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AUTONOMOUS GROUP LEARNING













FINANCIAL MANAGEMENT OF


WORKING CAPITAL


















Programme Learning Text


























Copyright
: RGAB

2007/1




CONTENTS



Page


Analysis of financial statements

Frame 1

1

Frame 2

14

Frame 3

26



Management of short
-
term cash


Frame 4

41

Frame 5

51



Funds flow


Frame 6

63

Frame 7

69



Management of long
-
term funds


Frame 8

76

Frame 9

84

Frame 10

91


Investment of surplus funds


Frame 11

107

Frame 12

113

Frame 13

123

Frame 14

127

Frame 15

132



APPENDIX A


GLOSSARY








136



APPENDIX B
-

OPTIONAL QUIZ ON FINANCIAL ARITHMETIC




158


ANALYSIS OF FINANCIAL STATEMENTS




FRAME 1








All analyses of accounting data involve comparisons. An absolute statement, such as “X
Company earned $1 mil
lion profit,” is, by itself, not useful. It becomes useful only when the $1 million
is compared with something else. The comparison may be quite imprecise and intuitive.




In general terms, the process of analysis can be described as one of comparing what

actually
happened with a
standard
.
A standard is a measure of what should have happened under the
circumstances prevailing.







































-
P1
-

BUSINESS OBJECTIVES




In order to decide the types of comparisons that are useful, we
need first to consider what
business is all about
-

what its objectives are
-

for the comparisons are essentially intended to shed
light on how well business is achieving objectives. As a generalization, it may be said that
insofar as it
can be measured qu
antitatively, the overall the objective of a business is to earn a satisfactory return
on the funds invested in it, consistent with maintaining a sound financial position.




The foregoing statement of objectives has two aspects:



1.

Earning a satisfactor
y return on its investment.



2.

Maintaining a sound financial position.




Return on Investment.

The return
-
on
-
investment measure is used in two senses:



1.

The return on shareholders’ investment.



2.

The return on total investment.



This topic is cove
red in more detail later.






























-
P2
-


Sound Financial Position.

In addition to a desiring a satisfactory return the investor expects
that his capital will be protected from more than a normal amount of risk.



The return on the
shar
eholder’s

investment could be increased if a larger proportion of the
investment came from long
-
term liabilities and net income remained unchanged. This move, however,
would increase the shareholders’ risk of losing their investment, since the interest cha
rges and
principal repayments on the long
-
term liabilities are fixed obligations and failure to make these
payments when due could throw the company into bankruptcy.



The degree of risk in a situation can be measured in part by the relative amounts of var
ious
types of liabilities and of the funds available to discharge them, and this also involves the use of
ratios.












































-
P3
-

SOME COMMON RATIOS




A ratio is simply one number expressed in terms of another.

It is found

by dividing one
number, the base, into the other.
A percentage is one kind of ratio in which the base is taken as
equaling 100 and the quotient is expressed as “per hundred” of the base.



Dozens of ratios can be computed from a single set of financial st
atements, but usually only a
few are helpful in a given situation. Thus, although many frequently used ratios are described below,
the best analytical procedure is not to compute all of them mechanically but rather to decide first
which ratios might be rel
evant in the particular type of investigation being made and then to compute
these, and only these, ratios.




Financial ratios can be grouped loosely into four categories:



1.

Tests of
profitability
.



2.

Tests of
liquidity
.



3.

Tests of
solvency
.



4.

Overall

ratios.


































-
P4
-


Since the balance sheet figures refer to one instant in time while the income statement figures
refer to events over a period of time, care must be taken in calculating ratios that use amounts from
bo
th statements. For many purposes, the income statement figure is best compared to the
average

of
the balance sheet figure.



1.

Tests of Profitability.

The gross profit percentage indicates the average mark
-
up or
margin obtained on products sold.

Since it
is an average, it does not necessarily represent the mark
-
up on Individual products, and these may differ widely from the average.


















































-
P5
-


The net income percentage is a measure of overall profitability.

This

measure is also referred
to as the
return on sales

or the
profit percentage.

Some people, particularly critics of a given industry
or company, treat this as if it were the more important single measure of performance. This is
erroneous, because net income

considered by itself does not take into account the assets employed
to produce that income.



2.

Tests of Liquidity.

Liquidity refers to the company’s ability to meet its current
obligations.

The liquidity ratios therefore have to do with the size and rel
ationships of current liabilities,
which are the obligations soon coming due, and current assets, which presumably provide the source
from which these obligations will be met.















































-
P6
-

CURRENT RATIO







s
Liabilitie

Current
Assets
Current





The
current ratio

is the most commonly used of all balance sheet ratios. Is is not only
a
measure of the company’s liquidity

but also is
a measure of the margin of safety

that management
maintains in order to allow for the inevitable un
evenness in the flow of funds through the current asset
and liability accounts. Since a company rarely can count on an even flow of funds, it needs a supply of
liquid funds to be assured of being able to pay its bills when they come due. The current ratio
indicates the size of this buffer.








































-
P7
-

QUICK RATIO OR ACID
-
TEST RATIO










s
Liabilitie

Current
Assets
Quick







Quick assets include cash, temporary investments held in lieu of cash, and current accounts
and notes rece
ivable.
Presumably, these items can be converted into cash quickly and at
approximately their stated amounts, unlike inventory, which is the principal current asset excluded.
The acid
-
test ratio,

or
quick ratio,

is therefore
a measure of the extent to whic
h liquid resources are
immediately available to meet current obligations.




































-
P8
-

RECEIVABLES TO SALES










Sales

Net
(Net)

s
Receivable






If available, the base should be net
credit

sales, which is of course more closely

related to
accounts receivable than is total sales. Sometimes
average

accounts receivable is used as the
numerator, but attention is more properly focused on the year
-
end figure. Receivables include trade
accounts receivable plus trade notes receivable.



Collection Period.
This is derived from the preceding ratio:





Receivables to Sales

X

Days in the Period

=

Collection Period
























-
P9
-


The collection period can be related roughly to the credit terms offered by the company. A
rule of

thumb is that the collection period should not exceed 1 1/3 times the regular payment period;
payment in 30 days, it is said that the average collection period should not exceed 40 days. Changes
in the ratio indicate changes in the company’s credit policy

or changes in its ability to collect its
receivables.






















































-
P10
-

INVENTORY TURNOVER







Inventory

Average
Sales

of

Cost







Inventory turnover is an indication of the velocity with which merchandise moves throu
gh the
business.

An increase in the absolute size of inventory, for example, may represent the additional
stocks required by an expanding business, or it may represent an accumulation of merchandise
because sales volume has recently declined. In the latter

case, the inventory turnover will decrease. A
decrease in the inventory turnover ratio may therefore be a significant danger signal.







































-
P11
-

State whether each of the following is true of false.


___1.

An accounting fi
gure is most useful when it is compared with another figures.



___2.

The gross profit percentage indicates the “mark
-
on” on individual products sold by the

business.


___3.

The current ratio is probably the most frequently used balance sheet ratio.


___4
.

Inventory is. excluded from the calculation of the “quick” or “acid
-
test” ratio.


___5.

The collection periods of all companies are uniform.


___6.

The number of times the inventory “turned
-
over” (was sold) during the period may be

calculated by dividin
g sales by the average inventory.



Check your answers on the next page.





































-
P12
-

ANSWER FRAME 1.




1.

True. Meaningful analyses of accounting data involve comparisons.


2.

False. The gross profit percentage indicates the

average mark
-
up obtained on
products sold; it does not necessarily equal the mark
-
up on individual products.



3.

True. The most frequently used balance sheet ratio is probably the current ratio.


4.

True. The “quick” or “acid
-
test” ratio is intended to m
easure the immediate liquidity
(without incurring a loss), it is excluded from the calculation (as are prepaid
expenses).


5.

False. The collection period is related to such things as the credit terms offered by the
company which vary widely among firms.


6.

