accounts payable paid 300,000 300,000
80 % costs paid in current quarter 832,848 1,015,776 1,050,022 1,072,250 3,970,897
20% of costs paid in following quarter 208,212 253,944 262,506 724,662 268,063
Cash disbursements Single Line$1,132,848Double line Single Line$1,223,988Double line Single Line$1,303,966Double line Single Line$1,334,756Double line Single Line$4,995,558Double line Single Line

 

Notice that Q1 expenditures of $1,041,060 were paid out as follows:

$832,848 in Q1 (80%)

$208,212 in Q2 (20%)

Different categories of expenses may warrant separate cash disbursement schedules that would be rolled up into one final number, but for GelSoft, we’ll just use this single set of assumptions.

The ending balance of Accounts Payable is 20% of the 4th Quarter costs ($1,415,313 * 0.20 = $286,063).

There will be other cash outlays, such as fixed asset acquisitions, dividends and other payments to owners, and income taxes.

We’ll assume income taxes are projected to be $51,105 and they will be paid in the first quarter of the following year, and that income taxes payable (from the prior year) were $20,000. We’ll assume there are no scheduled asset acquisitions and no scheduled distributions to the owners.

The complete schedule of cash payments would look like this:

Description Total
Beginning cash $250,000
Cash receipts 5,732,022
Cash disbursements (4,995,558)
Prior year income taxes (20,000)
Capital acquisitions (assets) –
Distributions to owners –
Ending cash balance Single Line$966,464Double line

 

We could also present this budget on a quarterly basis:

Description Q1 Q2 Q3 Q4
Beginning cash $250,000 $413,152 $589,964 $756,838
Cash Receipts 1,316,000 1,400,800 1,470,840 1,544,382
Cash Disbursements (1,132,848) (1,223,988) (1,303,966) (1,334,756)
Prior year income taxes (20,000) – – –
Capital acquisitions (assets) – – – –
Distributions to owners – – – –
Ending cash balance Single Line$413,152Double line Single Line$589,964Double line Single Line$756,838Double line Single Line$966,464Double line

 

The cash budget helps management to decide whether enough cash will be available for short-term needs. If a company’s cash budget indicates a cash shortage at a certain date, the company may need to borrow money on a short-term basis. If the company’s cash budget indicates a cash excess, the company may wish to invest the extra funds for short periods to earn interest rather than leave the cash idle. Knowing in advance that a possible cash shortage or excess may occur allows management sufficient time to plan for such occurrences and avoid a cash crisis. For instance, if GelSoft had a $600,000 debt payment due on June 30, they could plan for that and better arrange cash flows by either accelerating collections, delaying payments, or executing short-term borrowing, since there is projected to be only $589,964 in cash on June 30 (assuming the company is budgeting and reporting using a calendar year).

Here is another look at the cash budgeting process:

You can view the transcript for “The Cash Budget” here (opens in new window).

Now, check your understanding of cash budgeting.

Practice Question