The chapter illustrated the operating budget, which is one part of the master budget. The other part is the financial budget, which is composed of the capital expenditures budget, the cash budget, the budgeted balance sheet, and the budgeted statement of cash flows. This appendix focuses on the cash budget and the budgeted balance sheet. We discuss capital budgeting in Chapter 22. The budgeted statement of cash flows is beyond the scope of this text and generally is covered in financial accounting and corporate finance courses.
Why should Stylistic’s managers want a cash budget in addition to the operating income budget presented in the chapter? Recall that Stylistic’s management accountants prepared the operating budget on an accrual accounting basis consistent with how the company reports its actual operating income. But Stylistic’s managers also need to plan cash flows to ensure that the company has adequate cash to pay vendors, meet payroll, and pay operating expenses as these payments come due. Stylistic could be very profitable, but the pattern of cash receipts from revenues might be delayed and result in insufficient cash being available to make scheduled payments. Stylistic’s managers may then need to initiate a plan to borrow money to finance any shortfall. Building a profitable operating plan does not guarantee that adequate cash will be available, so Stylistic’s managers need to prepare a cash budget in addition to an operating income budget.
Exhibit 6-5 shows Stylistic Furniture’s balance sheet for the year ended December 31, 2019. The budgeted cash flows for 2020 are as follows:
Quarters
1
2
3
4
Collections from customers
$9,136,600
$10,122,000
$10,263,200
$8,561,200
Disbursements
Direct materials
3,031,400
2,636,967
2,167,900
2,242,033
Direct manufacturing labor payroll
1,888,000
1,432,000
1,272,000
1,408,000
Manufacturing overhead costs
3,265,296
2,476,644
2,199,924
2,435,136
Operating (nonmanufacturing) costs
2,147,750
2,279,000
2,268,250
2,005,000
Machinery purchase
—
—
758,000
—
Income taxes
725,000
400,000
400,000
400,000
Exhibit 6-5
Balance Sheet for Stylistic Furniture, December 31, 2019
The spreadsheet consists of four columns, first column includes the particulars of the balance sheet, and the details are as follows:
Assets
Current assets
Cash: dollar 300,000 (2nd column)
Accounts receivable: dollar 1,711,000 (2nd column)
Direct materials inventory: dollar 1,090,000 (2nd column)
Finished goods inventory: dollar 646,000 (2nd column)
Total current assets: dollar 3,747,000 (3rd column)
Property, Plant, and equipment
Land: dollar 2,000,000 (2nd column)
Building and equipment: dollar 22,000,000 (1st column)
Accumulated depreciation:
1st column: dollar 6,900,000
2nd column: dollar 15,100,000
3rd column: dollar 17,100,000
Total: dollar 20,847,000 (3rd column)
Liabilities and stockholders’ equity
Current liabilities
Accounts payable: dollar 904,000 (2nd column)
Income taxes payable
2nd column: dollar 325,000
3rd column: dollar 1,229,000
Stockholders’ equity
Common stock, no-par 25,000 shares outstanding: dollar 3,500,000 (2nd column)
Retained earnings
2nd column: dollar 16,118,000
3rd column: dollar 19,618,000
Total: dollar 20,847,000 (3rd column)
The quarterly data are based on the budgeted cash effects of the operations formulated in Schedules 1–8 in the chapter, but the details of that formulation are not shown here to keep this illustration as brief and as focused as possible.
Stylistic wants to maintain a $320,000 minimum cash balance at the end of each quarter. The company can borrow or repay money at an interest rate of 12% per year. Management does not want to borrow any more short-term cash than is necessary. By special arrangement with the bank, Stylistic pays interest when repaying the principal. Assume, for simplicity, that borrowing takes place at the beginning and repayment at the end of the quarter under consideration (in multiples of $1,000). Interest is computed to the nearest dollar.
Suppose a management accountant at Stylistic receives the preceding data and the other data contained in the budgets in the chapter. Her manager asks her to:
Prepare a cash budget for 2020 by quarter. That is, prepare a statement of cash receipts and disbursements by quarter, including details of borrowing, repayment, and interest.
Prepare a budgeted income statement for the year ending December 31, 2020. This statement should include interest expense and income taxes (federal, state, and local at a rate of 35% of operating income).
