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Financial Management: How To Make a Go Of Your Business 5V. Cash Flow Management: Budgeting and Controlling CostsIf there is anything more important to the successful financial management of a business than the thorough, thoughtful preparation of Pro Forma Income Statements, it is the preparation of the Cash Flow Statement, sometimes called the Cash Flow Budget. The Cash Flow StatementThe Cash Flow Statement identifies when cash is expected to be received and when it must be spent to pay bills and debts. It shows how much cash will be needed to pay expenses and when it will be needed. It also allows the manager to identify where the necessary cash will come from. For example, will it be internally generated from sales and the collection of accounts receivable--or must it be borrowed? (The Cash Flow Projection deals only with actual cash transactions; depreciation and amortization of good will or other non-cash expense items are not considered in this Pro Forma.) The Cash Flow Statement, based on management estimates of sales and obligations, identifies when money will be flowing into and out of the business. It enables management to plan for shortfalls in cash resources so short term working capital loans may be arranged in advance. It allows management to schedule purchases and payments in a way that enables the business to borrow as little as possible. Because all sales are not cash sales management must be able to forecast when accounts receivable will become "cash in the bank" and when expenses--whether regular or seasonal--must be paid so cash shortfalls will not interrupt normal business operations. The Cash Flow Statement may also be used as a Budget, permitting the manager increased control of the business through continuous comparison of actual receipts and disbursements against forecast amounts. This comparison helps the small business owner identify areas for timely improvement in financial management. By closely watching the timing of cash receipts and disbursements, cash balance on hand, and loan balances, management can readily identify such things as deficiencies in collecting receivables, unrealistic trade credit or loan repayment schedules. Surplus cash that may be invested on a short-term basis or used to reduce debt and interest expenses temporarily can be recognized. In short, it is the most valuable tool management has at its disposal to refine the day-to-day operation of a business. It is an important financial tool bank lenders evaluate when a business needs a loan, for it demonstrates not only how large a loan is required but also when and how it can be repaid. A Cash Flow Statement or Budget can be prepared for any period of time. However, a one-year budget matching the fiscal year of your business is recommended. As in the preparation and use of the Pro Forma Statement of Income, the projected Cash Flow Statement should be prepared on a monthly basis for the next year. It should be revised not less than quarterly to reflect actual performance in the preceding three months of operations to check its projections. In preparing the Cash Flow Statement or Budget start with the sales budget. Other budgets are related directly or indirectly to this budget. The following is a sales forecast in units: Sales Budget--Units For the Year Ended December 31, 2010 Territory Total 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
East....................26,000 5,000 6,000 7,000 8,000
West....................11,000 2,000 2,500 3,000 3,500
------ ----- ----- ------ ------
37,000 7,000 8,500 10,000 11,500
------ ----- ----- ------ ------Assume you sell a single product and the sales price for it is $10. Your sales budget in terms of dollars would look like this: Sales Budget--Dollars For the Year Ended December 31, 2010 Territory Total 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
East......................$260,000 $50,000 $80,000 $ 70,000 $ 80,000
West...................... 110,000 20,000 25,000 30,000 35,000
-------- ------- ------- -------- --------
$370,000 $70,000 $85,000 $100,000 $115,000
-------- ------- ------- -------- --------Say the estimated per unit cost of the product is $1.50 for direct material, $2.50 for direct labor, and $1.00 for manufacturing overhead. By applying unit costs to the sales budget in units, you would come out with this budget: Cost of Goods Sold Budget For the Year Ended December 31, 2010 Total 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
Direct material......$ 55,500 $10,500 $12,750 $15,000 $17,250
Direct labor......... 92,500 17,500 21,250 25,000 28,750
Mfg. overhead........ 37,000 7,000 8,500 10,000 11,500
-------- ------- ------- ------- -------
$185,000 $35,000 $42,500 $50,000 $57,500
-------- ------- ------- ------- -------Later on, before a cash budget can be compiled, you will need to know the estimated cash requirements for selling expenses. Therefore, you prepare a budget for selling expenses and another for cash expenditures for selling expenses (total selling expenses less depreciation): Selling Expenses Budget For the Year Ended December 31, 2010 Total 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
Commissions.............$46,500 $ 8,750 $10,625 $12,500 $14,375
Rent.................... 9,250 1,750 2,125 2,500 2,875
Advertising............. 9,250 1,750 2,125 2,500 2,875
Telephone............... 4,625 875 1,062 1,250 1,437
Depreciation--office.... 900 225 225 225 225
Other................... 22,250 4,150 5,088 6,025 6,983
------- ------- ------- ------- -------
$92,500 $17,500 $21,250 $25,000 $28,750
------- ------- ------- ------- -------Selling Expenses Budget--Cash Requirements For the Year Ended December 31, 2010 Total 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
Total selling expenses..$92,500 $17,500 $21,250 $25,000 $28,750
Less: depreciation......
