CIMA - C1 Fundamentals of Management Accounting
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9: Budget preparation ⏐ Part C Financial planning and control
Estimated cash payments
To suppliers of goods
8,000
7,800
10,500
To employees (wages)
3,000
3,500
3,500
Purchase of non-current assets
16,000
Rent and rates
1,000
Other overheads
1,200
1,200
1,200
Repayment of loan
2,500
14,700
28,500
16,200
Net surplus/(deficit) for month
2,300
(5,800)
5,300
Opening cash balance
1,200
3,500
(2,300
)
Closing cash balance
3,500
(2,300
)
3,000
In this example (where the figures are purely for illustration) the accounts department has calculated that the cash
balance at the beginning of the budget period, 1 January, will be $1,200. Estimates have been made of the cash which is
likely to be received by the business (from cash and credit sales, and from a planned disposal of non-current assets in
February). Similar estimates have been made of cash due to be paid out by the business (payments to suppliers and
employees, payments for rent, rates and other overheads, payment for a planned purchase of non-current assets in
February and a loan repayment due in January).
From these estimates it is a simple step to calculate the excess of cash receipts over cash payments in each month. In
some months cash payments may exceed cash receipts and there will be a deficit for the month; this occurs during
February in the above example because of the large investment in non-current assets in that month.
The last part of the cash budget above shows how the business's estimated cash balance can then be rolled along from
month to month. Starting with the opening balance of $1,200 at 1 January a cash surplus of $2,300 is generated in
January. This leads to a closing January balance of $3,500 which becomes the opening balance for February. The deficit
of $5,800 in February throws the business's cash position into overdraft and the overdrawn balance of $2,300 becomes
the opening balance for March. Finally, the healthy cash surplus of $5,300 in March leaves the business with a
favourable cash position of $3,000 at the end of the budget period.
5.2 The usefulness of cash budgets
The usefulness of cash budgets is that they enable management to make any forward planning decisions that may be
needed, such as advising their bank of estimated overdraft requirements or strengthening their credit control procedures
to ensure that customers pay more quickly.
The cash budget is one of the most important planning tools that an organisation can use. It shows the cash effect of all
plans made within the budgetary process and hence its preparation can lead to a modification of budgets if it shows
that there are insufficient cash resources to finance the planned operations.
It can also give management an indication of potential problems that could arise and allows them the opportunity to
take action to avoid such problems. A cash budget can show four positions. Management will need to take appropriate
action depending on the potential position.
FAST FORWARD
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5.3 Potential cash positions
Cash position
Appropriate management action
Short-term surplus
• Pay suppliers early to obtain discount
• Attempt to increase sales by increasing receivables and inventories
• Make short-term investments
Short-term shortfall
• Increase accounts payable
• Reduce receivables
• Arrange an overdraft
Long-term surplus
• Make long-term investments
• Expand
• Diversify
• Replace/update non-current assets
Long-term shortfall
• Raise long-term finance (such as via issue of share capital)
• Consider shutdown/disinvestment opportunities
Question
Cash budget
Tick the boxes to show which of the following should be included in a cash budget.
Include Do not include
Funds from the receipt of a bank loan
Revaluation of a non-current asset
Receipt of dividends from outside the business
Depreciation of distribution vehicles
Bad debts written off
Share dividend paid
Answer
Any item that is a cash flow will be included. Non-cash items are excluded from a cash budget.
Include Do not include
Funds from the receipt of a bank loan
9
Revaluation of a non-current asset
9
Receipt of dividends from outside the business
9
Depreciation of distribution vehicles
9
Bad debts written off
9
Share dividend paid
9
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9: Budget preparation ⏐ Part C Financial planning and control
5.4 Example: cash budgets again
Peter Blair has worked for some years as a sales representative, but has recently been made redundant. He intends to
start up in business on his own account, using $15,000 which he currently has invested with a building society. Peter
maintains a bank account showing a small credit balance, and he plans to approach his bank for the necessary additional
finance. Peter asks you for advice and provides the following additional information.