False. The inventory turnover is calculated by dividing the
cost of goods sold
, not
sales, by the average inventory.


If you missed more than one of the above, reread Frame 1. before turning to Frame 2. on
p.14.
































-
P13
-

FRA
ME 2




3.

Tests of Solvency. As liquidity refers to current obligations, solvency refers to a
company’s ability to meet the interest costs and repayment schedules associated with its long
-
term
obligations.



Equity Ratios.

The division of equities among c
urrent liabilities, long
-
term liabilities, and
owners’ equity has an important bearing on solvency.



The most important of the equity ratios are those showing the relationship between
debt
capital

and
equity capital
. Debt capital is another name for liabi
lities. From the point of view of the
company, debt capital is risky because if bondholders and other creditors are not paid promptly, they
can take legal action to obtain payment which can, in extreme cases, force the company into
bankruptcy. Equity capit
al is much less risky to the company because common shareholders receive
dividends only at the discretion of the directors.








































-
P14
-


From the company’s standpoint, the greater the proportion of its capital that is obta
ined from
shareholders, the less worry the company has in meeting its fixed obligations; but in return for this
lessened worry, the company must expect to pay a higher overall cost of obtaining its capital.
Conversely, the more funds that are obtained from

bonds, the more the company can
trade on the
equity

that is, it can use funds obtained at relatively low interest rates in the hopes of earning more on
these funds for the stockholders.


A company with a high proportion of bonds is said to be highly lever
aged.

The equity ratio shows the
balance that the management of a particular company has struck between these forces.
















































-
P14a
-


Times Interest Earned.






Operating Profit






Debenture or Bond Interest



The

numerator of this ratio is the amount of earnings available to meet the fixed obligation of bond
interest. This ratio
is a measure of the level to which income can decline without impairing the
company’s ability to meet interest payments on its fixed liab
ilities.

Income is taken before income
taxes because if income declined, income taxes would decline proportionately. The ratio implies that
net income is equivalent to additional cash, which is not necessarily the case, of course.



If preferred stock is o
utstanding, a similar coverage ratio can be computed for the preferred
stock dividends, but here the numerator is income after taxes and after interest charges.



A company may have fixed obligations in addition to its interest payments, as, for example,
w
hen it has rental commitments on leased property. In such a case coverage is properly computed by
adding these other obligations to the amount of interest. The ratio is then labeled “Times Fixed
Charges Earned”.































-
P15
-

4.

Over
all Measures.




Return on Investment.

This ratio may be expressed in several ways.
From the viewpoint of
the shareholders, it is the return on shareholders’ investment:





Equity

rs
Shareholde

Average
Income

Net



In computing the average shareholders’ equity, a simple
average of the beginning and ending figures
should not be used if additional equity funds were obtained and put to use at other than the middle of
the year. New funds obtained near the end of the year, for example, might well be excluded from the
denominat
or of the fraction because the income in the numerator did not arise from the use of these
funds.







































-
P16
-


Return on total investment looks at income in relation to the total of the permanent funds
invested in the enter
prise.

These permanent funds consist of shareholders’ equity plus noncurrent
liabilities; or the same figure may be found by subtracting current liabilities from total assets. The
earnings on these funds are usually taken as net income before income taxes,

plus interest on
noncurrent liabilities. The ratio is as follows:





s
Liabilitie
Capital
Fixed

Average
Equity

Average
Profit

Operating





The return
-
on
-
total
-
investment ratio is a measure of how well management has used all the
permanent funds entrusted to the business.




For many purposes, esp
ecially for comparing one division of a company with another division,
return on investment is best figured on the basis of
gross assets
, which means working capital plus
fixed assets at cost but with no deduction for accumulated depreciation.



































-
P17
-


Return on investment can be calculated in another manner which, although it is longer and
gives the same result, is often more illuminating. Two subsidiary ratios,
investment turnover

and
operating profit on sales
, are calcula
ted first. Investment turnover is as follows:
-








Sales



Equity Capital + Fixed Liabilities

=

Investment Turnover



Then:


Investment Turnover

X

Operating Profit Ratio

=

Return on Investment
































-
P18
-

Many consider this to
be the most useful way of looking at the overall performance of a business.
It
shows that performance can be improved either by generating more sales volume per dollar of capital
employed or by increasing the profit margin on each sales dollar generated.



Market Tests.

Persons who study the financial statements of companies as a basis for
deciding where to invest their funds may use any of a number of other ratios in addition to those
already listed. Some of these are mentioned on the next page.



















































-
P19
-

Earnings per Share.





g
Outstandin

Shares
Income

Net




Earnings per share is usually the most important single ratio for the investor
. He watches
changes in this ratio from year to year and also uses it to apprais
e the market price of the stock.



Price
-
Earnings Ratio
.
The price
-
earnings ratio

is based on the average market price of the
stock; the ratio is as follows:









P/E ratio =


































-
P20
-

Share

per

Earnings
Share

Per

Price

Market
Turning this ratio upside down gives
the
capitalization rate
, the rate at which the stock market is
apparently
capitalizing the

value of current earnings:






Share

per

price

Market
Share

per

Earnings







Yield.

The
yield
, or more properly the
dividends yield

is based on dividends declared during
the year.
The ratio is as follows:






Share

per

Price
Share

per

Dividends


































-
P21
-


The yield on stocks is often compared with the yield, or interest, on bonds, but such a
comparison is not valid. This is because the earnings of bondholders cons
ist entirely of their interest,
whereas the earnings of stockholders consist not only of their dividends but also of retained earnings.
Although stockholders have no guarantee that they will receive retained earnings, the fact that part of
the net income h
as been retained in income
-
producing assets should enhance the value of the
stockholders’ investment.



These points will be elaborated later in this programme, in relation to investment of surplus
funds, so make sure that you fully understand which has be
en said so far.
















































-
P22
-

True or False?



____1.

Solvency refers to the ability of the company to meet its current obligations.



____2.

In general, a company’s debt capital is “safer” than its equity capital.



____3.

Equity capital is generally more expensive to the firm than funds provided by debt.



____4.

The various return on investment ratios are overall measures of performance.



____5.

Earnings per share is usually the most important single ratio to the
investor.



____6.

The price
-
earnings ratio is calculated by dividing earnings per share by the market price per
share.



Go to Answer Frame 2 on page 25, and check your responses





































-
P23
-

ANSWER FRAME 2.



1.

False.
Liqui
dity

refers to the ability of a company to meet its short
-
term obligations.
Solvency refers to its ability to meet long
-
term obligations.


2.

False. Equity capital is “safer” because stockholders receive dividends only at the
discretion of the board of dir
ectors, while interest on debt is mandatory and must be
paid to creditors regardless of the firm’s earnings.


3.

True. Capital obtained from stockholders is usually more expensive than borrowed
funds.


4.

True. The return on investment calculations are int
ended to measure the firm’s over
all performance.


5.

True. The investor usually follows the earnings
-
per
-
share ratio more closely that any
other single ratio, and it is also likely to affect the share price.


6.

False. The calculation of the price

earning
s ratio is: market price per share divided by
earnings per share.


If you missed more than one of the above, reread Frame 2 before continuing with Frame 3 on
page 26.






























-
P24
-

FRAME 3
.



DIFFICULTIES IN MAKING COMPARISONS




Reas
onably accurate reports of actual performance often can be obtained. Finding an
adequate standard against which these actual can be measured, however, is often a perplexing and
difficult matter.



Some of the problems are described below,



1.

Deciding on
the Proper Basis for Comparison
. In business, there are many situations
in which one cannot tell whether a higher number for a ratio represents better performance than a
lower number.



A high current ratio is by no means necessarily better than a low curr
ent ratio.



A decrease in a current ratio, for example, may indicate no worsening of a company’s liquidity
position at all; rather, it may reflect the result of a well
-
carried
-
out expansion program.




































-
P25
-


In some compa
risons the direction of change that represents “good” or “better” is reasonably
apparent. Generally, a high net profit percentage is better than a low one, and a high return on
investment is better than a low one. Even these statements have many qualificat
ions, however.



