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Cash Flow Budget

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Cash Flow Budget

Did you know that many companies spend more than they receive? Although they are profitable, there is often more money flowing out of their bank accounts than into. In doing so, they might be unable to pay off their financial obligations. A way to avoid it is to make financial plans and forecast outflows and inflows. In order to stay solvent, companies need to budget and be aware of cash flow.

Cash flow is a movement of money. It can be either physical or virtual. It is when an amount of cash and cash equivalents are being transferred into and out of a business.

Solvency is an ability of a firm to meet long-term financial obligations.

Budget is a form of financial planning and forecasting.

Cash flow versus revenue and cost

Whereas revenue is the value of sales made, it is not the same as money in. For revenues, there has been a transaction made. However, for cash inflows, there has also been cash exchanged.

Cash sales made to customers are both revenues and cash inflows. However, credit sales made to customers are revenues but not cash inflows. This is because there has been a transaction but cash has not yet been exchanged.

Similarly to revenue and cash inflow, for costs, there has been a transaction made. However, for cash outflows, there has also been cash exchanged.

Cash payments to suppliers are both costs and cash outflows. However, credit payments to suppliers are costs but not cash outflows. This is because there has been a transaction but cash has not yet been exchanged.

Cash flow formula

Free cash flow determines how much cash a business is generating after paying the costs of remaining in business. There are three methods of calculating it.

These methods include:

Free Cash Flow = operating cash flow -capital expendituresFree Cash Flow =sales revenue -(operating costs + taxes) -required investments in operating capitalFree Cash Flow =net operating profit after taxes -net investment in operating capital

Cash flow calculation (based on the cash flow statement of the company below):

If operating cash flow is £22,700 and capital expenditures are £15,000, then the free cash flow is £7,700.

Free Cash Flow = £22,700 - £15,000 = £7,700

This means that the company's cash flow is positive.

Positive cash flow is when there are more cash inflows than outflows. The opposite it negative cash flow which is when there are more cash outflows than inflows.

Cash flow statement

Similar to the income statement, cash flow statements show the profit earned and loss sustained by a business entity over a particular period (usually 12 months) and how this figure is concluded. However, instead of showing revenues and costs, the cash flow statement includes cash inflows and outflows.

A company is selling jackets. In 2021, it bought 2,000 jackets for £20 each and sold all of them for £45 each. No other inventory was traded that year. Other payments were: rent and rates £5,000, heat and light £4,000, fixtures and fittings £30,000 (expected to last 5 years), and staff wages £18,000.

Based on the information, we know that:

  • Turnover (total revenue) is £90,000 (£45 x 2000).

  • Cost of sales is £40,000 (£20 x 2,000).

  • Gross profit is £50,000 (£90,000 - £40,000).

  • Other expenses are rent and rates, heat and light, fixtures and fittings, staff wages, and they equal £33,000 (£5,000 + £4,000 + £6,000 + £18,000).

  • Net profit is £16,000 (£50,000 - £34,000).

Based on these figures, we can create an income statement of the company:

Table 1. Income statement of the company in 2021

turnover£90,000
cost of sales£40,000
gross profit £50,000
Rent and rates£5,000
Heat and light£4,000
Depreciation of fixtures and fittings£6,000
Staff wages£18,000
Other expenses£33,000
net profit£17,000

Depreciation refers to allocating costs of assets over their life expectancy.

The business was created on 1.01.2021. On that day the owner put £30,000 of their own money into the business bank account. There were no other assets or liabilities.

On 31.12.2021:

  • A customer owed £900 to the company in return for 20 jackets sold on credit.

  • The company owed £1,600 to a supplier in return for 80 jackets bought on credit.

  • The owner withdrew £15,000 from the business bank account.

Table 2. Financial Statement of the company at the end of 2021

Cash: (31.12.2021)
+ Opening capital £30,000
+ Cash from sales £89,100 (£90,000 - £900)
- Cash paid for inventory £38,400 (£40,000 - £1,600)
-Other cash expenses £28,000 (£6,000 + £4,000 + £18,000)
- Fixtures and fittings £30,000
- Owner's drawings £15,000
Total cash£7,700

Table 3. Assets of the company at the end of 2021

Assets: (31.12.2021)
+ Fixtures and fittings £24,000 (£30,000 - £6,000)
+ Inventory £0
+ Prepaid rent £1,000
+ Receivables£900
+ Cash £7,700
Total assets£33,600

Receivables refer to money owed to a firm by its customers.

Table 4. Capital and liabilities of the company at the end of 2021
Capital and liabilities: (31.12.2021)
+ Payables£1,600
Capital:
+ Opening capital£30,000
+ Net profit£17,000
- Drawings£15,000
= total capital£32,000
Total capital and liabilities£33,600

Payables refer to money owed by a firm to its suppliers.

