Topic 7: The Cash Budget

Sections:

I. Overview
II. A Basic Cash Budget
III. What if?
IV. A Refined Cash Budget

I. Overview

The cash budget shows a firm’s projected cash inflows and outflows over some specified
period. The cash budget is useful for planning short-term borrowing and the timing of
expenditures. In a well-established firm, the task is usually performed or supervised by
the financial controller.

In general, firms use a monthly cash budget forecasted over the next year. This budget is
used for planning purposes. Firms also use a more detailed daily or weekly cash budget
for the coming month. This budget is used for actual cash control.

Again, the cash budget looks into future. The results are based on a set of assumptions
and forecasts. Building the cash budget is in the business of making mistakes (like
forecasting the path of a hurricane). As a result, we want to: (1) try everything possible
to ensure that our assumptions and inputs are reasonable accurate, (2) at the same time
understand that the cash budget is subject to errors, and (3) ask the question of “what if?”
and perform a set of scenario analyses (sensitivity analyses).

There are many IT vendors that sell user-friendly cash budget software. These products,
e.g., www.centage.com, and www.applix.com, usually cost about a couple of thousands
dollars for a single user to tens of thousands dollars for a big company.

This topic is to introduce you the basic concepts of cash budgeting. Excel is used to
generate the cash budget. If you work for a small company, these techniques will be
useful. If you work for a big firm with hundreds or thousands of products, like P&G,
you’d surely want to use commercial software.

The strengths of Excel: (1) inexpensive, and (2) user friendly for small problems. The
weaknesses of Excel: (1) harder to detect bugs, (2) not built for big problems.

II. A Basic Cash Budget

Textbook Example (pp. 157-85):

Suppose that today is May 31, 2005 and you are the financial controller of Bithlo BBQ, a
small manufacturer of BBQ grills. You need to prepare a monthly cash budget for the
next four months, i.e., June, July, August, and September. To do so, you need to figure
out all the possible cash inflows and outflows.

You’d need information on actual and expected sales. The reason for this is that sales
bring in cash inflows and many expenses (cash outflows) are related to sales. But before
you go to the sales department to get those numbers, you need to know how many
months’ sales numbers would be needed. To make this decision, you have to know (1)
the firm’s aging schedule (the way that your customers utilize your firm’s trade credit),
and (2) how your firm utilizes your suppliers’ trade credit.

Input (i.e., assumption) #1: (1) 40% of sales are for cash. 45% of sales are collected in
the following months (e.g., 45% of May sales are collected in June). 15% of sales are
collected two months after the sale (e.g., 15% of April sales are collected in June). (2)
Inventory purchases are equal to 50% of the following month’s sales (e.g., expected
September purchases are 50% of expected October sales). 60% of purchases are pay for
in the month following the purchase (e.g., 60% of May purchases are pay for in June).
40% of purchases are pay for two months after the purchase (e.g., 40% of April
purchases are pay for in June).

The three bolded months (April, October, April) define the scope of monthly sales that
we’d need. That is, we should ask the sales department to provide sales numbers in the
following format:

Input #2:

Month Sales
April 291000*
May 365000*
June 387000
July 329000
August 238000
September 145000
October 92000
*Actual sales

With these two inputs, now we can start to work on Excel. This leads us to the following
worksheet:

Bithlo BBQ
Cash Budget
For the Period June to September 2005
Septembe
April May June July August r October
29100 36500 38700 32900 23800
Sales 0 0 0 0 0 145000 92000
Collections
 15480 13160
Cash 40% 0 0 95200 58000
16425 17415 14805
First Month 45% 0 0 0 107100
Second Month 15% 43650 54750 58050 49350
36270 36050 30130
Total Collections 0 0 0 214450
18250 19350 16450
Purchases 50% 0 0 0 119000 72500 46000
Payments
First Month 60% 116100 98700 71400 43500
Second Month 40% 73000 77400 65800 47600
18910 17610 13720
Total Payments 0 0 0 91100

This can be found in BBQ1.xls.