(a) Arrangements have been made to purchase non-current assets costing $8,000. These will be paid for at
the end of September and are expected to have a five-year life, at the end of which they will possess a nil
residual value.
(b) Inventories costing $5,000 will be acquired on 28 September and subsequent monthly purchases will be
at a level sufficient to replace forecast sales for the month.
(c) Forecast monthly sales are $3,000 for October, $6,000 for November and December, and $10,500 from
January 20X4 onwards.
(d) Selling price is fixed at the cost of inventory plus 50%.
(e) Two months' credit will be allowed to customers but only one month's credit will be received from
suppliers of inventory.
(f) Running expenses, including rent but excluding depreciation of non-current assets, are estimated at
$1,600 per month.
(g) Blair intends to make monthly cash drawings of $1,000.
Required
Prepare a cash budget for the six months to 31 March 20X4.
Solution
The opening cash balance at 1 October will consist of Peter's initial $15,000 less the $8,000 expended on non-current
assets purchased in September. In other words, the opening balance is $7,000. Cash receipts from credit customers
arise two months after the relevant sales.
Payments to suppliers are a little more tricky. We are told that cost of sales is 100/150 × sales. Thus for October cost of sales
is 100/150 × $3,000 = $2,000. These goods will be purchased in October but not paid for until November. Similar calculations
can be made for later months. The initial inventory of $5,000 is purchased in September and consequently paid for in October.
Depreciation is not a cash flow and so is not included in a cash budget.
The cash budget can now be constructed.
CASH BUDGET FOR THE SIX MONTHS ENDING 31 MARCH 20X4
Oct
Nov
Dec
Jan
Feb
Mar
$
$
$
$
$
$
Payments
Suppliers
5,000
2,000
4,000
4,000
7,000
7,000
Running expenses
1,600
1,600
1,600
1,600
1,600
1,600
Drawings
1,000
1,000
1,000
1,000
1,000
1,000
7,600
4,600
6,600
6,600
9,600
9,600
Receipts
Receivables
–
–
3,000
6,000
6,000
10,500
Surplus/(shortfall)
(7,600)
(4,600)
(3,600)
(600)
(3,600)
900
Opening balance
7,000
(600
)
(5,200)
(8,800)
(9,400)
(13,000)
Closing balance
(600
)
(5,200)
(8,800)
(9,400)
(13,000)
(12,100)
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Question
Cash budget again
You are presented with the budgeted data shown in Annex A for the period November 20X1 to June 20X2 by your firm. It
has been extracted from the other functional budgets that have been prepared.
You are also told the following.
(a) Sales are 40% cash, 60% credit. Credit sales are paid two months after the month of sale.
(b) Purchases are paid the month following purchase.
(c) 75% of wages are paid in the current month and 25% the following month.
(d) Overheads are paid the month after they are incurred.
(e) Dividends are paid three months after they are declared.
(f) Capital expenditure is paid two months after it is incurred.
(g) The opening cash balance is $15,000.
Annex A
Nov X1 Dec X1 Jan X2 Feb X2 Mar X2 Apr X2 May X2 June X2
$ $ $ $ $ $ $ $
Sales 80,000 100,000 110,000 130,000 140,000 150,000 160,000 180,000
Purchases 40,000 60,000 80,000 90,000 110,000 130,000 140,000 150,000
Wages 10,000 12,000 16,000 20,000 24,000 28,000 32,000 36,000
Overheads 10,000 10,000 15,000 15,000 15,000 20,000 20,000 20,000
Dividends 20,000 40,000
Capital
expenditure 30,000 40,000
The net cash balance carried forward at the end of June 20X2 is $
.
Answer
The net cash balance carried forward at the end of June 20X2 is $
(156,000)
.
