Financial Planning: The Cash Budget

Financial Planning: The Cash Budget

• An organisation's goal is to maximize the wealth of its owners.
• The seven functions of the organisation must work together to achieve this goal: financial, communications, marketing, production, purchasing, human resources and information.
• Management functions (planning, control, organising, commanding and coordination) are used to coordinate activities in an organization to achieve its goal.
• Careful planning is vital to avoid failure.
• An integrated budget system can help implement planning and control.
• Budgets are a valuable tool for planning, controlling, commanding and coordinating.

Financial Planning and Control

• A budget is a financial plan outlining how an organization will achieve its goals.
• Budgets set specific goals and show how management plans to achieve them.
• Budgets compare actual and budgeted results with a focus on evaluating departments and the organization as a whole.
• Budget control ensures the organization stays on track to achieve its goals.
• Budget control identifies the causes of deviations and proposes corrective measures.

Successful Budget Implementation

• Successful budgets require:
  • Sufficient background information.
  • Clearly defined lines of responsibility with a distinction between line and staff functions.
  • Support from all levels of management.
  • A good organizational structure.
  • A reliable financial and management information system.

Goals of a Budget System

• Maximize profitability by coordinating activities and reducing unnecessary actions within the organization.
• Ensure optimal utilization of cash resources and financing through forecasting cash needs.

Functions of a Budget

• Assigns tasks and provides authority to act.
• Functions as a communication tool with subordinates.
• Indicates external factors beyond management's control.
• Coordinates different divisions within the organization to achieve synergy.
• Provides control mechanisms.
• Identifies manager responsibilities within their divisions and across the organization.

Limiting Factors of Budgeting

• External and internal factors can limit activities.
• Limitations can include:
  • Availability of production inputs (materials and labor).
  • Location and transport.
  • Availability of capital.

Using Budgets Effectively

• Effective implementation is key to the value of budgets.
• Budgets should be used daily to compare actual events with the plan, identifying deviations and implementing corrective measures.
• Zero-based budgeting, which starts from scratch and queries each expense, should be used strategically.

The Financial Planning Process

• Financial planning guides an organization's actions to achieve its objectives.
• Objectives can be long-term (e.g., maximizing owner wealth, sustainable profits) or short-term (e.g., efficient operations, liquidity).
• Organizations plan for return on assets (long-term) and liquidity (short-term).
• The five-year plan is a common example of a long-term financial plan, while a three-month cash budget is a common example of a short-term plan.
• Proforma Statements of Comprehensive Income and Statements of Financial Position form part of the financial planning process.
• The sales budget is the driving force of the financial planning process.
• The sales budget informs the production plan, personnel budget, inventory, factory overheads, operating expense budget, cash budget, and proforma financial statements (see Figure 8.1).
• Key outputs of the financial planning process are the cash budget and the proforma financial statements.

The Cash Budget

• Profitability does not guarantee sufficient cash to meet commitments.
• The cash budget helps plan future cash flow, forecasting expected cash receipts and payments for a specific period.
• The cash budget allows organizations to predict short-term cash needs.
• Businesses with a cash surplus can plan short-term investments, while those with a cash shortfall can arrange short-term financing.
• The cash budget usually covers a one-year period with monthly intervals, but can be prepared at shorter intervals depending on cash volume.
• The cash budget reveals the timing, extent, and sources of:
  • Cash inflows.
  • Cash outflows.
  • Cash surpluses and shortages, their frequency, and duration.

Compiling the Cash Budget

• Distinguish between cash and credit sales.
• Consider credit policy for collecting credit sales, including discounts, and measures to curb bad debts.
• Review payment policy for trade payables.
• Factor in cash outflows from operating and long-term budgets.
• Make provisions for interest, tax, and dividend payments.
• The sales budget is the primary input for the cash budget.
• The marketing department usually forecasts income.
• Table 8.1 and Table 8.2 provide examples of cash budget formats (see tables in the text).

Understanding Cash Flow Projections

• Cash flow projections focus on actual cash inflows and outflows.
• Non-cash transactions like depreciation, credit sales, and credit purchases are not included in the cash flow projection.
• Credit sales collections and credit purchase payments are included when they actually occur.
• Fixed asset purchases are included in the cash flow projection.
• Provisions like taxes and dividends are not included, but actual payments are.
• Remember that cash collection from trade receivables might occur months (or even years) later than the sale was made.

Example: Cashstrapped Ltd

• Cashstrapped Ltd expects credit sales of R210 000, R250 000, and R240 000 for June, July, and August, respectively.
• Their actual sales for March, April, and May were R140 000, R180 000, and R190 000.
• This example can be used to practice preparing a cash flow projection considering factors like credit sales collections, trade payables, and potential cash shortfalls.