Edmonds, Tsay, and Olds (2011, p.314) considers the cash budget to be one of the most important operating budgets developed by the company. The reason for this is that it reveals the amount of cash excess and deficit incurred by the company, which is usually on a monthly basis (Horngren, Harrison, & Oliver, 2012, p.1065). The additional purpose of the cash budget is that it reveals the amount of cash that can be used by the company for short-term investments or for the repayment of previous borrowings in the event of a cash excess (Edmonds, Tsay, & Olds, 2011, p.315). The cash budget also reveals potential cash shortages, which can be countered with short-term loan arrangements in order to prevent missed payments, reduction of interest costs, and a potential bankruptcy (Edmonds, Tsay, & Olds, 2011, p.314).
There are three major sections for the cash budget, which are (1) cash receipts, (2) cash payments, and (3) financing (Edmonds, Tsay, & Olds, 2011, p.315). The cash receipt section is divided into the beginning cash balance and the cash collected during the period (Edmonds, Tsay, and Olds, 2011, p.315). The company’s monthly sales are usually paid by the customers in cash at 30% and on credit at 70%, which are paid out equally in the next month and the succeeding month. The total January collection therefore includes the 30% cash sales during January, the 50% credit payment for December and the 50% credit payment of November.
The cash payment section is the planned payments of the company for its operations, which includes selling and administrative expenses, inventory payments, interest expenses, short-term investments, and long-term investments in the form of capital expenditures (Edmonds, Tsay, & Olds, 2011, p.315). In the case of the company the selling and administrative expenses include salaries and wages along with the capital expenditures, dividends, and interest expense. The reason for the inclusion of the interest expense in April is that the company planned to borrow additional cash in March. The material purchase value is 50% of the monthly revenue values and it would be paid a month after it was purchased. This means that the January purchase of raw materials will be paid in February and so on.
The net cash flow of figure 3 below is the difference between the cash collection and the cash disbursement section of the cash budget. The figure revealed that the company will have a negative cash flow in March at $35,950, which was countered by the cumulative cash flow of $36,700 resulting to a cash balance before financing of $750. Despite a positive value it was not enough to reach the required minimum cash balance of $5,000 resulting to a need for additional borrowings. The assumption is that the company will borrow in increments of $1,000, which was the reason why the cumulative cash flow in April was $5,750 since it borrowed $5,000. The cash surplus in April at $20,508.33 was more than enough to pay off the previous month’s loan, which means that it can be paid off in April. The April payment of the $5,000 loan was the reason why the cumulative cash flow in May was retained at $20,508.33.
As seen in the cash budget below, the company incurred a cash deficit of $4,250 in March. This means that the company arranged to borrow $5,000 for the month of March, the value of which was assumed to be in multiples of $1,000 (Horngren, Harrison, and Oliver, 2012, p.1066). This short-term borrowing was paid off in the next month since the company incurred a surplus of cash in April. However, the company was still required to pay off the interest expense for March during April at an interest rate of 10% per annum. The ending cash balance for January to June revealed that the company has more than enough cash to invest in short-term securities for the purpose of maximizing the company profitability.
Precision Machines
Cash Budget
Six Months Ending June 30, 2017
Since the company was able to generate excess cash, management can use these to invest in short-term marketable securities. The best month to start investing in short-term securities is in April since the company did not earmark its excess cash for the next three months.
References
Edmonds, T. P., Tsay, B., & Olds, P. R. (2011). Fundamental managerial accounting concepts (6th ed.). New York, NY: McGraw-Hill Irwin.
Horngren, C. T., Harrison, W. T. and Oliver, M. S. (2012). Financial & managerial accounting (3rd ed.). Boston: Prentice Hall.
