Question 14.1: Constructing a Cash Budget To demonstrate the construction a...
Constructing a Cash Budget
To demonstrate the construction and use of the cash budget, consider Salco Furniture Company Inc., a regional distributor of household furniture. Salco is in the process of preparing a monthly cash budget for the upcoming 6 months (January through June 2019). The company’s sales are highly seasonal, peaking in the months of March through May. Roughly 30 percent of Salco’s sales are collected 1 month after the sale, 50 percent 2 months after the sale, and the remainder during the third month following the sale.
Salco attempts to pace its purchases with its forecast of future sales. Purchases generally equal 75 percent of sales and are made 2 months in advance of anticipated sales. Payments are made in the month following purchases. For example, June sales are estimated at $100,000; thus, April purchases are 0.75 × $100,000 = $75,000. Correspondingly, payments for purchases in May equal $75,000. Wages, salaries, rent, and other cash expenses are recorded in Table 14-3, which shows Salco’s cash budget for the 6-month period ended in June 2019. Additional expenditures are
recorded in the cash budget related to the purchase of equipment in the amount of $14,000 during February and the repayment of a $12,000 loan in May. In June, Salco will pay $7,500 interest on its $150,000 long-term debt for the period of January to June 2019. Interest on the $12,000 short-term note repaid in May for the period January through May equals $600 and is paid in May.
Salco currently has a cash balance of $20,000 and wants to maintain a minimum balance of $10,000. Additional borrowing necessary to maintain that minimum balance is estimated in the final section of Table 14-3. Borrowing takes place at the beginning of the month in which the funds are needed. Interest on the borrowed funds equals 12 percent per annum, or 1 percent per month, and is paid in the month following the one in which funds are borrowed. Thus, interest on funds borrowed in January will be paid in February, equal to 1 percent of the loan amount outstanding during January.
STEP 1: Formulate a Solution Strategy
Construct a cash budget that includes estimates of the firm’s cash inflows and outflows for each of the next 6 months. This requires the preparation of estimates of monthly revenues and expenses, but this is not the end of the process. The analyst must then estimate when the revenues will actually be received (cash sales and collection of accounts receivable) as well as when the expenses will actually be paid. Once these estimates have been prepared, we can construct the cash budget and estimate the change in cash for the firm in each month of the forecast period.
STEP 2: Crunch the Numbers
Table 14-3 contains the monthly cash budget and all the supporting estimates that are required.
STEP 3: Analyze Your Results
The financing-needed line in Salco’s cash budget determines that the firm’s cumulative short-term borrowing will rise to $97,599 by May. However, this need for borrowing begins to subside in June, and the firm is able to reduce its borrowing to $79,875. Note that the cash budget indicates not only the amount of financing needed during the period but also when the funds will be needed.