expense--office......... 900 225 225 225 225
------- ------- ------- ------- -------
Cash requirements.......$91,600 $17,275 $21,025 $24,775 $28,525
------- ------- ------- ------- -------Basic information for an estimate of administrative expenses for the coming year is easily compiled. Again, from that budget you can estimate cash requirements for those expenses to be used subsequently in preparing the cash budget. Administrative Expenses Budget For the Year Ended December 31, 2010 Total 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
Salaries.................$22,200 $ 4,200 $ 5,100 $ 6,000 $ 6,900
Insurance................ 1,850 350 425 500 575
Telephone................ 1,850 350 425 500 575
Supplies................. 3,700 700 850 1,000 1,150
Bad debt expenses........ 3,700 700 850 1,000 1,150
Other expenses........... 3,700 700 850 1,000 1,150
------- ------ ------ ------ -------
$37,000 $7,000 $8,500 $10,000 $11,500
------- ------ ------ ------ -------Administrative Expenses Budget--Cash Requirements For the Year Ended December 31, 2010 Total 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
Estimated adm. expenses...$37,000 $ 7,000 $ 8,500 $10,000 $11,500
Less: bad debt expenses... 3,700 700 850 1,000 1,150
------- ------- ------- ------- -------
Cash requirements.........$33.300 $ 6,500 $ 7,650 $ 9,000 $10,350
------- ------- ------- ------- -------Now, from the information budgeted so far, you can proceed to prepare the budget income statement. Assume you plan to borrow $10,000 at the end of the first quarter. Although payable at maturity of the note, the interest appears in the last three quarters of the year. The statement will resemble the following: Budgeted Income Statement For the Year Ended December 31, 2010 Total 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
Sales...................$370,000 $70,000 $85,000 $100,000 $115,000
Cost of goods sold...... 185,000 35,000 42,500 50,000 57,500
-------- ------- ------- -------- --------
Gross Margin............$185,000 $35,000 $42,500 $ 50,000 $ 57,500
-------- ------- ------- -------- --------
Operating expenses:
Selling................$ 92,500 $17,500 $21,250 $ 25,000 $ 28,750
Administrative......... 37,000 7,000 8,500 $ 10,000 $ 11,500
-------- ------- ------- -------- --------
Total................ $129,500 $24,500 $29,750 $ 35,000 $ 40,250
-------- ------- ------- -------- --------
Net income
from operations........$ 55,500 $10,500 $12,750 $ 15,000 $ 17,250
Interest expense....... 450 150 150 150
-------- ------- ------- -------- --------
Net income before
Income taxes...........$ 55,050 $10,500 $12,600 $ 14,850 $ 17,100
Federal income tax..... 27,525 5,250 6,300 7,425 8,550
-------- ------- ------- -------- --------
Net income..............$ 27,525 $ 5,250 $ 6,300 $ 7,425 $ 8,550
-------- ------- ------- -------- --------Estimating that 90 percent of your account sales is collected in the quarter in which they are made, that 9 percent is collected in the quarter following the quarter in which the sales were made, and that 1 percent of account sales is uncollectible, your accounts receivable budget of collections would look like this: Budget of Collections of Accounts Receivable For the Year Ended December 31, 2010 Total 1st 2nd 3rd 4th
(net) Quarter Quarter Quarter Quarter
4th Quarter Sales 19-0... $ 6,000 $ 6,000
1st Quarter Sales 19-1... 69,300 63,000 $ 6,300
2nd Quarter Sales 19-1... 84,150 76,500 $ 7,650
3rd Quarter Sales 19-1... 99,000 90,000 $ 9,000
4th Quarter Sales 19-1.. 103,500 103,500
-------- ------- ------- ------- --------