Prepare a budgeted balance sheet on December 31, 2020.
Preparation of Budgets
The cash budget is a schedule of expected cash receipts and cash disbursements. It predicts the effects on the cash position at the given level of operations. Exhibit 6-6 presents the cash budget by quarters to show the impact of cash flow timing on bank loans and their repayment. In practice, monthly—and sometimes weekly or even daily—cash budgets are critical for cash planning and control. Cash budgets help avoid unnecessary idle cash and unexpected cash deficiencies. They thus keep cash balances in line with needs. Ordinarily, the cash budget has these main sections:
CASH AVAILABLE FOR NEEDS (BEFORE ANY FINANCING). The beginning cash balance plus cash receipts equals the total cash available for needs before any financing. Cash receipts depend on collections of accounts receivable, cash sales, and miscellaneous recurring sources, such as rental or royalty receipts. Information on the expected collectability of accounts receivable is needed for accurate predictions. Key factors include bad-debt (uncollectible accounts) experience (not an issue in the Stylistic case) and average time lag between sales and collections.
CASH DISBURSEMENTS. Cash disbursements by Stylistic Furniture include the following:
DIRECT MATERIALS PURCHASES. Suppliers are paid in full in the month after the goods are delivered.
DIRECT MANUFACTURING LABOR AND OTHER WAGE AND SALARY OUTLAYS. All payroll-related costs are paid in the month in which the labor effort occurs.
OTHER COSTS. These depend on timing and credit terms. (In the Stylistic case, all other costs are paid in the month in which the cost is incurred.) Note that depreciation does not require a cash outlay.
OTHER CASH DISBURSEMENTS. These include outlays for property, plant, equipment, and other long-term investments.
Income tax payments as shown each quarter.
FINANCING EFFECTS. Short-term financing requirements depend on how the total cash available for needs [keyed as (x) in Exhibit 6-6] compares with the total cash disbursements [keyed as (y)], plus the minimum ending cash balance desired. The financing plans will depend on the relationship between total cash available for needs and total cash needed. If there is a deficiency of cash, Stylistic obtains loans. If there is excess cash, Stylistic repays any outstanding loans.
ENDING CASH BALANCE. The cash budget in Exhibit 6-6 shows the pattern of short-term “self-liquidating” cash loans. In quarter 1, Stylistic budgets a $1,940,846 cash deficiency. The company therefore undertakes short-term borrowing of $1,941,000 that it pays off over the course of the year. Seasonal peaks of production or sales often result in heavy cash disbursements for purchases, payroll, and other operating outlays as the company produces and sells products. Cash receipts from customers typically lag behind sales. The loan is self-liquidating in the sense that the company uses the borrowed money to acquire resources that it uses to produce and sell finished goods and uses the proceeds from sales to repay the loan. This self-liquidating cycle is the movement from cash to inventories to receivables and back to cash.
Exhibit 6-6
Cash Budget for Stylistic Furniture for the Year Ending December 31, 2020
The details of the table are as follows:
Quarter 1:
Cash balance, beginning: dollar 300,000
Add receipts
Collections from customers: 9,136,600
Total cash available for needs (denoted by “x"): 9,436,600
Cash disbursements
Direct materials: 3,031,400
Direct manufacturing labor payroll: 1,888,000
Manufacturing overhead costs: 3,265,296
Nonmanufacturing costs: 2,147,750
Income taxes: 725,000
Total cash disbursements (denoted by “y”): 11,057,446
Minimum cash balance desired: 320,000
Total cash needed: 11,377,446
Cash excess: 1,940,846 (deficiency)
Financing
Borrowing (at beginning): 1,941,000