Steps:
1. On the top three rows, use the merger and center button from the toolbar to enter
“Bithlo BBQ,” “Cash Budget,” and “For the Period June to September 2005” across
columns A:I.
2. In C4 enter “April.” Then autofill (drag the small box at the lower right of the active
cell, i.e., C4) to I4.
3. In A5:A15 enter “Sales,” “Collections,” “Cash,” “First Month,” “Second Month,”
“Total Collections,” “Purchases,” “Payments,” “First Month,” “Second Month,” and
“Total Payments,” respectively.
4. In B7:B9 enter “40%,” “45%,” and “15%,” respectively.
5. In B11 enter “50%.”
6. In B13:B14 enter “60%” and “40%,” respectively.
7. In C5:I5 enter “291000,” “365000,” “387000,” “329000,” “238000,” “145000,” and
“92000,” respectively.
8. In E7 enter “=E5*$B7.” Autofill to H7.
9. In E8 enter “=D5*$B8.” Autofill to H8.
10. In E9 enter “=C5*$B9.” Autofill to H9.
11. In E10 use the autosum bottom from the toolbar. Autofill to H10.
12. In C11 enter “=D5*$B11.” Autofill to H11.
13. In E13 enter “=D11*$B13.” Autofill toH13.
14. In E14 enter “=C11*$B14.” Autofill to H14.
15. In E15 use the autosum bottom. Autofill to H15.

So far we calculate cash inflows and cash outflows for inventory purchases. There are
many other forms of cash outflows. So we need additional inputs.

Input #3: (1) Wages are equal to 20% of sales. (2) Leasing expense is $10000 per month.
(3) Interest payments of $30000 are due in June and September. (4) A $50000 dividend
will be paid in June. (4) Tax prepayments of $25000 will be paid in June and September.
(5) A $200000 capital improvement will be paid in July.

To make a better presentation, we first summarize the cash collections for each month.
Then we calculate total disbursements. This leads to the following worksheet:

Bithlo BBQ
Cash Budget
For the Period June to September 2005
Septembe
April May June July August r October
29100 36500 38700 32900 23800
Sales 0 0 0 0 0 145000 92000
Collections
15480 13160
Cash 40% 0 0 95200 58000
16425 17415 14805
First Month 45% 0 0 0 107100
Second Month 15% 43650 54750 58050 49350
36270 36050 30130
Total Collections 0 0 0 214450
18250 19350 16450
Purchases 50% 0 0 0 119000 72500 46000
Payments
First Month 60% 116100 98700 71400 43500
Second Month 40% 73000 77400 65800 47600
18910 17610 13720
Total Payments 0 0 0 91100

36270 36050 30130

Collections 0 0 0 214450
Less
Disbursements
18910 17610 13720
Inventory Payments 0 0 0 91100
 Wages 20% 77400 65800 47600 29000
Lease Payment 10000 10000 10000 10000
Interest 30000 0 0 30000
Dividend 50000 0 0 0
Taxes 25000 0 0 25000
20000
Capital Outlays 0 0 0 0
38150 45190 19480
Total Disbursements 0 0 0 185100

This is can be found in BBQ2.xls.

Steps:
16. In A17:A26 enter “Collections,” “Less Disbursements,” “Inventory Payments,”
“Wages,” “Lease Payment,” “Interest,” “Dividend,” “Taxes,” “Capital Outlays,” “Total
Disbursements,” respectively.
17. In B20 enter “20%.”
18. In E17 enter “=E10.” Autofill to H17.
19. In E19 enter “=E15.” Autofill to H19.
20. In E20 enter “=E5*$B20”. Autofill to H20.
21. Enter Input #3 (2), (3), (4), and (5) manually.
22. In E26, use autosum. Autofill to H26.

The formula for calculating the ending cash balance is:

Beginning Cash Balance

+ Total Collections
- Total Disbursements
= Unadjusted Cash Balance
+ Current Borrowing
= Ending Cash Balance

Thus, we’d need the June Beginning cash balance (i.e., May ending cash balance).

Input #4: The May ending cash balance is $20000. There is no borrowing in May.

Many firms establish a minimum cash balance requirement.

Input #5: The minimum cash balance requirement is $15,000.

These inputs lead to the following worksheet:

Bithlo BBQ
Cash Budget
For the Period June to September 2005
April May June July August Septembe
 r
29100 36500 38700 32900 23800
Sales 0 0 0 0 0 145000
Collections
15480 13160
Cash 40% 0 0 95200 58000
16425 17415 14805
First Month 45% 0 0 0 107100
Second Month 15% 43650 54750 58050 49350
36270 36050 30130
Total Collections 0 0 0 214450
18250 19350 16450
Purchases 50% 0 0 0 119000 72500 46000
Payments
First Month 60% 116100 98700 71400 43500
Second Month 40% 73000 77400 65800 47600
18910 17610 13720
Total Payments 0 0 0 91100

36270 36050 30130

Collections 0 0 0 214450
Less Disbursements
18910 17610 13720
Inventory Payments 0 0 0 91100
Wages 20% 77400 65800 47600 29000
Lease Payment 10000 10000 10000 10000
Interest 30000 0 0 30000
Dividend 50000 0 0 0
Taxes 25000 0 0 25000
20000
Capital Outlays 0 0 0 0
38150 45190 19480
Total Disbursements 0 0 0 185100
Beginning Cash Balance 20000 15000 15000 121500
Collections - 10650
Disbursements -18800 -91400 0 29350
12150
Unadjusted Cash balance 20000 1200 -76400 0 150850
Current Borrowing 0 13800 91400 0 0
12150
Ending Cash Balance 20000 15000 15000 0 150850
Notes:
Minimum Acceptable Cash 15000

This can be found in BBQ3.xls.

