Page 131 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes 1. Time Period: The first decision to make when simulating a cash budget is to decide the
period of time for which your budget has to apply. That is, are you simulating a budget for
the next three months, six months, twelve months or some other period? In this chapter,
we will be discussing the simulation of a 3-months budget. However, the instructions
given are applicable to any time period you might select.
2. Cash Position: The amount of cash you wish to keep on hand will depend on the nature of
your business, the predictability of accounts receivable and the probability of fast-
happening opportunities (or unfortunate occurrences) that may require you to have a
significant reserve of cash.

You may want to consider your cash reserve in terms of a certain number of days’ sales.
Your budgeting process will help you to determine if, at the end of the period, you have
an adequate cash reserve.
3. Estimated Sales and Expenses: The fundamental concept of a cash budget is estimating all
future cash receipts and cash expenditures that will take place during the time period. The
most important estimate you will make, however, is an estimate of sales. Once this is
decided, the rest of the cash budget can fall into place.

Example: If an increase in sales of 10 percent is desired and expected, various other
accounts must be adjusted in your budget. Raw materials, inventory and the
costs of goods sold must be revised to reflect the increase in sales. In addition,
you must ask yourself if any additions need to be made to selling or general
and administrative expenses, or can the increased sales be handled by current
excess capacity? Also, how will the increase in sales affect payroll and overtime
expenditures?
Instead of increasing every expense item by 10 percent, serious consideration
needs to be given to certain economies of scale that might develop. In other
words, perhaps, a supplier offers a discount if you increase the quantities in
which you buy a certain item or, perhaps, the increase in sales can be easily
accommodated by the current sales force, all of these types of considerations
must be taken into account before you start budgeting. Each type of expense
(as shown on your income statement) must be evaluated for its potential to
increase or decrease. Your estimates should be based on our experience running
your business and on your goals for your business over the time frame for
which the budget is being created.
At a minimum, the following categories of expected cash receipts and expected cash payments
should be considered:

Cash Balance

1. Expected cash receipts: The cash balance is your cash on hand. This includes what is in your
checking accounts, savings accounts, petty cash and any other cash accounts that you
might have.
2. Cash sales: After arriving at a base figure of cash sales, it must be adjusted for any trade or
other discounts and for possible returns. As stated previously, the base level of sales (and
of accounts receivable) will be determined by the company’s projections, goals and past
experience.

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