Repayment (at end): 0
Interest (at 12 percent per year): 0
Total effects of financing (denoted by “z”): 1,941,000
Cash balance, ending: 320,154
Quarter 2:
Cash balance, beginning: dollar 320,154
Add receipts
Collections from customers: 10,122,000
Total cash available for needs (denoted by “x"): 10,442,154
Cash disbursements
Direct materials: 2,636,967
Direct manufacturing labor payroll: 1,432,000
Manufacturing overhead costs: 2,476,644
Nonmanufacturing costs: 2,279,000
Income taxes: 400,000
Total cash disbursements (denoted by “y”): 9,224,611
Minimum cash balance desired: 320,000
Total cash needed: 9,544,611
Cash excess: 897,543
Financing
Borrowing (at beginning): 0
Repayment (at end): 846,000
Interest (at 12 percent per year): 50,760
Total effects of financing (denoted by “z”): 896,760
Cash balance, ending: 320,783
Quarter 3:
Cash balance, beginning: dollar 320,783
Add receipts
Collections from customers: 10,263,200
Total cash available for needs (denoted by “x"): 10,583,983
Cash disbursements
Direct materials: 2,167,900
Direct manufacturing labor payroll: 1,272,000
Manufacturing overhead costs: 2,199,924
Nonmanufacturing costs: 2,268,250
Machinery purchase: 758,000
Income taxes: 400,000
Total cash disbursements (denoted by “y”): 9,066,074
Minimum cash balance desired: 320,000
Total cash needed: 9,386,074
Cash excess: 1,197,909
Financing
Borrowing (at beginning): 0
Repayment (at end): 1,095,000
Interest (at 12 percent per year): 98,550
Total effects of financing (denoted by “z”): 1,193,550
Cash balance, ending: 324,359
Quarter 4:
Cash balance, beginning: dollar 324,359
Add receipts
Collections from customers: 8,561,200
Total cash available for needs (denoted by “x"): 8,885,559
Cash disbursements
Direct materials: 2,242,033
Direct manufacturing labor payroll: 1,408,000
Manufacturing overhead costs: 2,435,136
Nonmanufacturing costs: 2,005,000
Income taxes: 400,000
Total cash disbursements (denoted by “y”): 8,490,169
Minimum cash balance desired: 320,000
Total cash needed: 8,810,169
Cash excess: 75,390
Financing
Borrowing (at beginning): 0
Repayment (at end): 0
Interest (at 12 percent per year): 0
Total effects of financing (denoted by “z”): 0
Cash balance, ending: 395,390
Year as a whole:
Cash balance, beginning: dollar 300,000
Add receipts
Collections from customers: 38,083,000
Total cash available for needs (denoted by “x"): 38,383,000
Cash disbursements
Direct materials: 10,078,300
Direct manufacturing labor payroll: 6,000,000
Manufacturing overhead costs: 10,377,000
Nonmanufacturing costs: 8,700,000
Machinery purchase: 758,000
Income taxes: 1,925,000
Total cash disbursements (denoted by “y”): 37,838,300
Minimum cash balance desired: 320,000
Total cash needed: 38,158,300
Cash excess: 224,700
Financing
Borrowing (at beginning): 1,941,000
Repayment (at end): 1,941,000
Interest (at 12 percent per year): 149,310
Total effects of financing (denoted by “z”): 149,310
Cash balance, ending: dollar 395,390
Note:
Deficiency is the excess of total cash available minus total cash needed before financing.
12 percent interest per year is dollar 846,000 times 0.12 times 0.5 equals dollar 50,760; dollar 1,095,000 times 0.12 times 0.75 equals dollar 98,550.
Short-term interest payments pertain only to the amount of principal being repaid at the end of a quarter and depreciation does not require a cash outlay.
Ending cash balance equals Total cash available for needs (x) minus Total disbursements (y) plus Total effects of financing (z).
The budgeted income statement is presented in Exhibit 6-7. It is merely the budgeted operating income statement in Exhibit 6-3 expanded to include interest expense and income taxes.
Exhibit 6-7
Budgeted Income Statement for Stylistic Furniture for the Year Ending December 31, 2020
It includes four columns, the first column includes particulars the second, third, and fourth column depict the budget details respectively.