Many standards can usefully be thought of as a
quality range

rather than as a single number.
When actual performance is within this range, it may be regarded as satisfactory. When it begins to
go outside the range,
in either direction
, the
re is an indication of an unsatisfactory situation.



















































-
P26
-


2.

Differences in the Situation Being Compared
.


Differences in the factors that affect one company’s performance this year as compared with those

that affect the same company’s performance last year, or the performance of another company, are
complex and difficult to evaluate. Nevertheless, some attempt must be made to allow for these
differences. In general, this task is least difficult when all t
he figures being compared pertain to the
same company.



The task is more difficult when attempting to compare one company with another, even if they
are both of the same size and in the same industry, and it becomes exceedingly difficult if the two
compan
ies are in different industries or if they are of substantially different size.














































-
P27
-


3.

Changes in the Dollar Measuring Stick
.



Accounting figures are expressed in historical dollars. A change in the value o
f a dollar, that is, a
change in price levels, may therefore seriously lessen the validity of comparisons of ratios whose
numerator and denominator are expressed in different kinds of dollars, and it may have no useful
meaning at all.




















































-
P28
-

4
.

Differences in Definition
. The individual elements making up such terms as


current

a
ssets


and

current liabilities


are by no means precisely defined, and there is considerable diversity
in practice as to how they

should be measured.
























































-
P29
-

5.

Hidden Short
-
Run Changes
. A balance sheet may now reflect the average or typical

situation. A balan
ce sheet is prepared as of one moment of time, and it tells nothing abo
ut short
-
term
fluctuations in assets and equities that have occurred within the period bounded by the two balance
sheet dates. A
c
ompa
n
y that is analyzing its own data can study

seasonal movements by using
monthly, rather than annual, balance sheets, but
these are ordinarily not available to the outsider.



The analyst should also recognize that companies have been known to take deliberate steps
to


clean up

their balance sheets. They may, for example, pay off loans just before the end of the
year, which

increases the current ratio; they then borrow again early in the next year. Such
transactions, which are called
window dressing
, may not be discernible on the balance sheet.














































-
P30
-


6.

The Past as an Indication

of the Future
.


Financial statements are historical documents, and financial ratios show relationships that have
existed in the past. The analyst is, of course, interested in what is happening now and what is likely to
happen in the future rather than wha
t did happen in the past. Often the analyst has no choice but to
rely on past data a
s

an indication of the current situation,

but he should not be misled into believing
that the historical ratios necessarily reflect current conditions, and much less that t
hey reflect future
conditions.


















































-
P31
-

POSSIBLE BASES FOR COMPARISON



There are four types of
standards
against which an act
ual
figure can be
compared:



1.

Experience
. The analyst gradually builds up his ow
n idea as to what constitutes

good


or


poor

performance. One of the important adva
n
tages that an
e
x
perienced analyst has
o
ver
inexperienced ones is that
he possesses a feeling for what
are

right

relationships in a given
situation, developed on the bas
is of knowledge about similar situations. These subjective standards of
a competent analyst are more important than standards based on mechanical comparisons.














































-
P32
-


2.

Goals
. Many companies prepare
budgets

whi
ch show
what performance is expected
to be under the circumstances pre
v
a
i
ling
. If
a
ctua
l

performance corresponds with budgeted
performance, there is a reasonable inference that the performance
i
s good. There are tw
o

important
qualifications that affect thi
s inference, however.



First, the budgeted figures may not have been set very carefully in the first instance and the
comparison can of course be n
o

more valid than the goal figures themselves
.


Secondly, the goals were necessarily set on the basis of cer
tain assumptions as to the
conditions that would be prevailing during the period, and if these assumptions turn out to be
incorrect, the goal figures are also incorrect as a measure of results


under the circumstances
prevailing


. Nevertheless, the budge
t is a type of standard that has fewer inherent difficulties than
either the historical standards or the external standards.











































-
P33
-

3.

Historical Standards
. A comparison of current performance with past figures for

the
same company usually does not run into the problem of differences in account practice. If practices
have changed, the change is presumably known to the analyst.


Moreover, the analyst can also recollect, or finds
o
ut fro
m

supplementary data, some of t
he
circumstances that have changed between the two periods and thus allows for these changes in
making his comparison.


At best, however, a comparison between a current figure and a historical figure in the same
company can show only that the current perio
d is


better



or



worse



than the past. In many cases
this does not provide a sound basis for judgement, for the historical figure may not have represented
an acceptable standard.













































-
P34
-

4.

External Standards
. When one company is compared with another, the environmental and
accounting differences affecting the two sets of figures may raise serious problems of comparability.
If, however, the analyst is able to allow for these differences, even approximately, he

obtains an
outside check on performance that has the advantage, over a standard derived from internal sources,
of being arrived at independently.


Moreover, the two companies may well h
av
e been a
f
f
e
cted by the same set of economic
conditions, so this impo
rtant ca
u
se of noncomparability may not be operating.


Many sources contain
average ratios

for groups of com
panies in the same industry or of
similar size. Perhaps the best known are those published by Dun & Bradstreet, Inc
.
,














































-
P35
-

USE OF COMPARISONS



The principal value of an analysis of finan
c
ia1 statement information is that it suggests
questions that need to be answered; such as analysis rarely provides the answers. An
u
n
favourable
difference between actua
l performance and whatever standard is
u
sed, if it is large, indicates that
something
may

be

wrong and this leads to an investigation.


Even when the analysis indi
c
ates strongly that something
is

w
rong, the analysis rarely shows
what the
cause

of the diffi
culty

i
s
.

Nevertheless, the ability to pick from the thousands of questions
that
might

be asked those few that are really worth asking is an important one. The only number that
encompasses all of the relationships previously described is a return
-
on
-
invest
ment ratio.


A change in any less inclusive ratio may be misleading as an indication of better or worse
perfor
m
ance unless possible compensating changes in factors not covered by the ratio are taken into
account.








































-
P36
-

In short, any ratio other than return on inv
e
st
m
ent
,
taken by itself,
im
p
l
es that all other things

are equal. This ceteris paribus

c
ondition ordin
arily does not actually prevail

and the validity of
comparisons is lessened to the extent that it does not.

Yet the return
-
on
-
investment ratio is so broad
that it does not give a clue as to which of the underlying factors may be responsible for changes in it.


It is to find these factors, which if unfavourable indicate possibly trouble areas, that the
subsidiar
y ratios of profitability are used.


Furthermore, the return
-
on
-
investment ratio tells nothing about the financial condition of the
company; liquidity and solvency ratios are necessary for this
-
purpose.















































-
P37
-

Indicate whether each of the following statements is true or false.



___
1.

A firm’s balance sheet
m
ay be regarded as a representation of its typical financial position
during the period.


___
2.

If the firm’s current ratio is 2:1, the payment of a current
liability with cash will increase both its
current ratio and its working capital.


___
3.

Changes in the value of the dollar can make the comparison of ratios computed for different
periods less meaningful.


___
4.

It is impossible for a ratio to be too high

or too low.


___
5.

Information required by, and filed with, the Securities and Exchange Commission or its
equivalent may be more useful to the analyst than the information contained in the firm’ s
annual report to shareholders.


___
6.

The analysis of fina
ncial statements generally provides the answers to almost all of the major
questions concerning the firm which was studied.


Turn to Answer Frame 3, on page 40 and check your answers.
































-
P38
-

ANSWER TO FRAME 3.



1.

False. A b
alance Sheet discloses financial position as of a particular point in time. Its
position on this date may, or may not, be representative of the “typical” or average
financial position during the period.


2
.

False. The payment of a current liability with ca
sh will. Increase the current ratio, but
the amount of the working capital ratio, but the amount of the working capital will
remain unchanged since current assets and current liabilities will both be decreased
by the same amount


3
.

True. Changes in the va
lue of the dollar
can
make comparisons of ratios computed
for different times less meaningful. The numerators and denominators may not be
affected proportionately.