$361,950 $69,000 $82,800 $97,650 $112,500Going back to the sales budget in units, now prepare a production budget in units. Assume you have 2,000 units in the opening inventory and want to have on hand at the end of each quarter the following quantities: 1st quarter, 3,000 units; 2nd quarter, 3,500 units; 3rd quarter, 4,000 units; and 4th quarter, 4,500 units. Production Budget--Units For the Year Ended December 31, 2010 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
Sales requirements...........7,000 8,500 10,000 11,500
Add: ending
inventory requirements...... 3,000 3,500 4,000 4,500
------ ------ ------ -------
Total requirements..........10,000 12,500 14,000 16,000
Less: beginning
inventory................... 2,000 3,000 3,500 4,000
Production ------ ------ ------ -------
requirements............... 8,000 9,000 10,500 112,000
------ ------ ------ -------Next, based on the production budget, prepare a budget to show the purchases needed during each of the four quarters. Expressed in terms of dollars, you do this by taking the production and inventory fires and multiplying them by the cost of material (previously estimated at $1.50 per unit). You could prepare a similar budget expressed in units. Budget of Direct Materials Purchases For the Year Ended December 31, 2010 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
Required for production........$12,000 $13,500 $15,750 $18,000
Required for ending inventory.. 4,500 52,250 6,000 6,750
------- ------- ------- -------
Total........................ $16,500 $18,750 $21,750 $24,750
Less: beginning inventory...... 3,000 4,500 5,250 6,000
------- ------- ------- -------
Required purchases.............$13,500 $14,250 $16,500 $18,750
------- ------- ------- -------Now suppose you pay 50 percent of your accounts in the quarter of the purchase and 50 percent in the following quarter. Carryover payables from last year were $5,000. Further, you always take the purchase discounts as a matter of good business policy. Since net purchases (less discount) were figured into the $1.50 cost estimate, purchase discounts do not appear in the budgets. Thus your payment on purchases budget will come out like this:Payment on Purchases Budget For the Year Ended December 31, 2010 Total 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
4th Quarter Sales 19-0...$ 5,000 $ 5,000
1st Quarter Sales 19-1... 13,500 6,750 $ 6,750
2nd Quarter Sales 19-1... 14,250 7,125 $ 7.125
3rd Quarter Sales 19-1... 16,500 8,250 $ 8,250
4th Quarter Sales 19-1... 9,375 9,375
------- -------
Payments by Quarters $58,625 $11,750 $13,875 $15,375 $17,625
------- ------- ------- ------- -------Taking the data for quantities produced from the production budget in units, calculate the direct labor requirements on the basis of units to be produced. (The number and cost of labor hours necessary to produce a given quantity can be set forth in supplemental schedules.) Direct Labor Budget--Cash Requirements For the Year Ended December 31, 2010 Total 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
Quantity................ 39,500 8,000 9,000 10,500 12,000
Direct labor cost.......$98,750 $20,000 $22,500 $26,250 $30,000Now outline the items that comprise your factory overhead, and prepare a budget like the following: Manufacturing Overhead Budget For the Year Ended December 31, 2010 Total 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
Heat and power..........$10,000 $1,000 $2,500 $ 3,000 $ 3,500
Factory supplies........ 5,300 1,000 1,500 1,800 1,000
Property taxes.......... 2,000 500 500 500 500
Depreciation............ 2,800 700 700 700 700
Rent.................... 8,000 2,000 2,000 2,000 2,000
Superintendent.......... 9,400 2,800 1,800 2,500 4,300
------- ------ ------- ------- -------
$39,500 $8,000 $9,000 $10.500 $12,000
