The Cash Budget (SQA National 5 Business Management): Revision Note

Elements of a cash budget

The importance of cash

• Cash is the 'blood' of a business, as without it, a business cannot survive

  • It is a liquid asset in the form of notes, coins and money in the bank

• A new business may have to pay cash on purchase for all of its supplies until its suppliers trust them enough to provide credit terms (buy now, pay later)

  • A supplier may then give the business trade credit of 30 or 60 days

  • This means that the business can receive their stock now and only pay for it in 30 or 60 days; the cash outflow is delayed

  • As the business sells its products, they receive money generated from the business revenue, which represents a cash inflow

  • At the end of 60 days, they will pay their supplier (cash outflow), but the firm may still have half of its stock available for sale

• More established businesses need to ensure that they manage cash-flow to ensure that they do not run out of money

  • Cash-flow issues may put the business in a situation where

    • It is unable to pay key stakeholders, such as workers and suppliers

    • Production is likely to cease, as workers will not work without pay and suppliers will not supply goods if they are not paid

    • It is unable to pay utility bills and rent

  • The business could be forced into liquidation and, ultimately, is likely to fail

The cash budget

• A cash budget is a prediction of the anticipated cash inflows and outflows, usually for a six- to twelve-month period

Cash receipts and payments

• Cash receipts include income from sales, loan sums received from the bank, interest received or capital injected into a business by owners

• Cash payments include payments for stock, staff wages and salaries, rent and utility bills and repayments of bank loans

Opening balance

• The opening balance is the cash position at the beginning of each month

  • In the first month, this is usually

    • Cash carried forward from any earlier trading

    • Cash introduced by the owner or from loans received

  • In later months, the opening balance is the closing balance carried forward from the previous month

Net cash

• Net cash is the difference between cash inflows and cash outflows during a month

  • It is sometimes called net cash flow

Closing balance

• The closing balance is the sum of the month's net cash and the opening balance

  • The closing balance is calculated using the formula

The usefulness of cash budgets

• Cash budgets are particularly useful when

  • Starting up a business: identifying how much cash is needed in the first few months

  • Running an existing business: recognising where a fall in sales may require use of an overdraft facility

  • Applying for borrowing: determining the size of loan or overdraft needed, when and for how long it is needed and by when it is likely to be fully repaid

  • Managing transactions: identifying how much or how little cash is deposited at the bank can determine when bills should be paid

Interpreting a cash budget

• A business must first gather information about all cash inflows and cash outflows it expects to encounter over the period

• The following steps should then be taken to construct the cash budget

Step 1: Calculate total cash inflows

• In this instance, the business expects to receive cash inflows from sales in March, April and May

• Owners' capital of £6,000 will be introduced in March

• The total for each month is calculated by adding cash from sales to capital introduced

Step 2: Calculate total cash outflows

• In this instance, the business expects to pay rent of £1,400 in March, April and May

• It will purchase a significant amount of stock in March with smaller amounts in April and May

• Wages are expected to be £2,100 in each month

• Utilities of £460 will be paid in March and April, increasing to €480 in May

• Total cash outflows each month is calculated by adding these together

Step 3: Calculate net cash

• Net cash is calculated by subtracting total cash outflows from total cash inflows

• In March net cash is £10,500 - £10,760 = £(260)

  • Net cash is negative as cash outflows are greater than cash inflows

• In April net cash is £4,800 - £4,560 = £240

• In May net cash is £5,300 - £4,780 = £520

  • In both months, net cash is positive as cash inflows are greater than cash outflows

Step 4: Calculate opening and closing balances

• The opening balance is the previous month’s closing balance carried forward

• The closing balance is calculated by adding net cash to the opening balance

• In March the opening balance of €0 is added to the net cash of €(260) to leave a closing balance of €(260)

• In April the closing balance from March is carried forward to become its opening balance of €(260) 

• This opening balance is added to April's net cash of €240 to leave a closing balance of €(20)

• In May the closing balance from April is carried forward to become its opening balance of €(20)

• This opening balance is added to May's net cash of €520 to leave a closing balance of €500

The complete cash budget