Question

The following information is budgeted for Plumbing Limited for next quarter:

	April ($)	May ($)	June ($)
Sales	110,000	130,000	180,000
Merchandise purchases	85,000	92,000	105,000
Selling and administrative expenses	50,000	50,000	50,000

All sales at the company are on credit: 40% are collected in the month of sale, 58% in the month following the sale, and the remaining 2% are uncollectible. Merchandise purchases are paid in full the month following the month of purchase. The selling and administrative expenses above include $8,000 of depreciation on display fixtures and warehouse equipment. All other selling and administrative expenses are paid as incurred. The company wants to maintain a cash balance of $15,000. Any amount below this can be borrowed from a local bank as needed. All borrowings are made at month-end. The interest rate is 2% per month, which is paid in the following month.

Required:

i. Prepare a cash budget for May. The company expects to have $24,000 of cash on hand at the beginning of May.  

ii. Davey Pichai, a first-year undergraduate student, has recently joined as a summer intern in the accounting department at Plumbing Limited. While having lunch in the company’s cafeteria, Zarik Adler – Davey’s mentor at Plumbing Limited – observed that Davey mainly views budgets as a planning and controlling tool. Zarik was thinking to broaden Davey’s understanding of budgeting by providing a few examples of how budgets can also facilitate decision-making tasks in a company. Imagine yourself as Zarik and discuss three decision-making tasks that the above cash budget (refer to the Part-A above) could facilitate in the company.[Maximum word limit: 250 words].

Answer 1

ii. A cash budget is important aspect for the business. It shows the liquidity picture of the company.

• Cash shortage - A Cash budget helps to avoid a shortage of cash during periods in which a company required to spend huge amount of expenditure. Therefore company can manage the expenditure or boost the sales for the period. As in the given question company needed to maintain a minimum balance therefore that has to be maintained by bringing in additional borrowing
• Limitation on cash expenditure - A Cash budget is also useful tool to create a current observation of liquidity position of company. It sets limitation on cash expenditure which must be observed by all those whose activities involve cash spend. It can be analysed periodicall by comparing the actual receipts and disbursements with estimated figures of the budgets set.
• Oppotunity to Earn - With the help of Cash budget finance manager can identify in which months there is cash surplus, and holding excess liquid cash for any period of time is mainly waste of resource yielding no return. Thus, with the help of budget, finance manager can invest such idle cash in marketable securities to earn some extra income without compromising the firm's liquidity position and increasing company's profitablity.