Steps:
23. In A27:A33 enter “Beginning Cash Balance,” “Collections – Disbursements,”
“Unadjusted Cash Balance,” “Current Borrowing,” “Ending cash Balance,” “Notes:,” and
“Minimum Acceptable Cash,” respectively.
24. In B33 enter “15000.”
25. In D29:D30 enter “20000” and “0” respectively.
26. In D31 use autosum. Autofill to H31.
27. In E27 enter “=D31.’ Autofill to H27.
28. In E28 enter “=E17-E26.” Autofill to H28.
29. In E29 enter “Sum(E27:E28).” Autofill to H29.
30. In E30 enter “If(E29<$B33,$B33-E29,0).” Autofill to H30.

The If condition is specified as If(A,B,C). That is, the value of the active cell depends on
A. If A is met, the value of the cell is B; otherwise, the value of the cell is C.

Based on the cash budget, you know that you need to borrow $413800 and $91400 in
June and July, respectively. The rather large amount of borrowing in July is mainly due
to the capital outlay of $200000. Overall, this exercise gives us a lead time to prepare
financing.

III. What If?

Now, what if you are flexible on the scheduling of the capital outlay of $200000? Can
you time it so that you can reduce the amount of financing? What if the capital outlay
occurs in August?

By manually changing this input on the worksheet, we have the following new result:

Bithlo BBQ
Cash Budget
For the Period June to September 2005
Septembe
April May June July August r
29100 36500 38700 32900 23800
Sales 0 0 0 0 0 145000
Collections
15480 13160
Cash 40% 0 0 95200 58000
16425 17415 14805
First Month 45% 0 0 0 107100
Second Month 15% 43650 54750 58050 49350
36270 36050 30130
Total Collections 0 0 0 214450
18250 19350 16450
Purchases 50% 0 0 0 119000 72500 46000
Payments
First Month 60% 116100 98700 71400 43500
Second Month 40% 73000 77400 65800 47600
18910 17610 13720
Total Payments 0 0 0 91100

36270 36050 30130

Collections 0 0 0 214450
Less Disbursements
18910 17610 13720
Inventory Payments 0 0 0 91100
Wages 20% 77400 65800 47600 29000
Lease Payment 10000 10000 10000 10000
Interest 30000 0 0 30000
Dividend 50000 0 0 0
Taxes 25000 0 0 25000
20000
Capital Outlays 0 0 0 0
38150 25190 39480
Total Disbursements 0 0 0 185100
12360
Beginning Cash Balance 20000 15000 0 30100
Collections - 10860
Disbursements -18800 0 -93500 29350
12360
Unadjusted Cash balance 20000 1200 0 30100 59450
Current Borrowing 0 13800 0 0 0
12360
Ending Cash Balance 20000 15000 0 30100 59450
Notes:
Minimum Acceptable Cash 15000

This can be found in BBQ4.xls.

As you can see, there is no need to finance $91400 in July anymore. This exercise shows
that the cash budget can be useful for timing expenditures.

IV. A Refined Cash Budget

Now let’s review the worksheet in BBQ3.xls. If the capital outlay of $200000 occurs in
July, there would be considerable amounts of borrowing that would require interest
payments. At the same time, there would be considerable amounts of cash balances for
some months as well. The firm could lend or invest some of the balances and earn some
returns. These activities have impacts on the cash budget and we’d like account for them
in this section. To do so, we need to have more inputs (assumptions).
Input #6: (1) Pecking orders: (a) the firm will first sell any existing short-term
investments before borrowing, (b) the firm will first reduce its outstanding borrowing
before investing. (2) The firm will invest in any cash in excess of $40,000. (2) The return
of cash investment is 6% per annum. (3) The borrowing rate is 8%.

Bithlo BBQ
Cash Budget
For the Period June to September 2005
Septembe
April May June July August r
36500 38700 32900
Sales 291000 0 0 0 238000 145000
Collections
15480 13160
Cash 40% 0 0 95200 58000
16425 17415
First Month 45% 0 0 148050 107100
Second Month 15% 43650 54750 58050 49350
36270 36050
Total Collections 0 0 301300 214450
19350 16450
Purchases 50% 182500 0 0 119000 72500 46000
Payments
First Month 60% 116100 98700 71400 43500
Second Month 40% 73000 77400 65800 47600
18910 17610
Total Payments 0 0 137200 91100

36270 36050
Collections 0 0 301300 214450
Less Disbursements
18910 17610
Inventory Payments 0 0 137200 91100
Wages 20% 77400 65800 47600 29000
Lease Payment 10000 10000 10000 10000
Interest 30000 0 0 30000
Short-Term Interest
(Return) 0 92 701.9467 0
Dividend 50000 0 0 0
Taxes 25000 0 0 25000
20000
Capital Outlays 0 0 0 0
38150 45199
Total Disbursements 0 2 195501.9 185100
Beginning Cash Balance 20000 15000 15000 15506.05
Collections - -18800 -91492 105798.1 29350
 Disbursements
Unadjusted Cash balance 20000 1200 -76492 120798.1 44856.05
Current Borrowing 0 13800 91492 -105292 0
Current Investing 0 0 0 0 4856.053
Ending Cash Balance 20000 15000 15000 15506.05 40000
Cumulative Borrowing 10529
(Investing) 0 13800 2 0 -4856.05
Cumulative Interest
Expense 0 92 793.9467 793.9467
Notes:
Minimum Acceptable Cash 15000
Maximum Acceptable
Cash 40000
Borrowing Rate 8% Monthly 0.67%
Investment Return 6% Monthly 0.50%

This can be found in BBQ5.xls.

Steps:
31. Select A23. Insert a new row. In A23 enter “Short-term Interest (Return).”
32. Select A32. Insert a new row. In A32 enter “Current Investing.”
33. Select A34. Insert a new row. In A34 enter “Cumulative Borrowing (Investing).”
34. Select A35. Insert a new row. In A35 enter “Cumulative Interest Expense.”
35. In A38:B38 enter “Maximum Acceptable Cash” and “40000,” respectively.
36. In A39:C39 enter “Borrowing Rate,” “8%,” and “Monthly,” respectively.
37. In A40:C40 enter “Investment Return,” “6%,” and “Monthly,” respectively.
38. In D39 enter “=B38/12.”
39. In D40 enter “=B40/12.”
40. In D34 enter “=C34+D31-D32.” Autofill to H34.
41. In E23 enter “=If(D34>0, D34*$D39,D34*D40).” Autofill to H23.
42. In E35 enter “=D35+E23.” Autofill to H35.
43. Replace the formula in E31 with “=IF(E30<$B37,IF(D34<0,MAX($B37+D34-
E30,0),$B37-E30),IF(D34>0,-MIN(D34,E30-$B37),0)).” Autofill to H31.
44. Replace the formula in D33 as “=Sum(D30:D31)-D32.” Autofill to H33.
45. In E32 enter “=IF(AND(E30+E31<$B37,D34<0),E30+E31-
$B37,IF(E30+E31>$B38,E30+E31-$B38,0)).” Autofill to H32. Autofill to D32.

The logic in Step 43 is:

If Unadjusted Cash < Minimum Cash {i.e., the firm needs to raise funds}
If Cumulative Borrowing (Investing) < 0 {i.e., the firm has investments it can
sell}
Current Borrowing (Investing) = Maximum (Minimum Cash +
Cumulative Borrowing (Investing) – Unadjusted Cash, 0)
Else
Current Borrowing = Minimum Cash – Unadjusted Cash
 End
Else
If Cumulative Borrowing (Investing) > 0 {Use excess funds to reduce previous
borrowings}
Current Borrowing = -1 * Minimum(Cumulative Borrowing (Investing),
Unadjusted Cash-Minimum Cash)
Else
Current Borrowing = 0
End
End

This leads to the formula in E31:

=
IF(E30<$B37,
IF(D34<0,MAX($B37+D34-E30,0),$B37-E30),
IF(D34>0,-MIN(D34,E30-$B37),0)
)

where MAX and MIN return the largest and the smallest of the supplied arguments.

The logic in Step 45 is:

If (Unadjusted Cash + Current Borrowing < Minimum Cash) And (Cumulative

Borrowing (Investing) < 0 {the firm sells some investments)
Current Investing = Unadjusted cash + Current Borrowing – Minimum Cash
Else
If Unadjusted Cash + Current Borrowing > Maximum Cash (the firm invest the
excess)
Current Investing = Unadjusted cash + Current Borrowing – Maximum
Cash
Else
Current Investing = 0
End
End

This leads to the formula in E32:

=
IF(AND(E30+E31<$B37,D34<0),
E30+E31-$B37,
IF(E30+E31>$B38,E30+E31-$B38,0)
)
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Homework:

Please work on Problem #3 (only part a), pp. 187-188 (Idaho Springs Hardware). This
individual assignment is due Nov. 14.
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