Workings
January
February
March
April
May
June
$'000
$'000
$'000
$'000
$'000
$'000
Receipts
Sales revenue
Cash
44
52
56
60
64
72
Credit
48
60
66
78
84
90
92
112
122
138
148
162
Payments
Purchases 60 80 90 110 130 140
Wages
75% 12 15 18 21 24 27
25% 3 4 5 6 7 8
Overheads 10 15 15 15 20 20
Dividends 20
Capital expenditure
30
40
85
114
178
152
181
235
Net cash flow
7
(2)
(56)
(14)
(33)
(73)
b/f
15
22
20
(36
)
(50)
(83)
c/f
22
20
(36
)
(50)
(83)
(156)
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9: Budget preparation ⏐ Part C Financial planning and control
Question
ABC Co
The following information is available for ABC Co.
May June
$ $
Budgeted sales 30,000 40,000
Gross profit as a percentage of sales 30% 30%
Closing trade payables as a percentage of cost of sales 50 50%
Opening inventory nil nil
Closing inventory nil nil
How much money should be budgeted for supplier payments in June?
A $10,500
B $14,000
C $24,500
D $30,000
Answer
C
May
June
$
$
Sales
30,000
40,000
Gross profit (@ 30%)
9,000
12,000
Cost of sales (sales – GP)
21,000
28,000
Closing trade payables (@ 50%)
10,500
14,000
$
June opening payables
10,500
Increase in amounts owing (COS)
28,000
June closing payables
(14,000
)
Amount paid in June
24,500
5.5 Example: using cash budgets
Suppose that a bank overdraft with a ceiling of $50,000 has been arranged to accommodate the increased inventory
levels and wage bill for overtime required to support the rising sales shown in Annex A in the question above.
What advice might be offered, given the cash budget prepared in answering the question?
Solution
The overdraft arrangements are quite inadequate to service the cash needs of the business over the six month period. If
the figures are realistic then action should be taken now to avoid difficulties in the near future. The following are possible
courses of action.
(a) Activities could be curtailed.
(b) Other sources of cash could be explored, for example a long-term loan to finance the capital expenditure and a
factoring arrangement to provide cash due from customers more quickly.
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(c) Efforts to increase the speed of debt collection could be made.
(d) Payments to suppliers could be delayed.
(e) The dividend payments could be postponed (the figures indicate that this is a small company, possibly
owner-managed).
(f) Staff might be persuaded to work at a lower rate in return for, say, an annual bonus or a profit-sharing
agreement.
(g) Extra staff might be taken on to reduce the amount of overtime paid.
(h) The stockholding policy should be reviewed: it may be possible to meet demand from current production and
minimise cash tied up in inventories.
Questions on functional and cash budget preparation are likely to appear in your assessment.
6 Master budgets
The master budget provides a consolidation of all the subsidiary budgets and normally consists of a budgeted income
statement, budgeted statement of financial position, and a cash budget.
As well as wishing to forecast its cash position, a business might want to estimate its profitability and its financial
position for a coming period. This would involve the preparation of a budgeted income statement and statement of
financial position, both of which form a part of the master budget.
6.1 Example: preparing a budgeted income statement and statement of financial
position
Using the information in Section 5.4, you are required to prepare Peter Blair's budgeted income statement for the six
months ending on 31 March 20X4 and a budgeted statement of financial position as at that date.
Solution
The income statement is straightforward. The first figure is sales, which can be computed very easily from the
information in Section 5.4(c). It is sufficient to add up the monthly sales figures given there; for the income statement
there is no need to worry about any closing receivables. Similarly, cost of sales is calculated directly from the
information on gross margin contained in Section 5.4(d).
FORECAST TRADING AND INCOME STATEMENT
FOR THE SIX MONTHS ENDING 31 MARCH 20X4
$
$
Sales (3,000 + (2 × 6,000) + (3 × 10,500))
46,500
Cost of sales (2/3 × $46,500)
31,000
Gross profit
15,500
Expenses
Running expenses (6 × $1,600)
9,600
Depreciation ($8,000 × 20% × 6/12)
800
10,400
Net profit
5,100
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Assessment
focus point
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9: Budget preparation ⏐ Part C Financial planning and control
Items will be shown in the statement of financial position as follows.
(a) Inventory will comprise the initial purchases of $5,000.
(b) Receivables will comprise sales made in February and March (not paid until April and May respectively).
(c) Accounts payable will comprise purchases made in March (not paid for until April).
(d) The bank overdraft is the closing cash figure computed in the cash budget.
STATEMENT OF FINANCIAL POSITION
FORECAST AT 31 MARCH 20X4
$
$
Non-current assets $(8,000 – 800)
7,200
Current assets
Inventories
5,000
Receivables (2 × $10,500)
21,000
26,000
Current liabilities
Bank overdraft
12,100
Trade suppliers (March purchases)
7,000
19,100
Net current assets
6,900
14,100
Proprietor's interest
Capital introduced
15,000
Profit for the period
5,100
Less drawings
(6,000
)
Deficit retained
(900
)
14,100
We have now prepared all of the elements of Peter Blair's master budget: the budgeted income statement and statement
of financial position, and the budgeted cash flow from Section 5.4
6.2 A few hints
Budget questions are often accompanied by a large amount of sometimes confusing detail. This should not blind you to
the fact that many figures can be entered very simply from the logic of the trading situation described. For example in the
case of Blair you might feel tempted to begin a T-account to compute the closing receivables figure. This kind of working
is rarely necessary, since you are told that receivables take two months to pay. Closing receivables will equal total credit
sales in the last two months of the period.
Similarly, you may be given a simple statement that a business pays rates at $1,500 a year, followed by a lot of detail to
enable you to calculate a prepayment at the beginning and end of the year. If you are preparing a budgeted income
statement for the year do not lose sight of the fact that the rates expense can be entered as $1,500 without any
calculation at all.
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7 Capital expenditure budgets
Because of the monetary amounts involved in capital expenditure, the capital expenditure budget is one of the principal
subsidiary budgets.
7.1 Steps in the preparation of capital expenditure budgets
The steps in the preparation of such a budget are as follows.
Step 1
An accountant or budget officer should be responsible for the capital expenditure budget. Their tasks
should include communicating between interested parties, providing necessary data to assist in budget
preparation, drawing up a timetable to ensure that proper consultation takes place and so on.
Step 2
Sales, production and related budgets cover, in general, a 12-month period. A detailed capital
expenditure budget should be prepared for the budget period but additional budgets should be drawn
up for both the medium and long term. This requires an in-depth consideration of the organisation's
requirements for land, buildings, plant, machinery, vehicles, fixtures and fittings and so on for the short,
medium and long term.
Step 3
The budget covering the 12 month period should be broken down into monthly or quarterly spending,
and details incorporated into the cash budget.
Step 4
Suitable financing must be arranged as necessary.
Step 5
The capital expenditure budget should take account of the principal budget factor. If available funds are
limiting the organisation's activities then they will more than likely limit capital expenditure.
Step 6
As part of the overall budget coordination process, the capital expenditure budget must be reviewed in
relation to the other budgets. Proposed expansion of production may well require significant non-current
asset expenditure which should be reflected in the budget.
Step 7
The capital expenditure budget should be updated on a regular basis since both the timing and amount of
expenditure can change at short notice.
7.2 Example of a capital expenditure budget
A capital expenditure budget might appear as follows.
XYZ Company: Capital expenditure budget – 20X4
Project Description/detail of capital investment items Month $’000
LV45 Installation of new personal computers and flat screen monitors
throughout office and factory
April 100
LV46 Plant replacement of obsolete packing equipment by new
automated and electronic machinery
October 500
Budgeted capital expenditure 600
7.3 Depreciation
Any depreciation on budgeted capital expenditure will need to be incorporated into the budgeted income statement,
along with depreciation on existing non-current assets. The depreciation on planned disposals of non-current assets also
needs to be taken into consideration.
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9: Budget preparation ⏐ Part C Financial planning and control
7.3.1 Example: budgeted depreciation.
Suppose, for simplicity, XYZ Company (whose capital expenditure budget is shown above) applies a 10% straight-line
depreciation policy to all non-current assets. All non-current assets are under ten years old. Non-current assets had a
cost value of $4,000,000 at the beginning of 20X4. Budgeted additions to non-current assets are shown above. The plant
being replaced by project LV46 has a cost value of $200,000, and will be disposed of at the very end of September (the
new plant becoming operational on 1 October 20X4).
The budgeted depreciation charge for the year is:
$
Depreciation on non-current assets held at 1 January 20X4 ($4,000,000 × 10%)
400,000
Less: depreciation not charged on disposals (3/12 × 10% × $200,000)
(5,000)
Plus: depreciation on additions
LV45 (9/12 × 10% × $100,000)
7,500
LV46 (3/12 × 10% × $500,000)
12,500
Budgeted depreciation charge for 20X4
415,000
8 Approaches to budgeting
There are several different approaches to budgeting. These include incremental budgeting, zero-based budgeting, rolling
budgeting and participative budgeting.
8.1 Incremental budgeting
The traditional approach to budgeting is to base next year's budget on the current year's results plus an extra amount
for estimated growth or inflation next year. This approach is known as incremental budgeting since it is concerned
mainly with the increments in costs and revenues which will occur in the coming period.
8.2 Zero-based budgeting
Zero-based budgeting involves preparing a budget for each cost centre from a zero base. Every item of expenditure has
then to be justified in its entirety in order to be included in the next year's budget.
ZBB rejects the assumption inherent in incremental budgeting that next year's budget can be based on this year's costs.
8.3 Rolling budgets
As an organisation and the environment it operates in are dynamic (always changing) management may decide to
introduce a system of rolling budgets (also called continuous budgets).
A rolling budget is a budget which is continuously updated by adding a further accounting period (a month or quarter)
when the earlier accounting period has expired.
8.4 Participative budgeting
Participative budgeting is 'A budgeting system in which all budget holders are given the opportunity to participate in
setting their own budgets'. (CIMA Official Terminology)
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Chapter Roundup
•
Budgeting is a multi-purpose activity.
•
A budget might be a forecast, a means of allocating resources, a yardstick or a target.
•
The budget committee is the coordinating body in the preparation and administration of budgets.
•
The manager responsible for preparing each budget should ideally be the manager responsible for carrying out the
budget.
•
The budget manual is a collection of instructions governing the responsibilities of persons and the procedures, forms
and records relating to the preparation and use of budgetary data.
•
The first task in the budgetary process is to identify the principal budget factor. This is also known as the key budget
factor or limiting budget factor. The principal budget factor is the factor which limits the activities of an organisation.
•
Functional/departmental budgets include budgets for sales, production, purchases and labour.
•
A cash budget is a statement in which estimated future cash receipts and payments are tabulated in such a way as to
show the forecast cash balance of a business at defined intervals.
•
The usefulness of cash budgets is that they enable management to make any forward planning decisions that may be
needed, such as advising their bank of estimated overdraft requirements or strengthening their credit control procedures
to ensure that customers pay more quickly.
•
The master budget provides a consolidation of all the subsidiary budgets and normally consists of a budgeted income
statement, budgeted statement of financial position and a cash budget.
•
Because of the monetary amounts involved in capital expenditure, the capital expenditure budget is one of the principal
subsidiary budgets.
•
There are several different approaches to budgeting. These include incremental budgeting, zero-based budgeting, rolling
budgeting and participative budgeting.
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