Question

Naa Tetterley Company Ltd engaged your firm to prepare a Cash Budget for them. They informed you that:
a. They have two bills payable of $55,000 and $60,000 with due dates of 31st July and 30th September, 2020 respectively.
These bills will be paid on their due dates
b. The Company wishes to arrange with its bankers for any necessary re-financing in advance, which will ensure a minimum end of month cash balance of $25,000
You are also given the following information: i. The projected sales and purchases:
SALES     ($)         PURCHASES ($)

June 65,000              July.    57,000

July 90,000              August. 45,000

August 65,000          September.    51,000

September 68,000        October.    42,000

October 75,000

ii. The cash balance on 1st July, 2020 will be $18,000

iii. All sales are on terms of a 2% discount allowed on any payment made by the tenth of the month following the sale. Past experience indicates that 70% of the sales are collected within the first 10 days; 20% during the remainder of the first month; and 8% in the second month following the sale. 2% of the sales are considered irrecoverable.

iv. All payments for purchases qualify for 2% discount. Two-thirds of the invoices will be paid in the month of the purchase, and one-third in the month following the purchase.

v. Operating expenses are expected at $6,000 for July 2020. This will increase by 10% per month for the subsequent months.

vi. The company will receive $1,500 monthly from property rentals. This amount will be paid half-a-month in arrears.

vii. An amount of $2,500 will be realised in July from the sale of obsolete equipment.

viii. The company will buy a new plant for $42,000 on 1st June, 2020. The payment for this amount will be spread over 6 monthly equal instalments, starting from August, 2020.

ix. The company anticipates receiving interest on investment of $10,000 every month.

Required:
a. Prepare the Cash Budget for the three months ending 30th September, 2020

b. Outline any four benefits and four limitations respectively of a Cash Budget.          

Answer 1

a)Preparation of Cash Budget

S.No	Particulars	July	August	September
	Opening Balance	$18,000	$25,000	$39,670
Add:	Receipts from previous month sale	$5,200.00	$7,200.00	$5,200.00
	1.$ 65000*0.08=$ 5200
	2.$ 90000*0.08= $ 7200
	3.$ 65000*0.08=$ 5200
	Discounted sales( 70% sales)	$          61,740.00	$                  44,590.00	$      46,648.00
	1. $ 90000*70%*98%=$ 61740
	2. $ 65000*70%*98%=$ 44590
	3. $ 68000*70%*98%=$ 46648
	Non Discounted sale( 20% sales)	$18,000	$13,000	$13,600
	1. $ 90000*0.20=$ 18000
	2. $ 65000*0.20=$ 13000
	3. $ 68000*0.20=$ 13600
	Rental amount	$1,500	$1,500	$1,500
	Previous month amount = $ 1500/2=$ 750
	Current month amount = $ 1500/2=$ 750
	`
	Sale of Obselete equipment	$2,500
	Interest income	$10,000	$10,000	$10,000
	Total Receipts ( Including OB)	$116,940	$101,290	$116,618
Less:	Current Month Purchases	$37,240	$29,400	$33,320
	1.$ 57000*2/3*0.98=$ 37240
	2.$ 45000*2/3*0.98=$ 29400
	3.$ 51000*2/3*0.98=$ 33320
	Previous Month Purchases	0	$18,620	$14,700
	1
	2.$ 57000/3*0.98=$ 18620
	3.$ 45000/3*0.98=$ 14700
	Bills payable	$55,000		$60,000
	Operating Expenses	$6,000	$6,600.0	$7,260.0
	EMI		$7,000	$7,000
	1.Aug = $ 42000/6=$ 7000
	2. Sep = $ 7000
	Total payments	$98,240	$61,620	$122,280
	Net Cash inflow( Receipts-Payment)	$18,700	$39,670	($5,662)
	Add: Financing needed	$6,300	0	$30,662
	Total cash balance	$25,000	$39,670	$25,000

Assuming that operating expenses are increased by 10% every year on the previous year amount.

b)Benefits of Cash Budget:

1.Cash budget helps us to determine whether the cash resources are sufficient to pay out the regular obligations

2.It helps us to assess whether the minimum cash balance as required by the bank are maintained by the company or not for liquidity purpouse.

3.If large cash balances are retained, we can plan adequately where to invest the cash to maximize the returns

4. If the Company is suffering from liquidity crisis, it may offer some discount to the customer to get back the amount immediately. Conversely,if the Company is having large cash resources , company may extend credit to the customer which enhances the sales and boosts profitability.

5..It also allows us to cut down the unproductive expenses

Limitations of Cash budget.:

1.If you donot give much credit to your customers ( By strictly following cash budget) then it decreases the sales which inturn effects the profitability of a concern adversely.

2.It limiits the purchasing power. If you don’t hve enough money, generally you were not interested in purchasing more.

3.Cash budget does not reflect the profitability of a concern. Since we purchase a capital asset there is a large amount of cash outflow occurs.

4.When we are preparing the cash budget,we are preparing the estimates of cash inflows and ouflows. But it may not turn true in actual.

If you have any doubts,please post it in the comments.

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