4
.

False. It is possible for a ratio to be too high as well as too low. When a ratio is fou
nd
to be within a certain range it normally is thought to be satisfactory.


5
.

True. Information filed with an SEC may be more useful to the analyst because it
must be prepared according to a uniform format and is usually more detailed than the
annual repo
rt to shareholders.


6.

False. The analysis of the financial statement of a firm often suggests the need for
additional information which may be useful to the analyst.



If you missed more than one of the above, restudy Frame 3. before beginning the next

Chapter.

























-
P39
-

MANAGENENT OF

SHORT
-
TERM CASH



FRAME 4




Cash is the most liquid of all forms of working capital, and successful management is
essential to the well being of the business. It is necessary to plan the use of cash to

finance
immediate operations It is done to the cash budget.



A cash budget, translates budgeted sales, cost and expenses into a forecast of periodic cash
receipt and payment based upon assumption as to ‘credit terms’. This budget may be three
-
monthly,
mo
nthly or weekly depending upon the nature of the business, although in certain circumstances
other period may be used.



Thus a sale on 20
th

of January at credit terms ’60 days from invoice date’ becomes a cash
receipt in the month of March. Similarly, a p
urchase on 20
th

of January at credit terms ’30 days from
invoice date’ becomes a cash payment in February.



We forecast cash receipt and payment to determine future monthly excesses and shortages
of cash, and to see in advance the likely timing and durati
on of peak cash requirements.

































-
P40
-























-
P41
-

FRAME DETAIL



1.

In the operating budget, we plan profit for the budget period but if we
have no cash, can we achieve the operating budget targets? . . . .
.
(yes, no). Therefore, is planning cash often more important than
planning profit? . . . . .(true, false).

Now check your
answer with the correct
answer in the frame
below. Tick it if correct.

2.

We need cash to pay for labour, materials, overheads, divi
dends, fixed
assets, etc. If we wish to operate and survive in business we may or
may not have profit, but we must have . . . . . .

No

true

3.

We forecast and plan our cash to make it available when . . . . . .

cash

4.

We plan cash receipts and payments

to compute a monthly net
balance. We thus forecast the cash . . . . . each month during a budget
period. Is this based on assumptions? . . . . . .

required

5.

In the cash budget we estimate the detailed receipts and payments.
Thus a sale in January on cr
edit terms of 30 days after invoice date
would become a cash receipt in the month of . . . . . .If, however, the
sale in January was on terms of 60 days after date of invoice, then it
would become a cash receipt not in February but in . . . . . . .

Balanc
e

yes

6.

Similarly, a purchase in the month of December on credit terms of 90
days after invoice date would not be paid in cash until the month of . . . .
. . By contrast, labour . . . . . (is, is not) paid in the month in which the
cost is incurred.

Febr
uary

March





-
P42
-

Exhibit I

Cash Budget January

June Year I



(to be completed and checked with Exhibit 2)



Jan.

Feb.

Mar.

Apr.

May

June


£

£

£

£

£

£

Cash receipts:

Sales

Loans


100




㄰N

㈰O


ㄶN







㄰N

㌰3

ㄶN




䍡C栠haym敮瑳W

m畲u桡s敳

i
慢o畲

䱯慮s⁲e灡id

bx灥湳敳









R





























ㄱN




䑩ff敲敮e攠ef⁲散敩灴p

潶敲e灡ym敮瑳⁳畲灬畳

E摥fici敮cyF

l灥湩湧⁣慳栠扡l慮ce





㌰3



㈱O

㌳3





㔴R




䍬潳i湧⁣慳栠扡l慮ce

㌳3

㔴R

㔹R








A摤i瑩潮慬⁄慴a

p慬
敳W


c敢⸠.㈰〬⁍ rc栠ꌳM〬MApril₣㄰〬⁍ y ꌵ〬⁊畮攠ꌲ〠剥ceiv慢l攠e渠n慳栠慦瑥爠㈠


m潮瑨t


m畲u桡s敳W

䵡rc栠hN〰ⰠA灲il ꌱR〬Mjay ꌵ〬⁊畮攠ꌲM⁐慩d⁩n⁣慳栠hf瑥爠䤠t潮瑨


䱡扯畲u


ꌲ〠M潮瑨ty mai搠i渠n慳栠e慣栠h潮瑨


bx灥湳敳W

A灲pl₣㈰Ⱐ䵡y₣㈵ⰠIu湥

£㔠Rai搠i渠n慳栠h潮瑨ty


䱯慮sW


乥w潡n⁲散敩ve搠d渠nay 慮搠牥灡i搠i渠n畮攠e㈰M



















J
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7.

Payments for dividends and loan repayments . . . . . (do, do not)
depend upon normal credit terms.

March is

8.

Such special items may not be pa
id immediately in cash. In a cash
budget, therefore, we have to be particularly concerned about the
special ..............for major receipts and.........

do not

9.

If the cash budget shows cash receipts of £10 and payments of £5, the
net effect on the cas
h balance for the month is an . . . . . (increase,
decrease) of £. . . . . . . .

C
redit

Terms

payments

10.

A cash budget shows the timing of peaks of cash balances and
overdrafts. Where the cash balance is negative we call it an. . . . . . Is
an overdraft

of £300 000 for one month the same as £30 000 for ten
months? . . . . . .

Increase

£5

11.

Now read Exhibit I, which is a . . . . . . . .. . . . . . . It shows completed
cash receipts and payments for the period . . . . . . to . . . . . . and
provides col
umns for a fore
-
cast for the months . . . . . . . . . . . and . . . .
. .

overdraft

(opposite of
balance) no

12.

In January cash receipts total £ . . . . . . . . . . and payments £ . . . . . .
The net effect on the cash balance is therefore a . . . . .
. . . (increase,
decrease) of £ . . . . . . . . .

cash budget January

March

April, May and June

13.

The opening cash balance in January 1st, Year I is £300 and therefore
the closing cash balance is £ . . . . . .

£100 £65 increase
£35

14.

Similarly in Feb
ruary cash receipts exceed payments by £ . . . . . . and
the closing balance increases to £. . . . . . .

£335





-
P44
-


15.

What is the exceptional receipt of cash in the month of February? . . . . .
.

£210

£545

16.

In the month of March, receipts amou
nted to £ . . . . . . . , payments to £ .
. . . . . and the final cash balance to £. . . . . .

loan of £200
received

17.

The January cash receipts £100 are actually for sales in November,
What are the credit terms for such sales:


(a)

cash


(b)

30 days af
ter date of invoice


(c)

60 days after date of invoice

Choose one of the above . . . . . .

£160

£110

£595

18.

On credit terms of 60 days after date of invoice, sales in the month of
February become cash receipts in the month of . . . . . . .

(c)

19.

To f
orecast cash receipts and payments therefore, we must assume the
. . . . . . . .terms.

April

20.

In the month of March, purchases paid amount to £ . . . . . . . This is for
purchases during the month of February and paid on credit terms:


(a)

cash


(b)

30

days after the invoice date


(c)

60 days after the invoice date

Choose one of the above . . . . . .

credit

21.

The cash for labour in March is for expenditure actually incurred in the
month of . . . . . .

£80

(b)

22.

Complete the cash budget for the mon
th of April in Exhibit I. (Do it step
by step with us.) The first figure is cash receipts from sales, and if we
look at the additional data at the bottom of the Exhibit I, we see that
sales are received in cash two months after date of invoice. Thus cash
r
eceipts for April will be for sales made in . . . . . . . . £. . . . . .

March








-
P45
-


23.

Similarly purchases are paid one month after date of invoice and so
the payment for purchases in the month of April will be for amounts
purchased in in the m
onth of . . . . . . ., £. . . . . .

February

£200

24.

Purchases for March on credit terms of one month become payments
in the month of . . . . . . .

March

£100

25.

Now complete the item of labour and expenses and compute the
excess of receipts £ . . .
. . . , over payments £ . . . . . . as £. . . . . . .

