Three methods of preparing a cash budget are outlined below:
- Receipt and payment method
- Adjusted profit and loss method
- Balance sheet method
Receipt and Payment Method
Here, cash is received from cash sales, receipts from debtors, the sale of fixed assets and investments, and the issue of shares and debentures. Both capital and revenue receipts are forecasted.
The cash is applied for wage payment, salaries, and overheads, and capital and revenue expenditure are forecasted. It is noteworthy that outstanding payments and accrued incomes are not recorded under this method.
Prepare a cash budget for the months of May, June, and July 2019 based on the following information.
The first piece of information is an income and expenditure forecast, which is shown below.
The remaining information for this example is given below:
- Cash balance on 1 May 2019 amounts to $8,000
- Plant costing $16,000 is due for delivery in July 2019 with payable 10% on delivery and balance to be paid after 3 months
- Advance tax of $8,000 each is payable in March and June 2019
- Period of credit allowed (i) by suppliers, two months; and (ii) to customers, one month
- Lag in payment of manufacturing expenses amounts to 1/2 month
- Lag in payment of office and selling expenses amounts to one month
- 50% of the manufacturing expenses for April and May will be paid in May, and so on
- Office and selling expenses of April shall be paid in May, and so on
Adjusted Profit and Loss Method
Under this method, net profit is adjusted by adding items of non-fund expenses and deducting non-fund incomes. This method is used to forecast long-term cash requirements.
Here, the cash forecast is made similar to a fund flow statement. Profit is added by non-fund expenses and non-fund incomes are deducted.
The items of addition include depreciation, goodwill written off, preliminary expenses written off, loss on sale of fixed assets, transfer to general reserves, decrease in the value of current assets, and increase in the value of current liabilities.
The items of deductions are dividends received, interest on debentures, income from properties, increase in current assets, and decrease in current liabilities.
The following is the Balance Sheet of AK Trading Co.:
The following is additional information for the year 2019:
- Shares were issued for $25,000
- Debentures were issued for $5,000
- On 31 December 2019, accrued expenses were $1,250, debtors $50,000, creditors $75,000, and land & buildings $100,000
Cash Budget Adjusted Profit and Loss Account
as on 31 December 2019
Balance Sheet Method
Under this method, at the end of the budget period, a balance sheet forecast is prepared in which assets and liabilities are also shown. The difference on both sides of the balance sheet represents the overdraft or cash balance, depending on the case.
When assets are less than liabilities, then the difference will be a cash balance. On the other hand, when assets exceed liabilities, the difference will be a bank overdraft.
On 1 January 2019, John Trading Company had $150,000 as share capital, $18,000 as a reserve, $120,000 as investment in fixed assets, $12,000 as debtors, $39,000 as creditors, and $60,000.
To sustain the increase in activity, it is proposed that the stock level be increased by 100% by the end of the year. The machinery to be purchased during the year will also be worth $6,000.
The estimated profit for the year is $21,000 after charging $12,000 depreciation and 50% profit for taxation. Advance income tax is estimated at $18,000. Trade creditors are likely to be doubled.
A 5% dividend is to be paid and provision for the dividend for next year is to be made. Debtors are estimated to be outstanding for 2 months. The sales budget shows sales of $450,000.
Required: Make an estimate of the company’s cash position by budgeted cash balance sheet as on 31 December 2019.
- The previous year’s loss can be ascertained by preparing an opening balance sheet as follows:
- The calculation for debtors at the end of the year is the following: