Cash Budget

It is important to mention that sales and income generation may not

necessarily mean that there is sufficient cash on hand to meet the financial
debts of the entity. Credit sales or charge sales generate revenue however, this
transaction does not generate immediate cash. Because of this, we need to
translate the pro-forma income statement into cash flow. This can be done by
dividing the budgeted income statement into smaller time frames in order to
appreciate monthly trend of net cash flows. The net cash flow is the difference
between cash inflow and cash outflow. This is presented in the comprehensive
example in the next slide.

In so far as cash outflow is concerned, the usual items that should be

taken into consideration would be the payments made for inventory
acquisition, payment of labor and overhead costs, selling and administrative
expenses, interest expense, taxes and dividends.
Comprehensive Example for Pro-Forma Income Statement (adopted from
Block and Hirt):
Assume you are tasked to prepare the pro-forma financial statement
of Ocin Corporation, June 30, 2020. Ocin Corporation is the leading
producer and seller of DVD and Blue Ray players in the market. Consider
the assumed figures below to facilitate the preparation of the pro-forma
financial statement.

Step 1: Estimate Sales

Table 1
Assumed Projected Sales of DVD and Blue Players (first 6 months of 2020)
DVD Blue Ray Total
Estimated Sales Volume 300 units 600 units
Estimated sales price/unit P2,000 P3,000
Sales revenue P600,000 P1,800,000 P2,400,000
 Based on the given data, the total sales forecast is
P2,400,000(P600,000 + P1,800,000). Let us assume that the
method used by the company in forecasting sales is the sales
trend analysis.

Step 2: Estimate Number of Units to be Produced and the Gross

Profit.

Based on the estimated sales in step 1, we now determine the

number of units we need to produce to bring about the sales
estimates. In order to determine the number of units we need to
produce, we need the beginning inventory or both players. Let us
assume the given found in table 2.
 Table 2
Assumed Stock of Beginning Inventory
DVD Blue Ray Total
Beginning Inventory 26 units 54 units
Cost per unit P1,067 P1,714
Total Costs P27,742 P92,556
Desired Ending Inventory (10% of 30 units 60 units
estimated sales volume – see table 1)
Table 3
Computation of estimated number of units to produce
DVD Blue Ray
Estimated Sales Volume 300 units 600 units
Desired Ending Inventory 30 units 60 units
Less: Beginning Inventory 26 units 54 units
Estimated Units to be produced 304 units 606 units
 After computing the estimated number of units to be produced, we now
compute for the cost of the estimated number of units to be produced.
Assume the given in table 3.
Table 4
Assumed Cost per unit

DVD Blue Ray

Raw Material cost/unit P 567 P 629
Direct Labor cost/unit 867 1,214
Overhead cost/unit 200 243
Total production cost/unit P1,634 P2,086

Table 5
Computation of Estimated Production Costs

DVD Blue Ray Total

Total production cost/unit P1,634 P2,086
Multiplied by estimated units to be produced 304 units 606 units
Total Production Costs P496,736 P1,264,116 P1,760,852
 After computing the production cost, we now compute the Cost of Goods Sold
and Gross Profit that FIFO is used in costing the company’s inventory.
Table 6
Computation of Cost of Cost of Good Sold and Gross Profit
DVD Blue Ray Total
Sales revenue P600,000 P1,800,000 P2,400,000
Less: Cost of Gods Sold
Beginning Inventory
(see table 2) 27,742 92,556 120,298
Ending Inventory
(remainder)
DVD:
300 units – 26 units
= 274 units x P 1634/unit (see Table 4)

Blue Ray: 447,716

600 units – 54 units
= 546 units x P 2,086 1,138,956 1,586,672
Cost of Goods Sold 475,458 1,231,512 1,706,970
Gross Profit P 124,542 P 568,488 P 693,030
 The portion of the ending inventory is derived by
getting the total number of units sold and
subtracting the beginning inventory. The difference is
actually the amount of the sales that has been taken
from the current purchases. For the DVD player, 300
units is to be sold, deduct from this the 24 units
which was from last year’s inventory, the result of
274 units pertains to the number of units sold taken
from the current purchases. Multiply to this the
production cost/unit of P1,634 you will have the cost
of the units sold taken from the current purchases
amounting to P447,716. Add to this the beginning
inventory and you will have the cost of goods sold for
the DVD player.
 Table 7
Computation of the cost of ending inventory