April

26.

The opening balance in April is £595 and therefor the closing balance

is £. . . . . . .

£200

£140

£60

27.

Then compare your solution with the answers in Exhibit 2 but do not
look at the m
onths of May and June.

£655

28.

We shall now forecast for May in just the same way as for April except
for one special figure of £200 for a loan received in the month of May
and repaid in the month of June. The excess of receipts over
payments for the mon
th of May is £ . . . . . . and the final closing
balance is £. . . . . . .

If you did not get it
right, go through the
last few frames
again in order to
check your
calculation

29.

N
ow check your solution with Exhibit 2 and then complete the similar
budge
t for the month of June.

£305

£960

30.

F
or the month of April, receipts totalled £200 and payments £140,
giving an amount of £60 which was:


(a)

an excess of receipts over payments


Or

(b)

an excess of payments over receipts



. . . . . . . . . (a, b)

Che
ck your figures
with Exhibit 2 and if
you are making
mistakes try to
understand where
you. are going
wrong. If you did not
go wrong, well
done!











-
P46
-

Exhibit 2

Cash Budget April

June Year I (solution to Exhibit I)




Apr.

May

June


£

£

£

Cash

receipts:

Sales

Loans


200


J


㌰3

㈰O


㄰N




㈰O

㔰R

㄰N

䍡C栠haym敮瑳W

m畲u桡s敳

䱡扯畲

䱯慮s⁲e灡id

bx灥湳敳


㄰N








ㄵN












㈰O

R


ㄴN

ㄹN

㈷O

䑩ff敲敮e攠ef⁲散敩灴pv敲

灡ym敮瑳⁳畲灬畳
d敦ici敮cyF

l灥湩湧⁣慳栠扡l慮ce




㔹R


㌰3

㘵S


Eㄷ㔩

㤶9

䍬潳i湧⁣慳栠扡l慮ce

㘵S

㤶9

㜸T


































J
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31.

The opening cash balance in April is £595 which is . . . . . .
.(increased, decreased) by £60 to give a closing balance of £. . .
. . . .

(a)

32.

Similar
ly in May the payments of £195 . . . . . . . (do, do not)
exceed receipts of £500 and the closing balance was £ . . . . . .

increased

£655

33.

In June, however, receipts of £100 are exceeded by payments of
£ . . . . . . . The receipts . . . . . . (do, do
not) exceed payments.
The opening balance of £960, therefore is . . . . . . . (increased,
reduced) by £175 to a figure of £. . . . . .

do not

£960

34.

During which month is the cash balance the highest? . . . . . . .
During which month are the receipts g
reatest? . . . . . .

£275

do not

reduced

£785

35.

During which months did the cash balance exceed £600? . . . . . .
, . . . . ., . . . . . .

May

May

36.

The cash budget simply translates transactions of sales, receipts
and expenses and miscellaneous ite
ms into cash . . . . . and . . . .
. for a period.

April, May, June

37.

From the receipts and payments we may compute the key figure
of the excess of . . . . . over . . . . .for each month, and the final . .
. . . .or . . . . . of cash.

receipts

payments

38.

The excess of receipts over payments for the month (or vice
versa) is then adjusted to the opening balance to produce a new
balance of . . . . . at the . . . . . of each month and to direct
attention to expected peak cash requirements.

receipts

paymen
ts balance
overdraft














-
P48
-


3
9.

The cash budget shows the forecast of monthly cash or
overdraft balances and emphasises the timing and duration of
the….. (peak, normal, minimum) cash requirement. Is it based
潮⁡ s畭灴p潮s㼮?⸮⸮

c慳h

敮e

4


In business we plan cash very carefully because it is often…..
Em潲攬敳sF⁶it慬 瑨t渠nmme摩慴攠e⸮.⸮

灥慫 y敳
慬l⁢畤g整e⁡牥

㐱4

乯w⁲敡搠d条i渠nh攠e畭mary ⁴ 攠e整⁡ 搠d瑵ty⁴桥 l敡r湩湧
灡瑴tr湳⸠䍯C湴nu瀠ph攠e畭扥r ⁣潲o散琠t湳w敲e⸠䥦 y潵

h慶攠
m潲攠瑨o渠n㔠R潲o散琬⁣慲ay ⁴漠oh攠e數琠te琮

䵯r攠er潦it









































J
m㐹
J

FRAME 5



Cash planning is critical to the business, because management needs cash to carry out its
plans and policies.


A cash budget reveals

the timing and the peaks of cash surpluses and of cash shortages. We
plan to make adequate cash available when required and to avoid excessive idle cash balances which
do not earn profit.


Cash availability depends upon ‘debt capacity’, i.e. the ability t
o borrow new cash. Debt
capacity exists roughly to the extent that owner’s equity exceeds liabilities.


The annual cash budget normally forecasts six months in detail and six months in total and is
revised at least six monthly for twelve months ahead.


Now

study the learning pattern for this frame, complete the set and then study this summary
again.






































-
P50
-























-
P51
-

FRAME DETAIL


1.

The monthly cash balance depends upon the….. and….. during
瑨t潮瑨t

乯w⁣桥ck y潵r⁡湳w敲e
睩瑨t瑨t⁣潲o散琠慮sw敲e
i渠n桥⁦r慭攠e敬ow⸠.ick
if⁣潲o散琮



Cash receipts and payments depend upon….. ….. of sales and
灵rc桡s敳.

剥o敩p瑳⁰ ym敮瑳



䍡渠m慮慧敭敮琠t湦l略湣e⁳慬敳⁡湤⁣潮瑲潬 灵rc桡se㼮?⸮⸮ 䍡渠
i琠tl慮⁴ e⁴
imi湧⁡湤 灥慫 ⁣慳栠hvail慢ility 慮搠d瑳 acc数瑡tl攠
cr敤i琠瑥rms㼮?⸮⸮

cr敤i琠瑥rms



䵡湡来m敮琠tl慮s⁣慳栠ho⁤ 瑥牭i湥⁴ 攠e畲ul畳爠 桯r瑡t攠e漠
requirements; it is the timing and duration of the…….cash
r敱畩r敭敮瑳⁴ a琠⸮⸮.
isⰠIs 琩⁣ritica
l⁴漠oh攠e畣c敳s ⁴ 攠
扵sin敳s.

yes

yes



Failure to plan cash carefully could lead to a…… of cash when
r敱畩re搮d䥳⁣慳栠牥煵ir敤⁦潲慢潵rⰠI慴arialsⰠIivi摥湤sⰠ
敱ui灭敮琬o慤⁲e灡ym敮tsⰠI瑣㼮?⸮⸮⁂畴uis i琠t 杯潤⁦i湡湣ial
灯licy⁴漠o慶攠e慲来a
c慳栠b慬a湣敳yin朠g摬攠e渠nh攠ea湫⁡ 慩湳琠
敭敲来湣i敳?

m敡k





䍡C栠牥h潵rc敳⁳桯uld⁢ 慤敱畡t攠e漠oov敲⁲e煵ir敭敮瑳⁡ 搠
敭敲来湣i敳⁢ 琠湯琠數c敳siv攠扥c慵seW


E愩

c慳栠hay⁢ 潳t


E戩

i摬攠e慳栠h慲湳 ⁰牯 it


EcF

s桡r敨ol摥rs 睩ll⁤敭慮搠divi
摥湤s

Choose one of the above……

s桯r瑡te

yes





q桥⁣慳栠h畤g整ed数e湤s 異潮⁡ s畭灴p潮s⸠t攠e慮⁦潲散慳琠
cash for any period ahead if we know what….. to make.

