7 Cash Budgeting

The Theory

Part of preparing the master budget is planning for when cash inflows and outflows will occur during the period. Doing so allows firms to better understand their cash needs, such as taking out and repaying bank loans.

Firms budget cash collections, the amount of cash inflows collected during the period, using budgeted revenues and the firm’s anticipated pattern of collections. Collections can come from cash sales, when the customer pays in cash at the time of purchase. Cash sales, therefore, always occur in the period of sale. Cash collections can also come from credit sales, when the customer pays in cash after the time of purchase, either in the period of sale or in later periods.

Cash disbursements are the amount of cash the firm pays to vendors during the period. Disbursements include cash paid for direct materials, so the firm must prepare a direct materials purchases budget. Other cash disbursements include cash sent to vendors for other variable manufacturing costs, fixed manufacturing costs, and period costs, both variable and fixed. A firm budgets cash disbursements using budgeted costs and the firm’s anticipated pattern of payment.

Once cash collections and cash disbursements are calculated, the final step in preparing a cash budget is to calculate the ending balance in the Cash account.

The Method

The first step in cash budgeting is to prepare a cash collections budget. Use the company’s anticipated pattern of collections to determine how much of the current period’s revenues are collected in the period of sale, either because they are cash sales or because they are credit sales collected in the period of sale. After that, you’ll determine how much of the credit sales from previous periods are collected in the current period. Add all cash collected in the current period to arrive at total cash collections.

Next, prepare a direct materials purchases budget. During the period, the company will need enough materials to cover production, so the direct materials purchases budget should begin with direct materials usage—the amount of direct materials to be used in production, which is also the amount of direct materials reflected on the budgeted income statement. The company will also need enough materials to end the period with the projected amount in ending raw materials inventory. However, the company does not need to buy materials they already own, so the amount in beginning raw materials inventory should be subtracted. Thus, direct materials purchases would be calculated with the following formula, measured in either direct materials units (such as pounds or gallons) or dollars:

Next, prepare a cash disbursements budget. Add the dollar value of direct materials purchases together with all other costs the company plans to pay out during the month, using the company’s anticipated pattern of payment. Do not include direct materials usage, as you will have already included usage in your calculation of direct materials purchases.

Finally, calculate the ending balance in the Cash account. Start with the beginning balance. The cash you collect will add to the balance, so add in collections. The cash you pay out will reduce the balance, so subtract disbursements to arrive at the ending balance:

Illustrative Example

MunchyCorp sells goods for $50 per unit. The costs per unit for variable costs are as follows:

Fixed overhead is budgeted at $200,000 per month, and fixed operating expenses are budgeted at $300,000 per month. The selling price and variable costs per unit are anticipated to remain constant each month, as are total fixed costs each month. Work-in-process and finished goods inventories are expected to remain constant from month to month. MunchyCorp plans to carry 10% of the following month’s production needs in raw materials inventory. Sales for the next four months are planned as follows:

• January: 75,000 units
• February: 71,000 units
• March: 59,000 units
• April: 74,000 units

MunchyCorp’s customers have historically paid for goods entirely on credit. Fifty percent of collections are made in the month of purchase, 30% in the month following purchase, 15% in the second month following purchase, and 5% are considered uncollectible. MunchyCorp purchases direct materials on credit and pays for them in the month following purchase. All other expenses are paid in cash. The cash balance on April 1 is expected to be $100,000.

Prepare a cash budget for April.

First, prepare a cash collections budget:

• In April, the firm will collect 50% of April revenues, 30% of March revenues, and 15% of February revenues.
  • From April: 74,000 × $50 × 50% = $1,850,000
  • From March: 59,000 × $50 × 30% = $885,000
  • From February: 71,000 × $50 × 15% = $532,500
  • Total collections: $1,850,000 + $885,000 + $532,500 = $3,267,500

Next, prepare a direct materials purchases budget.

• In April, the firm will be paying for direct materials from March.
  • March direct materials purchases:
    • Direct materials used: 59,000 × $15 = $885,000
    • Beginning raw materials inventory (10% of March direct materials used): $885,000 × 10% = $88,500
    • Ending raw materials inventory (10% of April direct materials used): 74,000 × $15 × 10% = $111,000
    • Direct materials purchases: $885,000 + $111,000 – $88,500 = $907,500

Next, prepare a cash disbursements budget:

• In April, the firm will be paying for all expenses other than direct materials from April.
  • April expenses:
    • Direct labor: 74,000 × $12 = $888,000
    • Variable overhead: 74,000 × $8 = $592,000
    • Fixed overhead: $200,000
    • Variable operating expenses: 74,000 × $5 = $370,000
    • Fixed operating expenses: $300,000
  • Total cash disbursements: $907,500 + $888,000 + $592,000 + $200,000 + $370,000 + $300,000 = $3,257,500

Finally, calculate the ending Cash balance:

 

Beginning balance	100,000
Add collections	3,267,500
Less disbursements	3,257,500
Ending balance	110,000

 

Lecture Example

The following information pertains to your firm:

• Selling price per unit: $500
• Direct materials cost per unit: $80
• Direct labor cost per unit: $75
• Variable overhead cost per unit: $135
• Fixed overhead per month: $600,000
• Period expenses per month: $500,000

Sales for the next five months are expected to be as follows:

March	6,000 units
April	7,500 units
May	7,000 units
June	6,800 units
July	7,250 units

Your firm’s beginning cash balance on May 1 is $0. There are no finished goods inventories, but ending raw materials inventories are 10% of the next month’s budgeted direct materials usage. Historically, half of revenues have been paid in cash at the time of sale. Credit sales are collected 50% in the month of sale, 30% in the month following sale, 15% in the second month following sale, and 5% are uncollectible. Direct materials are paid for in the month following sale, while all other costs are paid for as incurred.

1. Prepare a cash collections budget for May through July.
2. Prepare a direct materials purchases budget for May through July.
3. Prepare a cash disbursements budget for May through July.
4. Calculate the ending Cash account balance each month May through July.