Beginning Inventory (Table2) P120,298

Production costs (Table 5) P1,760,852
Total Goods Available for Sale 1,881,150
Less: Cost of Goods Sold 1,706,970
Ending Inventory P 174,180
Step 3: Create the Pro-Forma Income Statement
Table 8
Ocin Corporation
Pro-Forma Income Statement
For the 6-month Period Ended June 30, 2020
Sales P2,400,000
Less: Cost of Goods Sold 1,706,970
Gross Profit P 693,030
Less: Selling and Administrative Expenses (assumed figures) 350,000
Net income before finance charges 343,030
Less: Interest Expense (assumed figure) 12,000
Net income before taxes 331,030
Less: Income tax (35%) 115,861
Net income after tax P215,169
Cash Dividends (assumed) 15,000
Increase in Retained Earnings P200,169
Step 4: Prepare the Cash Budget

Assumptions and computations on cash receipts:

1. All sales are credit sales. The P2,400,000 estimated sales is divided into 6
months
2. Based on historical data, 20% of the credit sales are collected in the
month of sale and 80% is collected in the following month.
3. Assume the following monthly sales revenue of Ocin Corporation:

Estimated January February March April May June

Sales P360,000 P240,000 P360,000 P600,000 P360,000 P480,000

4. December 31, 2019 sales is P288,000

 Table 9
Summary of Monthly Cash Receipts

December January February March April May June

Sales P288,000 P360,000 P240,000 P360,000 P600,000 P360,000 P480,000

Collection
20% of current sales 72,000 48,000 72,000 120,000 72,000 96,000
{
80% previous 230,400 288,000 192,000 288,000 480,000 288,000
month’s sales
Total P302,400 P336,000 P264,000 P408,000 P552,000 P384,000

Note: The total cash receipts is the sum of the total collection. Sales are NOT PART of the
computation of the cash receipts. Sales were placed in the summary ONLY TO SHOW the
source in computing the collections.
 Assumption and Computations made on cash payments
Table 10
Computation of the composition of production costs:

DVD Player Blue Ray Player

Unit Unit costs Total costs Unit Unit costs Total costs Combined Cost
Material 304 P 567 P172,368 606 P 629 P381,174 P553,542
Labor 304 867 263,568 606 1,214 735,684 999,252
Overhead 304 200 60,800 606 243 147,258 208,058
P1,760,852

The units and unit costs are taken from the Table 3 and Table 4 respectively. The total
cost = Units x Unit costs. The combined cost is equal to the total cost of DCD and total costs
of Blue Ray players.
 Table 11
Computation of the Average monthly production costs

Total costs Time frame Average monthly costs

A B C = A/B
Materials P553,542 6 months P 92,257
Labor 999,252 6 months 166,542
Overhead 208,058 6 months 34,676

The total cost is taken from Table 10. The average monthly cost is derived by dividing total
costs by the time frame
 Assume that the December 31, 2019 raw material
purchases is P75,500. Assume further that all raw
material purchases are on credit and that full payment
is made a month after the purchase. All expenses will
also be divided equally for 6 months. They are paid on
the month they were incurred. The 6-month income tax
due shall be paid in two installments (March and June).
This is also true with dividends, labor and overhead.
Dividends shall be paid on June 2020. A new
equipment will be acquired for cash amounting to
P5,000 in February 2020 and P8,000 in June2020.
 Table 12
Summary of the Monthly Cash Payments (in Php)

December January February March April May June

Monthly RM purchases 75,500 92,257 92,257 92,257 92,257 92,257 92,257
(Table 11)
Pay’t for material 75,500 92,257 92,257 92,257 92,257 92,257
Labor (Table 11) 166,542 166,542 166,542 166,542 166,542 166,542
Overhead (Table 11) 34,676 34,676 34,676 34,676 34,676 34,676
Selling and Administrative 58,333 58,333 58,333 58,333 58,333 58,333
Expenses (Table 8)
Interest Expense(Table 8) 2,000 2,000 2,000 2,000 2,000 2,000
Income Tax (Table 8) 57,930 57,930
Cash Dividends (Table 8) 15,000
New Equipment
acquisition 5,000 8,000
Total 337,051 358,808 411,738 353,808 353,808 434,738
 Table 13
Monthly Cash Flow
January February March April May June
Total Receipts (table 9) P302,400 P336,000 P264,000 P408,000 P552,000 P384,000
Total Payments (Table 12) 337,051 358,808 411,738 353,808 353,808 434,738
Net Cash Flow P(34,651) P(22,808) P(147,738) P54,192 P198,192 P(50,738)

The main purpose for cash budget is to aid management in anticipating the need for
outside funding at the end of each month. In this example, let us assume that the company
desires to keep a minimum cash balance of P200,000 at all times. If the cash balance goes
below the minimum level, the firm will borrow funds from the bank. If the cash balance goes
above the minimum level and it still has loan outstanding from the bank, the company will
use the excess cash to pay the loan. Let us further assume that in January 1, 2020, the
beginning cash balance is P200,000 practice in Table 14
 Table 14
Cash Budget (Including borrowing and repayment)
January February March April May June
Net Cash Flow P (34,651) P (22,808) P(147,738) P 54,192 P 198,545 P (50,738)
Beginning cash balance 200,000 200,000 200,000 200,000 200,000 200,000
Cumulative Cash balance 165,349 177,192 52,262 254,192 398,545 196,802
Monthly loan (repayment) 34,651 22,808 147,738 (54,192) (151,005) 3,198
Cumulative loan balance 34,651 57,459 205,197 151,005 0 3,198
Ending Cash balance P200,000 P200,000 P200,000 P200,000 P247,540 P200,000

Now let us start to analyze the January column of the cash budget. The
net cash flow based on Table 13 is P(34,651), we then added this to the
beginning balance of cash of P200,000. The difference is P 165,349. Now this
cash balance is below P200,000. Based on the assumption, the company
maintains P200,000 cash balance at all times this is their company policy. In
order for them to make their cash balance of P165,349 to P200,000 the
company borrowed money from the bank amounting to P22,808 (P200,000 –
required minimum balance MINUS P165,349 actual cash balance). By
Borrowing P22,808 the cash balance now of the company is P200,000, which
is required minimum balance. The cumulative loan balance of P 34, 651 is the
monthly loan balance of P34,651 plus the cumulative loan balance of zero.
This is zero because before the company borrowed, it has no loan balance yet.
The ending cash balance of P200,000 is the result of adding the cumulative
cash balance of P165,349 plus the monthly loan balance of P34,651

Looking at the February column, the beginning cash balance of

P200,000 is the ending cash balance of January. The net cash flow based on
Table 13 is P(22,808), we then added this to the beginning balance of cash in
February if P200,000. The difference is P177,192. Now this cash balance is
below P200,000. Based on the assumption, the company maintain P200,000
cash balance at all times. This is their company policy. In order for them to
make their cash balance of P177,192 to P200,000 the company borrowed
money from the bank amounting to P22,808 (P200 – required minimum
balance MINUS P177,192 actual cash balance). By borrowing P22, 808 the
cash balance now of the company is P200,000, which is the required
minimum balance. The cumulative loan balance of P57,459 is the monthly
loan balance of P22,808 plus the cumulative loan balance of P34,651. The
ending cash balance of P200,000 is the result of adding the cumulative cash
balance P177,192 plus the month loan balance of P22,808.

Notice that the explanation for the February column figures is almost
exactly the same as January column. The cycle goes on to March. HOWEVER,
if you look at April column figures, the net cash low of P54,192 added to the
beginning cash balance of April of P200,000give you cumulative cash balance
of P254,192. This greater than P200,000 which the minimum required cash
balance. Based on the assumption give which is the company policy, any
excess of the cash balance to the required minimum balance SHALL BE USED
TO PAY any loan balance outstanding. Therefore P54,192 was used to pay the
cumulative loan balance of P205,197 for the March column. This would make
the cumulative loan balance of April to P151,005. The same explanation for
April will be used to explain the May column figures.
Pro-Forma Statement of Financial Position (SFP)

In creating the current pro forma statement of financial

position, the following statement are needed.
1. Pro-forma income statement
2. Pro-forma cash budget
3. Prior period pro-forma statement of financial position

