Question

Beta Company prepared its 2022 operating budget and management was pleased with the $1,000,000 of net income that the budget was showing for the year ended December 31, 2022.  As the firm started to perform actual operations for 2022 it monitored actual results vs. budgeted expectations. Management was satisfied with the firm’s actual profit financial outcomes.  For the month of March actual net income and the forecast of net income was just about on target ($100,000 for March) but Beta was having difficulty paying its obligations on time.  The budgeting process had not forecasted this cash shortfall arriving in March.

Required:   Identify and discuss (thorough on the discuss part) 2 different potential causes of the “surprise” cash shortfall.   

Answer 1

2 reasons for surprise cash shortfall

The net income in Income statement is prepared based on accrual concept. But the cash flow of the firm is based on actual inflow and outflow of cash. It takes into account only actual cash receipts and payments and not income which is earned or expenses which are accrued. Based on this concept the following can be 2 reasons for “surprise” cash shortfall

· Higher credit sales during the period. The high credit sales leads to increase in net income in income statement but from cash flow point of view increase in accounts receivable will lead to decrease in cash inflow since debtors do not give cash immediately to the firm

· Lower credit period availed on the purchases can lead to more outflow of cash than the expenses incurred. For example : Rent paid a year in advance, Advertising prepaid for next 6 months etc will have an immediate impact on cash outflow though affect on income statement is lower due to monthly accruals.

· Higher Capital expenditure during a particular month can also lead to cash shortfalls if the cash flow from operating activities cannot fund the same. Capital expenditure is incurred on fixed assets acquisition and is an investing activity.