week 3 budgeting & cash management

FINANCIAL MANAGEMENTPrepared by Tishta Bachoo

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Lecture 3 - overview

Prepared by Tishta Bachoo

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• Management Decision Making:Budgeting and Cash Management

1.explain what a budget is and describe the key steps in the budgeting process

2.explain the different types of budgets3.prepare a schedule of receipts from accounts receivable and a

cash budget4.explain the use of budgeting in planning and control5.debt management – method of finance6.loan repayment schedule

Strategic planning concerns longer term planning (typically, 3-5 years)

It is usually carried out by senior managementBudgeting is a process that focuses on the short

term, commonly one year, and results in the production of budgets that set the financial framework for that period

Budgets operationalise strategic plans and allow operational areas to understand how their area contributes to the entity’s strategic objectives

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Budgets continuedA budget is the quantitative expression of an entity’s plans

Budgeting can assist in decision making by: putting into operation longer term plans Assessing the feasibility of strategic plans setting targets for managers identifying resource constraints in budget period identifying periods of expected cash shortages and excess cash holdings assisting with short-term planning decisions, such as capacity utilisation providing profit forecasts and other financial data to the capital markets forecasting data such as sales or fees, which commonly set the level of activity for

the budget period helping determine required inventory levels and purchasing requirements for raw

materials planning labour and other inputs determining the ability of the entity to meet financing commitments

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1. Consideration of past performance

2. Assessment of expected trading and operating conditions

3. Preparation of initial budget estimates

4. Adjustment to estimates based on communication with, and feedback from, managers

5. Preparation of budgeted reports and sub-budgets

6. Monitoring of actual performance against the budget over the budget period

7. Making any necessary adjustments to the budget during the budget period

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Sales (or fees) budgetOperating (expenses) budgetProduction and inventory budgets Purchases budgetManufacturing overhead budgetBudgeted income statementCash budgetBudgeted balance sheetCapital budgetsProgram budget

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The cash budget is a statement of expected future cash receipts and payments

It assists decision making by: documenting timing of all cash receipts and payments

helping to identify periods of expected cash shortages and surpluses

identifying suitable times for purchase of non-current assets

assisting with planning and use of borrowed funds

providing a framework for ‘what if’ analysis

For an entity that provides goods or services on credit, one of the main tasks in the preparation of a cash budget is calculating the cash receipts from the credit sales or fees generated

This is commonly shown in a schedule of receipts from debtors/accounts receivable

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To illustrate the calculations in the schedule, if we take the December sales of $303 000: •50% will be received in the month following the sale (January);•40% in the second month (February); and •the final 10% in the third month (March).


The preparation of the cash budget is an important part of the planning process

It can then be used for monitoring cash performance, also known as the control process

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A cash budget prepared on a month-by-month basis is much more useful for planning and control than one prepared on a quarterly or yearly basis

As each month passes, actual cash numbers can be compared to the budget numbers, with the difference between the two known as a variance

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A favourable variance (‘F’) will occur when actual revenues are larger than budgeted, or actual costs are lower than budgeted.

An unfavourable variance (‘U’) will arise when the actual revenue is less than budgeted, or actual costs are greater than budgeted

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Improving cash flow

Cash inflow may be increased by: improving the collections of cash from debtors

seeking ways to improve sales or fees

reducing unnecessary stock levels

arranging external finance

providing an extra capital contribution from the owners, or considering a change in ownership structure

selling excess non-current assets

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Cash outflow may be reduced by: cutting expenses by identifying areas of waste, duplication or

inefficiency

making use of creditors’ terms

keeping inventory levels to only what is required, as excess inventory ties up cash and often adds to storage and handling costs

deferring capital expenditures

Reducing carbon footprint

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1. Equity FinancingAdditional investment from owners.

Sole Trader: Owner contributes more money.Partnership: Partners contribute more money

and/or admit a new partner(s).Company: Issue more shares.

2. Debt FinancingBorrowing money. Increases the level of financial risk.

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The risk of defaulting on an interest payment.

The more funds that are borrowed, the greater the financial risk.

Loans

Risk ofDefault

Risk of Failure

Interest Payments

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Each loan repayment will be the same therefore the following equation can be used:

PV = NCFi]n

Where:NCF: Loan Repaymenti: Interest calculated each compounding

period.n: Number of repayments throughout life

of loan/investment.

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Compounded Annually 8%

12 Months

Compounded Semi-Annually

4% 4%

12 6 (Months)

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Compounded Quarterly 2% 2% 2% 2%

12 3 6 9 (Months)

0.66 0.66 0.66 0.66 0.66 0.66 0.66 0.66 0.66 0.66 0.66

0.66 0.66%

1 2 3 4 5 6 7 8 9

10 11 12

Compounded Monthly


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Practice Question 1

Edward wants to buy a new car. He will need to borrow $20,000. The best interest rate Edward can get from the bank is 8%pa and he wants to repay the loan in ten years. If repayments are made annually, what is the amount of each repayment?

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Solution PV = $20,000 i = 8% pa N = 10

PV = NCFi]n

20,000 = NCF (T2,8%,10) Referring to Table 2 (annuity table) (T2, 8%. 10) = 6.710 NCF = 20,000 / 6.710 Yearly repayment = $2,981 (rounded to nearest whole $)

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Practice Question 2

If Edward makes quarterly repayments, what is the amount of each repayment?

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Solution

PV = $20,000 i = 2% per quarter N = 40

PV = NCFi]n

20,000 = NCF (T2,2%,40) Referring to Table 2 (annuity table) (T2, 2%, 40) = 27.355 NCF = 20,000 / 27.355 Quarterly repayment = $731 (rounded to nearest whole $)

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END OF SESSION

Next week …

Financing the Investments


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week 3 budgeting & cash management

Economy & Finance