In continuing the comprehensive example of the pro-forma

income statement, we shall assume the prior period SFP on the
next slide.
 Ocin Corporation
Statement of Financial Position
December 31, 2019
Current Asset
Cash and Cash Equivalents P200,000
Trade Securities 128,000
Trade & Other Receivables 230,400
Inventory (Table 2) 120,298
Total Current Assets 678,698
Non-Current Asset
Property, Plant and Equipment 827,680
Total Assets P1,506,378
Liabilities and Shareholders’ Equity
Accounts Payable P75,500
Notes Payable 0
Loan Payable – long-term 447,440
Ordinary Shares 316,340
Retained Earnings 667,098
Total Liabilities & Shareholders’ Equity P1,506,378
 Items in the pro-forma income statement and cash
budgets have effects on some of the items in the pro-forma
SFP for June 30, 2020. The items in projected SFP are
derived from the different tables found in the
comprehensive example. See on the next slide.
 Ocin Corporation
Pro-Forma Statement of Financial Position
December 31, 2019
Current Asset
Cash and Cash Equivalents (Table 14) P 200,000
Trade Securities (assumed) 127,000
Trade & Other Receivables (480,000 x 80%) 284,000
Inventory (Table 2) 174,180
Total Current Assets P 886,698
Non-Current Asset
Property, Plant and Equipment 840,680
Total Assets P1,725,860
Liabilities and Shareholders’ Equity
Accounts Payable (Table 12) P92,257
Notes Payable (Table 14) 3,198
Loan Payable – long-term (assumed) 447,440
Ordinary Shares (assumed) 316,340
Retained Earnings 866,625
Total Liabilities & Shareholders’ Equity P1,725,860
 The trade and other receivables is 80% of the credit
sales (P480,000) for June 2020. The accounts payable is
the June purchases found in Table 12. The ordinary
shares could be accounted for as additional subscriptions.
The retained earnings is a derived figure in creating the
SFP. The retained earnings could be accounted for by the
various adjustments (net income dividends, and other
prior period adjustments) made to the account. Let us
assume that after all the adjustments the resulting
retained earnings amounted to P866,625.
Percentage-Of-Sales Method

Another method by which forecasting can be done is through the use of

the percentage-of-sales-method. Under this method, the financial forecaster
assumes that the accounts found in the SFP have a percentage relationship
with the company’s sales revenue account. Gillian presents the SFP based on
the assumed projected sales of P750 million. It is important to note that even
under this method, it is still important to project sales before all other
forecasting is done.
 Gillian Corporation
Statement of Financial Position
& Corresponding Percentage of Sales
(In Thousand Pesos for the Value)

Value Percent of Sales

P750,000
Cash & Cash Equivalent P15,000 2
Trade and other Receivables 120,000 16
Merchandise Inventory 75,000 10
Property, Plant & Equipment 150,000 20
Total Assets P360,000 48

Trade and Other Payables 120,000 16

Accrued Payable 30,000 4
Loans Payable 45,000 6
Ordinary Shares 30,000 4
Retained Earnings 135,000 18
Total Liabilities & Shareholders’ Equity P360,000 48
 The 15 million cash balance is assumed to represent 2% of
projected sales. The trade and other receivables of P120 million is 16% of
projected sales. This is true with the other accounts.
It is noticeable that the loans payable, ordinary shares and retained
earnings do not have corresponding percentages. This is so because
Gillian does not assume that these account have direct relationship with
sales. We could also infer based on the figures above that increase in
sales will require a 46% increase in Gillian’s total assets. Twenty percent
(16% + 4%) of such an increase in assets would be financed by trade and
other payables and accrued payables. Twenty eight percent (28% - 20%)
would be financed by income ( retained earnings) and by other means of
financing (making borrowing or issuance or ordinary shares).
Let us assume that Gillian’s net profit ratio (NPR) is 5% and that
40% of the profit is used to pay dividends to shareholders this is dividend
payout ratio (DPR). If Gillian is to increase sales to P900 million, Gillian
will need additional funding of about 42 million [(900 mill – P750 mil) x
28%)]. The twenty eight percent is derived by subtracting 20% (liability
ratio) from 48% (asset ratio). The net profit for Gillian under this
assumption would be P45 million [(P750m + P150m) x 5%]. The
dividends paid from this sales level is P18 million (P45m x 40%).
The formula used to compute for the Required New Fund (RNF) is:

RNF = Asset ratio (sales) – Liability ratio (sales) – NPR (new sales) x DPR
= [48%(P150mil)] – [20%(P150mil)] – [5%(P900mil] x 40%
= P24 million

Or

RNF = P42 million – P18million = 24 million

We could presume that the P24 million would be financed through

loans and other sources.

Although this method is much easier than the pro-forma statement

method, the result form this is less precise. The detail in so far as month-to-
month values of cash flows are not provided under this method.