------- ------ ------- ------- -------Figure the cash payments for manufacturing overhead by subtracting depreciation, which requires no cash outlay, from the totals above, and you will have the following breakdown: Manufacturing Overhead Budget--Cash Requirements For the Year Ended December 31, 2010 Total 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
Productions--units...... 39,500 8,000 9,000 10,500 12,000
------- ------ ------ ------- -------
Mfg.overhead expenses...$39,500 $8,000 $9,000 $10,500 $12,000
Less: depreciation...... 2,800 700 700 700 700
------- ------ ------ ------- -------
Cash requirements.......$36,700 $7,300 $8,300 $ 9,800 $11,300
------- ------ ------ ------- -------Now comes the all important cash budget. You put it together by using the Collection of Accounts Receivable Budget; Selling Expenses Budget--Cash Requirements; Administrative Expenses Budget--Cash Requirements; Payment of Purchases Budget; Direct Labor Budget--Cash Requirements; and Manufacturing Budget--Cash Requirements. Take $15,000 as the beginning balance, and assume that dividends of $20,000 are to be paid in the fourth quarter. Cash Budget For the Year Ended December 31, 2010
Total 1st 2nd 3rd
4th Assets 2010 2009
Current assets:
Cash $ 10,000 $ 15,000
Accounts receivable 11,500 6,666
Less: allowance for doubtful accounts (1,150) (666)
Inventory:
Raw materials 6,750 3,000
Finished goods 22,500 10,000
-------- --------
Total current assets $ 49,600 34,000
-------- --------
Fixed assets:
Land $ 50,000 $ 50,000
Building 148,000 148,000
Less: allowance for depreciation (37,000) (33,000)
-------- --------
Total fixed assets $161,100 $164,700
-------- --------
Total assets $210,600 $198,700
-------- --------Liabilities and Shareholders' EquityCurrent liabilities:
Account payable $ 9,375 $ 5,000
-------- --------
Shareholders' equity:
Capital stock (10,000 shares; $10 par value) $100,000 $110,000
Retained earnings 101,225 93,700
-------- --------
$201,225 $193,700
-------- --------
Total liabilities and shareholders' equity $210,600 $198,700
-------- --------In order to make the most effective use of your budgets to plan profits, you will want to establish reporting devices. Throughout the time span you have set, you need periodic reports and reviews on both efforts and accomplishments. These let you know whether your budget plan is being attained and help you keep control throughout the process. It is through comparing actual performance with budgeted projections that you maintain control of the operations. Your company should be structured along functional lines, with well identified areas of responsibility and authority. Then, depending upon the size of your company, the budget reports can be prepared to correspond with the organizational structure of the company. Two typical budget reports are shown below to demonstrate various forms these reports may take.Report of Actual and Budgeted Sales For the Year Ended December 31, 2010 Variations from budget (under)
Actual sales Budgeted sales Quarterly Cumulative
1st Quarter $ $ $ $
2nd Quarter
3rd Quarter
4th QuarterBudgeted Report on Selling Expenses For the Year Ended December 31, 2010 -------------------------------------------------------------------------- Budget ¦ Actual ¦ Variation¦ Budget ¦ Actual ¦Variations¦ Remarks This ¦ This ¦ This ¦ Year to ¦ Year to ¦ Year to ¦ Month ¦ Month ¦ Month ¦ Date ¦ Date ¦ Date ¦ ----------+-----------+----------+----------+----------+----------+-------- ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ Remember, the Cash Flow Statement used as the business's Budget allows the owner/manager to anticipate problems rather than react to them after they occur. It permits comparison of actual receipts and disbursements against projections to identify errors in the forecast. If cash flow is analyzed monthly, the manager can correct the cause of the error before it harms profitability. |