E戩















J
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J

Exhibit. I

Cash Budget Year I

(to be completed and checked with Ex
hibit 2)




Jan

Feb

Mar

Apr

May

June

Total
Jan.
-
June

Total
July
-
Dec

Total
for

year


£

£

£

£

£

£

£

£

£

Cash receipt
s
:










Sales










Loans










New
c
apital

200





200


500












Cash payments
:










Purchases










Labour










Expenses










Dividends



100







Fixed assets


20


40






Loans repaid




















Receipts over

payments excess

(deficiency)










Opening balance

(overdraft)










Closing balance

(overdraft)











Additional d
ata

Sales:

December year o £50; January
-
June year I £40 monthly; July
-
November year I £50
monthly; December year I £110. Payable 30 days after date of sale.

Purchases:

December year o £20; thereafter £30 monthly. Payable 30 days after date of
purchase.

Loa
n:

Received in May and repaid in September: £300.

Lab
our:

£30 monthly.

Expenses:

Normally £20 each month, but increased in both March and September to £120.















-
P53
-


8.

Is it fairly complex to translate each sale and purchase into a
cash recei
pt or payment? ....... But could we easily prepare
such a detailed forecast of cash for, say, five years ahead? .....

assumptions

9.

Should we forecast critical peaks, surpluses and shortage of
cash? …… (yes, no) Why? ...... …….. …….. …….. …. …….



湯Ⱐi
琠wo畬搠de⁴ o
cum扥rsom攠e漠睥⁵ 攠
f畮摳⁦l潷

㄰N

䥮f慮⁡ 湵al⁢畤g整e湧⁳yst敭⁷攠e潲o慬ly⁰l慮⁣慳h⁲散敩灴pⰠ
灡ym敮瑳⁡ 搠dala湣敳⁦潲⁡oye慲⁡桥a搠dy⁳ix潮瑨s⁩渠
摥瑡il 慮d⁳ix潮瑨t⁩渠n.⸮.⸮⁓畣h⁦潲散慳瑳 may 扥⁲evise搠
six m潮瑨ty⁦潲‮⸮⸮o
m潮瑨t 慨敡搠dr潲攠or敱略湴ly
摥灥湤i湧 異潮⁨ow‮ ⸮⸮⁣慳栠hay⁢攠eo⁴ e⁢ si湥ss.

yes

瑯tavoi搠i摬攠e慳栠h湤 慬s漠
瑯tavoi搠d潬摩n朠g瀠
扵sin敳s 敲慴io湳⁤ e⁴
c慳栠h桯r瑡te

ㄱN

乯w⁲敡搠dxhibi琠䤠睨wc栠hs 愠a潭灬數⁣慳栠h畤来琮tAr攠e桥re
慬r敡dy⁣e
r瑡t渠nt敭s⁳桯睮⁩n⁴ e⁢ 摧整㼠?⸮⸮⸮⸮.⁄漠瑨ts攠
i瑥ts⁤ 灥湤⁵ 潮潲o慬⁣r敤i琠瑥rms爠異 渠np散ific
management policies? ........ ......... …….

瑯tal‱ ⁣ri瑩cal

ㄲN

乯w⁲敡搠dh攠e摤i瑩o湡l⁤ t愠aive渠n渠nh攠eo瑴tm ⁅x桩bi琠䤠
睨wc栠h潲os⁴ 攠e慳
is  r⁥ 瑩m慴as ⁣慳栠h潲⁴桥o晩rs琠tix
months in ...... and for the last six months in …… The
additional data provides the …….. for our cash budget.

yes

s灥cific m慮慧敭敮琠
灯lici敳

ㄳN

p慬敳⁩n⁄散敭扥rⰠI㔰Ⱐwill 扥⁣慳栠牥heiv敤 i渠na湵慲y⸠
q桥r
敦潲攠瑨o⁣r敤i琠瑥牭s 景爠f慬敳⁡牥W


E愩

c慳栠h渠n敬iv敲y


E戩

㌰⁤ays整


EcF

㘰⁤ays整

Choose none of the above…….

摥瑡il

瑯tal

assumptions (Don’t do the
f潲散慳琠y整e⁤漠o琠wi瑨t畳 in
瑨t⁦r慭敳F












J
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J


14.

January sales of £40 on cred
it terms of 30 days will be received in cash
in the month of……

E戩

瑨t整em敡湳
睩瑨潵琠摩sc潵n琩

ㄵN

乯w⁣潭灬整e⁴桥⁣慳栠牥h敩灴p⁦r潭⁳慬敳⁦潲⁆敢r畡ry


gu湥 慮搠d潲o
g畬y


䑥a敭扥r⸠till⁴ 攠䑥a敭扥r⁳慬攠ef₣ N〠M攠r散敩v敤 i渠n慳栠
摵rin朠ghis⁢
摧e琠t敲i潤㼠?⸮⸮.

c敢r畡ry

ㄶN

The total cash received from sales for January to June amounts to £……
and for July to December to £…….



ㄷN

乯w⁲散潲搠o桥 l潡渠nf₣ M〠牥M敩ve搠d渠nay 慮搠d数ai搠i渠p数t敭扥r
慳⁡ r散敩灴pa湤 愠aaym敮t⁩渠yo畲⁣慳栠hud
来t

ꌲ㔰

ꌲ㤰

ㄸN

䑯ayo甠敶敲⁦敥l⁴桡琠湯慴a敲⁨ow y潵 扵摧整 yo甠ur攠el睡ys畳琠t
li瑴l攠eh潲琠潦⁣慳栿

qry 瑯tav潩d
c桥cki湧⁷ 瑨t
bx桩bi琠㈠⡰⸠㔸F

ㄹN

䥮fbxhibi琠䤠睥⁦潲攠o慳琠tew⁣a灩t慬I⁩n⁊慮u慲yⰠIu湥 慮搠p数瑥t扥r⸠
Ar攠eh敳攠牥eei灴p爠 ay
ments’…… Do they increase owner’s equity?

te⁡ m⁴
im灲潶攠yo畲u
扵摧整e湧⁳killsⰠ
s漠o桡琠yo甠睩ll
桡v攠e潮g敲⁴漠
睯wry⁡扯畴⁡
f畴ur攠e桯r瑡t攮

㈰O

乯w⁡摤⁵瀠ph攠eo瑡t⁲散敩p瑳⁦潲⁴桥otw漠灥ri潤s ⁳ix潮瑨t⁡ 搠d潲o
the year as a whole, totals £……

r散敩灴p

yes

㈱O

te w⁦潲散慳琠taym敮瑳⁦潲⁴桥o灥ri潤.⁆楲 瑬yⰠl慢o畲Ⱐꌳu⁥ c栠
month, is easy to record as it….. (is, is not) paid in the month that it is
摵攮

ꌱ‷㐰
c桥ck
睩瑨tbx桩扩琠t if
湯琠t潲o散琩

㈲O

m
畲u桡s敳⁦潲⁄散敭扥rⰠI㈰ⰠIre⁰ i搠in

ga湵慲y⁡湤⁴ 攠牥慦瑥爠灡t搠
慴a愠牡a攠ef₣ 〠M敲潮瑨t th慴a慲攠瑨a⁴潴ol⁰畲u桡s敳⁰ i搠d渠n慳栠h潲o
January to June? £….. And July to December? ……What is the

慭潵湴n
of purchases not paid for at December 31? £……

i
s




J
m㔵
J


23.