Revenue (Schedule 1): dollar 38,000,000
COGS (Schedule 7): 24,440,000
Gross margin: 13,560,000
Operating costs
Product design costs (Schedule 8): dollar 1,024,000
Marketing costs (Schedule 8): 3,800,000
Distribution costs (Schedule 8): 3,876,000
Total operating costs: 8,700,000
Operating income: 4,860,000
Interest expense (Exhibit 6-6): 149,310
Income before income taxes: 4,710,690
Income taxes (at 35 percent): 1,648,742
Net income: dollar 3,061,948
The budgeted balance sheet is presented in Exhibit 6-8. Each item is projected in light of the details of the business plan as expressed in all the previous budget schedules. For example, the ending balance of accounts receivable of $1,628,000 is computed by adding the budgeted revenues of $38,000,000 (from Schedule 1 in Steps in Preparing an Operating Budget) to the beginning balance of accounts receivable of $1,711,000 (from Exhibit 6-5) and subtracting cash receipts of $38,083,000 (from Exhibit 6-6).
Exhibit 6-8
Budgeted Balance Sheet for Stylistic Furniture, December 31, 2020
The details of assets, liabilities and stockholder’s equity are as follows:
Assets
Current assets
Cash (from Exhibit 6-6): dollar 395,390
Accounts receivable (1): 1,628,000
Direct materials inventory (2): 760,000
Finished goods inventory (2): 4,486,000
Total current assets: dollar 7,269,390
Property, Plant, and equipment
Land (3): dollar 2,000,000
Building and equipment (4): dollar 22,758,000
Accumulated depreciation (5): dollar 8,523,000
Total property plant and equipment: dollar 16,235,000
Total assets: dollar 23,504,390
Liabilities and Stockholders' Equity
Current liabilities
Accounts payable (6): dollar 775,700
Income taxes payable (7): 48,742
Total current liabilities: dollar 824,442
Stockholder equity
Common stock, no-par, 25,000 shares outstanding (8): 3,500,000
Retained earnings (9): 19,179,948
Total stockholder’s equity: 22,679,948
Total liabilities and stockholder’s equity: dollar 23,504,390
Notes:
Beginning balances are used as the starting point for most of the following computations
(1) dollar 1,711,000 plus dollar 38,000,000 revenues minus dollar 38,083,000 receipts (Exhibit 6-6) equal dollar 1,628,000
(2) From Schedule 6B, p. 216
(3) From opening balance sheet (Exhibit 6-5)
(4) dollar 22,000,000 (Exhibit 6-5) plus dollar 758,000 purchases (Exhibit 6-6) equals dollar 22,758,000
(5) dollar 6,900,000 (Exhibit 6-5) plus dollar 1,020,000 plus dollar 603,000 depreciation from Schedule 5, p. 214—215
(6) dollar 904,000 (Exhibit 6-5) plus dollar 9,950,000 (Schedule 3B) minus dollar 10,078,300 (Exhibit 6-6) equals dollar 775,300.
There are no other current liabilities. From Exhibit 6-6:
Cash flows for direct manufacturing labor equal dollar 6,000,000 from Schedule 4
Cash flows for manufacturing overhead costs equals dollar 10,377,000 (that is dollar 12,000,000 minus depreciation dollar 1,623,000) from Schedule 5
Cash flows for nonmanufacturing costs equal dollar 8,700,000 from Schedule 8.
(7) dollar 325,000 (Exhibit 6-5) plus dollar 1,648,942 (from Exhibit 6-7) minus dollar 1,925,000 payment (Exhibit 6-6) equals dollar 48,742
(8) From opening balance sheet (Exhibit 6-5)
(9) dollar 16,118,000 (Exhibit 6-5) plus net income dollar 3,061,948 (Exhibit 6-7) equals dollar 19,179,948.
For simplicity, this example explicitly gave the cash receipts and disbursements. Usually, the receipts and disbursements are calculated based on the lags between the items reported on the accrual basis of accounting in an income statement and balance sheet and their related cash receipts and disbursements. Consider accounts receivable.
The budgeted sales for the year are broken down into sales budgets for each month and quarter. For example, Stylistic Furniture budgets sales by quarter of $9,282,000, $10,332,000, $10,246,000, and $8,140,000, which equal 2020 budgeted sales of $38,000,000.
