Cash budget After the preceding analyses have 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.

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.

Leed Company has determined that all sales are on credit and they do not have any cash sales.  For the credit sales, experience tells Leed they will collect 60% of sales in the quarter of the sale and the remaining 40% is collected the quarter after the sale (yes, we understand collecting 100% is unlikely but Leed chooses to budget for 100% collection).  Accounts Receivable at the beginning of the year is $200,000 and is expected to be collected in the 1st Quarter.  Leed Company prepares the following schedule of planned cash receipts:

** Cash receipts from previous quarter for Quarter 1 comes from the beginning balance in Accounts Receivable.

We can calculate the ENDING balance of Accounts Receivable for the budgeted balance sheet by taking the 4th Quarter sales $1,000,000 x 40% to be received in 1st Quarter of the next year as $400,000.  In addition to cash receipts, we also need to understand how we plan to make our cash payments or disbursements.

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.

This video discusses the purchases budget for a merchandiser but if you begin at minute 9 it will pick up with the cash disbursement schedule example.

Leed Company is a manufacturing company and will need to use the information from the materials purchases budget first.  Leed Company makes all material purchases on credit.  Leed Company will pay for material purchases 80% in the quarter of purchase and 20% in the quarter after the purchase.   Accounts Payable at the beginning of the year is $80,000 and will be paid in the 1st Quarter. We will calculate cash payments for material purchases as shown in the following table.

** Cash payments from previous quarter for Quarter 1 comes from the beginning balance in Accounts Payable.

We can calculate the ENDING balance of Accounts Payable for the budgeted balance sheet by taking the 4th Quarter merchandise purchases of $217,500 x 20% to be paid during 1st Quarter of the next year as $43,500.  In addition to these cash payments for merchandise, we also need the cash disbursements from the direct labor budget, manufacturing overhead budget, and selling and administrative budget.  Remember, we want the CASH PAYMENT amounts only and not the total budget amount (depreciation is a non-cash expense and is excluded from cash payments).

Using our example, Leed Company, we need the information from the cash payments of merchandise we just calculated, cash payments for direct labor (all direct labor paid in the quarter it was incurred), cash payments for manufacturing overhead and cash payments for selling and administrative expenses.  But, we also need information on  dividends payments, and income taxes.

Income taxes are assumed to be 40% of budgeted income before income taxes and are paid in the next quarter.   *Income taxes payable on January 1 were $100,000.  We assume that $40,000 of dividends will be paid in the second quarter and $80,000 in the third quarter.  Also, Leed plans to expand operations into a new building that will cost $650,000 in Quarter 4.  Leed plans to pay cash for the new building.

The complete schedule of cash payments would look like this:

Now let’s put it all together in the complete cash budget.  The cash budget is a plan indicating expected inflows and outflows of cash.  At the simplest form, a Cash budget is:

We can make it a little more complicated by adding financing considerations.  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.

To illustrate, we will complete the cash budget for Leed Company.  On January 1, Leed Company’s cash balance was $130,000.  We will calculate the cash budget for each quarter using the information from the schedules on this page.  We will get our cash receipts from the Schedule of Cash Receipts and the cash disbursements (or payments) from the Schedule of Cash Payments.

Important:  The ending cash balance of one quarter is the beginning cash balance of the next quarter!

Leed Company appears to have a little bit of a problem.  There is plenty of cash for the year but when we look each quarter, we see we are not planning enough cash to cover the 1st Quarter.  We recover in the 2nd quarter and have sufficient cash for the remaining quarters.  But what can we do about 1st quarter?  We can review the budgets and see if there is anything we can cut or modify.  Or, Leed can arrange short term financing with the bank.  Leed Company like to keep at a minimum of $10,000 as their ending cash balance each quarter.  Leed has arranged a credit line with the bank to access funds on a short term basis.  Leed will pay off any loan amount at the next possible quarter and the bank will charge 12% interest per year (3% interest per quarter).  How will this change the cash budget if no changes are made to the previous budgets?

Notice how Leed borrowed $11,750 in the 1st Quarter to cover the $6,750 shortage + $5,000 minimum we want on hand.  Leed plans to pay the loan off during the 2nd quarter by paying the full amount of $11,750 plus interest for 1 quarter (11,750 x 3% per quarter).