No
w record expenses pa
id currently at £20 each month with additional
expenses in. March and September of £100 each month. Expenses for
January to June amounted to £220 and for July to December to £……

ꌱ㜰

ꌱ㠰

ꌳ£

㈴O

f
渠nxhibi琠䤠睥⁨慶攠elr敡dy⁲散潲摥搠sp散ial⁰aym敮瑳⁦潲o
摩vi摥湤sⰠ
ꌱ〰⁩n⁍ rc栠慮搠dixe搠dss整eⰠI㈰ i渠n敢r畡ry⁡湤 £㐰⁩渠n灲pl⸠.渠
慤di瑩潮al⁦ix敤⁡ s整eis⁰畲u桡s敤⁦潲₣㄰〠M渠nay 慮搠dai搠d潲⁩f⁩渠
June. This will be recorded as a payment in the month of ……

ꌲ㈰

㈵O

k
ow⁴ k攠e慣栠h潮瑨ti湤ivi摵allyⰠI
瑡牴i湧 wit栠h慮畡ry. A摤 異⁴桥⁣慳栠
r散敩灴p⁡湤⁴桥n⁴ e⁣慳栠灡ym敮瑳⸠䍯.灵瑥t瑨攠exc敳s ⁲散敩灴p
over payments as £…… in January. The opening balance at the
扥gi湮i湧 ⁊慮畡ry⁩s ꌱM〬M瑨敲敦潲攠瑨o⁣l潳in朠g慳栠hal慮ce⁡ ⁴桥
敮搠潦⁊慮畡ry is
£……

g畮e

㈶O

a
漠oh攠e慭攠e潲⁴桥om潮瑨s⁆敢 畡ry 慮搠d慲a栠慮d com灵瑥t瑨攠
balance at the end of March as an overdraft (negative balance) of £……

ꌱ㠰

ꌲ㠰
c桥ck⁷it栠
bx桩bi琠㈠Of t
c潲o散琩

㈷O


mil慲ay⁣潭灵瑥t瑨攠e慬a湣攠e慣栠h潮瑨t畮til⁴桥 e湤
g畮攠睨w渠
瑨t⁢慬慮c攠em潵湴n⁴

£
……

ꌲ〠⡣桥ck⁷ 瑨t
bx桩bi琠㈠Of t
c潲o散琩

㈸O

c
潲⁴桥osix潮瑨t⁥ 摥d⁊畮攠e桥⁴潴ol⁲散ei灴p⁡ 潵湴n搠瑯t£㤵M⁡ 搠
灡ym敮瑳⁴

£
慮搠dh敲敦潲攠瑨o⁲散ei灴p⁥ cee
摥搠daym敮瑳⁢y 慮
慭潵湴n潦₣
……

ꌲ㈰

㈹O

f
f⁷攠i湳敲琠e
桥灥湩n朠g慬慮c攠et⁴ e⁢ 杩n湩湧 潦⁴ 攠ye慲Ⱐa㄰〬⁴ e
cl潳i湧⁢ l慮c攠es ⁴ e⁥湤 ⁊畮攠睩ll 扥₣㈲〮M䑯敳⁴ is⁡杲敥g睩t栠
瑨t⁢慬慮c攠e渠nh攠e潬畭渠n潲⁴桥om潮瑨t潦⁊畮政‮ ⸮⸮

ꌸ㌰

ꌱ㈰













J
m㔶
J

Exhibit 2

Cash Budget Year I (solution

to Exhibit I)




Jan

Feb

Mar

Apr

May

June

Total
Jan.
-
June

Total
July
-
Dec

Total
for

year

Cash receipt
s
:










Sales


50


40


40


40


40


40

250

290


540

Loans













㌰3




㌰3





㌰3

乥w
c
慰i瑡l

㈰O













㈰O

㐰4

㔰R


㤰9


㈵O







㌴3

㈴O

㤵9

㜹T

ㄷ㐰

䍡C栠haym敮瑳
W










m畲u桡s敳














ㄷN

ㄸN


㌵3

䱡扯畲














ㄸN

ㄸN


㌶3

bx灥湳敳





ㄲN








㈲O

㈲O


㐴4

䑩vid敮摳







㄰N










㄰N





㄰N

cix敤⁡ s整e














㄰N

ㄶN





ㄶN

䱯慮s⁲e灡id






















㌰3


㌰3




㄰N

㈸O

ㄲN




ㄸN

㠳8

㠸8

ㄷ㄰

剥o敩p瑳 敲

灡ym敮瑳⁥ c敳s

E摥fici敮cyF



ㄸN



E㘰F



E㈴〩



E㠰F



㈶O








ㄲN



E㤰F






l灥湩湧 扡l慮ce

E潶敲摲慦琩


㄰N


㈸O


㈲O


E㈰F


E㄰〩


ㄶN


N



㈲O


㄰N

䍬潳i湧⁢慬慮ce

E潶敲摲慦琩

⸮⸮⸮


㈸O


㈲O


E㈰F


E㄰〩


ㄶN


㈲O


㈲O


ㄳN


ㄳN





























J
m㔷
J


30.

We

can compute the cash budget month by month from January to June
and then we can check our figures in total by looki
ng at the balance at
the end of June with the summary figures for the period January to June.
The closing balance, £220 ….. (is, is not) the same.

yes

㌱3

t
e revise the bud get every six months for …. months ahead. If we had
愠a敲楯畳⁣慳h⁳桯r瑡t攠er潢le
m⁷攠ei杨琠ti湤 i琠t摶is慢l攠瑯trevise⁴ e
扵摧整e⸮⸮⸠Em潲攬敳sF⁦re煵敮瑬y.



㌲3

k
ow⁣潭灵瑥t瑨攠e潴慬⁲散ei灴p⁡湤⁴潴ol⁰ ym敮瑳⁦潲o瑨t⁰敲楯搠d畬y⁴漠
䑥a敭扥r⁡ 搠dh攠exc敳s ⁰ ym敮瑳v敲⁲散敩p瑳

£
…… Add the
潰敮in朠gala湣攠et⁴ e⁢ gi湮
i湧 ⁊畬y 潦₣ O〠M漠oom灵瑥t瑨t⁣l潳i湧
扡l慮c攠ef

£
⸮⸮⸠a琠瑨攠en搠潦⁄散敭扥r⸠䍯m灵瑥t瑨e⁴ 瑡l⁣潬畭渠
r散敩灴p⁡湤 灡ym敮瑳Ⱐ瑯t慬⁲散ei灴p

£
….. and total payments

£
…..
leading to an excess of receipts over payments of £….. for the whole
ye慲a

ㄲ
潲o

㌳3

A
摤 瑨t 潰e湩湧 扡l慮c攠潦₣ M〠M琠瑨t 扥gin湩湧 ⁴ 攠ye慲⁴漠瑨t
摩ff敲敮e攠e整睥敮 瑨t⁲散敩灴p 慮搠灡ym敮瑳⁦潲⁴桥oye慲⁴漠oiv攠e
cl潳i湧⁢ l慮c攠ef

£
…… Does this agree with the July to December
fi杵r攠e潲⁴桥ocl潳i湧⁢ la湣政

ꌹ£

ꌱ㌰

ꌱ‷4
M

ꌱ‷㄰

ꌳ£

㌴3

C
潭灡r攠y潵r⁳ol畴i潮⁩n⁅x桩扩琠䤠睩瑨t瑨t⁣潲o散琠慮s睥w⁩渠bxhi扩琠t
慮搠inv敳瑩条t攠eny 摩ff敲敮e敳⁩渠nh攠ei杵r敳⸠䥦 yo甠慲攠湯t⁳畲攠潦⁴ 攠
瑥t桮i煵eⰠ瑨敮⁤漠oh敳攠er慭敳⁡ 慩渮neow⁤漠y潵 瑥ll 慮v敲摲慦琠
fi杵r攠erom⁡ 扡l慮c攠e
i杵re⁩渠愠a慳栠h畤g整e

ꌱ㌰

yes






















J
m㔸
J


35.

When is the balance highest during the year? . . . . . When is the
overdraft or cash requirement highest? . . . . . What can we do when the
cash budget shows requirements greater than the b
alance figures? . . . .
. Why do we borrow £300 in the month of May?. . . . . .

overdraft figures
are shown in
brackets

36.

In summary, therefore, we forecast cash receipts and payments by
translating transactions for sales, purchases, expenses and
misce
llaneous items into actual receipts and payments of . . . . . We do
this to compute the extent and timing of peak requirements so that
enough . . . . . is always available, when . . . . .

January

April probide
extra funds
(borrow) to
provide extra
funds

3
7.

In a cash budget we have to make broad assumptions. Shall we work out
the figures to the nearest penny? . . . . . If we make broad assumptions
we should use . . . . . (large, small) figures.

cash cash
required

38.