The table depicts the budgeted sales in units, selling price, and budgeted revenues for quarters 1 through 4 for casual and deluxe tables, as well as quarterly totals. The details of the table are as follows:
Budgeted sales in units
Quarter 1, Casual: 12,270
Quarter 1, Deluxe: 2,400
Quarter 2, Casual: 13,620
Quarter 2, Deluxe: 2,700
Quarter 3, Casual: 13,610
Quarter 3, Deluxe: 2,600
Quarter 4, Casual: 10,500
Quarter 4, Deluxe: 2,300
Selling price
Quarter 1, Casual: 600 dollars
Quarter 1, Deluxe: 800 dollars
Quarter 2, Casual: 600 dollars
Quarter 2, Deluxe: 800 dollars
Quarter 3, Casual: 600 dollars
Quarter 3, Deluxe: 800 dollars
Quarter 4, Casual: 600 dollars
Quarter 4, Deluxe: 800 dollars
Budgeted revenues
Quarter 1, Casual: 7,362,000 dollars
Quarter 1, Deluxe: 1,920,000 dollars
Quarter 2, Casual: 8,172,000 dollars
Quarter 2, Deluxe: 2,160,000 dollars
Quarter 3, Casual: 8,166,000 dollars
Quarter 3, Deluxe: 2,080,000 dollars
Quarter 4, Casual: 6,300,000 dollars
Quarter 4, Deluxe: 1,840,000 dollars
Total budgeted revenues by quarter
Quarter 1: 9,282,000 dollars
Quarter 2: 10,332,000 dollars
Quarter 3: 10,246,000 dollars
Quarter 4: 8,140,000 dollars
Notice that sales are expected to be higher in the second and third quarters relative to the first and fourth quarters when weather conditions limit the number of customers shopping for furniture.
Once Stylistic’s managers determine the sales budget, a management accountant prepares a schedule of cash collections that serves as an input for the preparation of the cash budget. Stylistic estimates that 80% of all sales made in a quarter are collected in the same quarter and 20% are collected in the following quarter. Estimated collections from customers each quarter are calculated in the following table:
The table depicts. The details of the table are as follows:
Accounts receivable balance on January 1, 2020 (Fourth-quarter sales from prior year collected in first quarter of 2020)
Quarter 1: 1,711,000 dollars
From first-quarter 2020 sales
Quarter 1: 9,282,000 dollars times 0.8 equals 7,425,600 dollars
Quarter 2: 9,282,000 dollars times 0.2 equals 1,856,400 dollars
From second-quarter 2020 sales
Quarter 2: 10,332,000 dollars times 0.8 equals 8,265,600 dollars
Quarter 3: 10,332,000 dollars times 0.2 equals 2,066,400 dollars
From third-quarter 2020 sales
Quarter 3: 10,246,000 dollars times 0.8 equals 8,196,800 dollars
Quarter 4: 10,246,000 dollars times 0.2 equals 2,049,200 dollars
From fourth-quarter 2020 sales
Quarter 4: 8,140,000 dollars times 0.8 equals 6,512,000 dollars
Total collections
Quarter 1: 9,136,600 dollars
Quarter 2: 10,122,000 dollars
Quarter 3: 10,263,200 dollars
Quarter 4: 8,561,200 dollars
Uncollected fourth-quarter 2020 sales of appear as accounts receivable in the budgeted balance sheet of December 31, 2020 (see Exhibit 6-8). Note that the quarterly cash collections from customers calculated in this schedule equal the cash collections by quarter shown above.
Watch Appendix: Try It Video
Sensitivity Analysis and Cash Flows
Exhibit 6-4 hows how differing assumptions about selling prices of coffee tables and direct material prices led to differing amounts for budgeted operating income for Stylistic Furniture. A key use of sensitivity analysis is to budget cash flow. Exhibit 6-9 outlines the short-term borrowing implications of the two combinations examined in Exhibit 6-4. Scenario 1, with the lower selling prices per table ($582 for the Casual table and $776 for the Deluxe table), requires $2,146,000 of short-term borrowing in quarter 1 that cannot be fully repaid as of December 31, 2020. Scenario 2, with the 5% higher direct material costs, requires $2,048,000 borrowing by Stylistic Furniture that also cannot be repaid by December 31, 2020. Sensitivity analysis helps managers anticipate such outcomes and take steps to minimize the effects of expected reductions in cash flows from operations.
Exhibit 6-9
Sensitivity Analysis: Effects of Key Budget Assumptions in Exhibit 6-4 on 2020 Short-Term Borrowing for Stylistic Furniture