In making a cash budget with substanti
al assumptions it is not worthwhile
to forecast small sums of money. Big assumpt
ions therefore require . . . .
figures. This normally means using figure of:


(a)

thousands of £


(b)

hundreds of £


(c)

thousands of pennies

Choose one of the above . . . . .

No large


39.

If management is not confident of the assumptions underlying a cash
budget, it should make another budget with other . . . . .

round (big)

(a)

40.

Cash planning is often more critical for management than profit planning
. . . . . (true, fa
lse). We therefore often reforecast monthly or even weekly
. . . . . (true, false)

assumptions


















-
P59
-


41.

Every business however large or small may not know the profit until the
end of the year, but it must know its cash position and imm
ediate cash
forecast all the time . . . . . (true, false).

true

true

42.

Cash budgeting depends not only on actual cash held but also on the
ability to raise cash by loans. If we have a balance sheet as follows, do
you think we could raise a loan of cash
from the bank?

Current assets

£100

Owner’s equity

ꌲ〰

䍵Cr敮t

cix敤⁡ s整e

㄰N

䍵Cr敮t


l
ia扩liti敳






£
㈰O

ꌲ〰



qbW

Owner’s equity: liabilities



Er慴a漠o〰㨠湩lF


.

⸠⸠⸠.

Ey敳ⰠI漩o

瑲略

㐳4

‘Debt Capacity’ is the ability of a business to borro
w潮ey⸠䥴 摥灥n摳
on the relationship between owner’s equity and liabilities. Now look at the
f潬lo睩湧 扡l慮ce⁳桥整W

䍵Cr敮琠tss整e

ꌱ〰

Owner’s equ
i


ꌱ〰

cix敤⁡ s整e

㄰N

䍵Cr敮t


l
ia扩liti敳

㄰N


ꌲ〰

ꌲ〰


乏qbW

Owner’s equity: liabilities



Er慴a
漠o〰W㄰〩


䍯畬搠we⁢ rrow⁦r潭⁡ 扡湫㼠?

⸠⸠⸠⸠.y
esⰠI漬op潳si扬yF.

v敳ⰠI散慵s攠睥w
have an owner’s
敱uity 潦₣ M〠
慮搠湯 lia扩liti敳Ⱐ
i.e. we have ‘Debt
Capacity’

㐴4

䥦⁷攠桡搠愠a慬a湣攠e桥整eas⁦潬lows⁣潵l搠睥⁢潲oo眠m潮ey⁦r潭⁡
扡湫?

䍵Cr敮琠tss
整e

ꌱ〰

Owner’s equi


ꌱ£

cix敤⁡ s整e

㄰N

䍵Cr敮t


l
ia扩liti敳

N
9
M


ꌲ〰

ꌲ〰


乏qbW

Owner’s equity: liabilities



Er慴a漠o〺M㤰F

灯ssi扬y
s漠l潮朠
慳⁴ 瑡lia扩liti敳
慲攠湯
si杮ific慮瑬y慲来a
than owner’s
敱uityF













J
m㘰
J


45.

The ‘Debt
Capacity’ of a business is a measure of its ability to raise cash
慮搠d桥r敦潲攠⸠o‮‮‮ ⸠⸠EisⰠis 琩⁡ si杮ifica湴nf慣瑯爠t渠c慳栠hla湮i湧.

湯ⰠI散慵s攠
lia扩liti敳
si杮ific慮瑬y
exceed owner’s
敱uity 慮搠
瑨tr敦潲攠w攠桡v攠
no ‘Debt
Capacity’

㐶4

䥮⁴
his⁩n瑲潤畣瑯ty⁰ 潧r慭m攠e攠e慮n潴odisc畳s⁩渠n整eil⁴桥⁡扩lity 潦⁡
扵sin敳s⁴ ⁢ rro眠w慳栠hr潭⁢ nks⁡ 搠d瑨敲e⸠.畣栠慢ility 摥p敮摳
only partly upon owner’s equity: the ratio liability, and partly on many
潴o敲⁦慣瑯牳⸠⸠⸠⸠⸠⸠⸠⸠⡴.略ⰠI慬s攩



㐷4

q桥⁰ 慮湩湧 ⁴ 攠e慳栠牥s潵rc敳 ⁴ 攠e畳i湥ss‮‮‮‮‮‮
 sⰠis 琩⁴ 攠
mos琠tm灯r瑡t琠t慲琠潦⁴ 攠e畤来琠t散a畳攠睩瑨潵琠t慳栠hr⁴ 攠ebility⁴
r慩s攠e慳栬ht桥⁢畳in敳s‮‮ ⸠⸠⸠⸠.
c慮ⰠI慮湯琩⁳畲vive.

瑲略

㐸4

乯w⁲敡搠d条i渠nh攠e畭m
ary ⁴ 攠e整⁡ 搠d瑵ty⁡条i渠n桥e慲湩湧
灡瑴tr湳⸠䍯C湴nu瀠ph攠e畭扥r yo畲⁣潲o散琠t湳w敲e.



c慮湯t
































J
m

J

FUNDS FLOW






FRAME 6


A flow statement explains the changes that occurred in an account or a group of acc
ounts
during an accounting period
. The income statement is a flow statement; It explains the changes that
occurred in retained earnings in connection with the operation of the business by summarizing the
increases (i.e. revenues) and decreases (i.e., expen
ses) during the period. Another report,
the funds
flow statement, describes the sources from which additional funds were derived and the uses to which
these funds were put
. This statement is also called “statement of sources and applications of funds,”
“Fu
nds statement,” and a variety of other names.


The funds flow statement is essentially derived from an analysis of changes that have
occurred in asset and equity items between two balance sheet dates. It is not prepared directly from
the accounts, as is th
e balance sheet itself.





































-
P62
-

THE CONCEPT OF FUNDS FLOW



Resources flow into the business from shareholders and from banks and other sources of
borrowed capital. Some of these resources are held as cash until needed; s
ome flow directly to plant
facilities and inventory. As resources are needed in operations, cash is disbursed, and these
resources, together with material furnished by suppliers, are used in the manufacturing and selling
process. At the end of this process
, cash is replenished by receipts from customers.


The receivable balances indicate that cash is not replenished as soon as goods are shipped
to customers but rather that there is a lag until customers pay the amounts they owe. Cash also flows
to suppliers

and others to reimburse them for the resources they have provided.


The funds flow statement describes these flows, but it does not describe all of them. The
funds flows statement does not show the details of the constantly recurring process of manufactur
ing
and selling goods and collecting receivables from customers. Instead, it focuses on more basic
changes. These changes are associated with the
permanent capital

of the business.







































-
P63
-

Permanent capital consists of
resources supplied by long
-
term creditors and by shareholders
.
On the balance sheet, the amount of such resources is the sum of noncurrent liabilities plus owners’
equity; in other words,
it is the total of the right
-
hand side* of the balance sheet, less t
he current
liabilities
.


Part of the permanent capital is invested in buildings, equipment and other noncurrent assets.
The remainder is invested in current assets, but only a fraction of the current assets has to be
financed from permanent capital, since
vendors and short
-
term creditors provide the remainder. The
amount that is financed from permanent capital is
the difference between the total current assets and
the total current liabilities. The excess of current assets over current

liabilities is called

working capital.






* In U.S.A. it would be the left
-
hand side









































-
P64
-

The funds flow statement shows changes in permanent capital and in the assets in which this
permanent capital is invested. Changes in the sourc
es of permanent capital and in the uses to which it
is put are likely to be of more than ordinary interest both to management and to outsiders since these
changes reflect the results of the important financial decisions that have significant long
-
run
conse
quences. The funds flow statement shows these changes.


The funds flow statement shows changes in the total amount of working capital but not
fluctuations in the individual items comprising working capital.


It can be seen that the word “funds” in this con
text has a specialized meaning. It is not
synonymous with “cash”, for cash is only one of the items comprising working capital. Rather, it is