The cash-flow statement of the company would look as follows:

Table 5. Cash flow statement of the company in 2021

+ Net profit£17,000
+ Depreciation£6,000
=£23,000
- Receivables£900
- Prepayments£1,000
+ Trade payables£1,600
= Net inc. working capital-£300
Operating cash flow£22,700 (£23,000 - £300)
- Investing in non-current assets£30,000
+ Financing£15,000
=-£15,000
Net cash flow £7,700 (£22,700 - £15,000)

Important points to mention:

  • Since cash paid for the depreciation is already included in the £30,000 investment in non-current assets, depreciation is added back onto the profit figure. £6,000 was taken off the profit to avoid double-counting it.

  • An increase in receivables is negative to cash flow because by giving credit to customers, the company does not receive cash for sales.

  • An increase in payables is positive to cash flow because by receiving credit from suppliers, the company keeps cash.

  • An increase in prepayments is negative to cash flow because by paying in advance, the company gets rid of cash.

  • 'Financing' consists of new capital introduced and capital withdrawn (can also include loans).

Budget

As you already know, a budget is a form of financial planning. It is forecasting of cash received and cash payable, of incomes and revenues, and the resulting state of the financial health of a company where:

  • cash received and cash payable = cash flow forecast (cash budget),

  • revenues and expenses = budgeted income statement,

  • state of financial health = budgeted balance sheet.

Types of budget

  • A balanced budget is when revenues are equal to expenses.

  • A budget surplus occurs when revenues exceed expenses.

  • A budget deficit occurs when expenses exceed revenues.

Cash budget

A cash budget is an estimation of a business's cash flows over a period of time.

The cash budget can also be defined as a forecast of a company's future financial position. It is usually based on anticipated payments and receivables.

It is 1.01 of year 1 and a company has just issued £100,000 worth of share capital. Its rent of premises costs £8,000 per quarter to be paid quarterly. Salaries cost £15,000 per quarter and will be paid quarterly as well. Patent agents need to be paid £8,000 due in quarter 2, and £12,000 in quarter 4. The initial value of this is £50,000 in quarter 7, rising by 5% per quarter thereafter. Revenues will be received in the same quarter as they are earned. In this case, a revenue stream will begin to accrue in quarter 7. Leases on equipment are to be paid annually in advance: £7,500 per quarter in year 1 and £10,000 per quarter in year 2. It is anticipated that in quarter 6, the company will enter into its first license-to-manufacture agreement.

Table 6. Cash budget of the company (all figures £1000):

year 1year 2
Q1Q2Q3Q4Q5Q6Q7Q8
Opening balance1004716-7-42-105-128-101
License balance0000005052.5
pension88888888
salaries1515151515151515
IP costs080120000
lease equipment3000040000
Total outflows5331233563232323
Net cash flow-53-31-23-35-63-232729.5
Closing balance4716-7-42-105-128-101-71.5

Important points to mention:

  • Total outflows = rent + salaries + IP costs + equipment lease

  • Net cash flow = license balance - total outflows

  • Closing balance = opening balance + net cash flow

Based on the cash budget, the company's closing balance in the first two quarters of 2021 will be positive. Unfortunately, later on, it is expected to drop to below 0 and the company might become insolvent. To keep prospering in the future, the company will need external funding.

Advantages and disadvantages of budgets

AdvantageDisadvantages
Budgets help manage cash flow.Budgets can prevent a company from overspending.
Budgets may identify a possible shortage of cash.Budgets can change and therefore be misleading.
Budgets allow for planning.Budgets can eliminate rewards.
Budgets help to reach goals.It can be hard to estimate the amount of money to be spent and create a budget.

Cash Flow and Budgets - Key takeaways

  • Cash flow is a movement of money.

  • Cash flow statement shows the amount of cash inflows and outflows.

  • Budgets refer to financial planning and forecasting.

  • There are three types of budgets: balance budget, surplus budget and deficit budget.

  • Cash budget shows predicted cash based on earnings and expenses.

Frequently Asked Questions about Cash Flow Budget

Cash flow is the movement of money. It can be either physical or virtual. It is when an amount of cash and cash equivalents are being transferred into and out of a business. 


Budget is a form of financial planning and forecasting. 

The cash flow budget shows predicted cash based on earnings and expenses.

The 3 types of budgets include:

  • A balanced budget is when revenues are equal to expenses.

  • A budget surplus occurs when revenues exceed expenses.

  • A budget deficit occurs when expenses exceed revenues.

Free cash flow = Operating cash flow - Capital expenditures


Free cash flow = Sales revenue - (operating costs + taxes) - required investments in operwating capital.

A cash flow budget is based on anticipated payments and receivables. 

Final Cash Flow Budget Quiz

Question

What is a cash-flow?

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Answer

Cash-flow is a movement of money.

Show question

Question

What is a basic cash flow formula?


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Answer

Free cash flow = operating cash flow - capital expenditures

Show question

Question

What is a cash flow statement?


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Answer

Likewise, by the income statement, cash flow statements show the profit earned and sustained loss by a business entity over a particular period (usually 12 months) and how this figure is concluded. However, instead of showing revenues and costs, the cash flow statement includes cash inflows and outflows.


Show question

Question

What is a budget?


Show answer

Answer

Budget is a form of financial planning and forecasting.

Show question

Question

What are the three types of budgets?


Show answer

Answer

  • Balance budget
  • Surplus budget
  • Deficit budget

Show question

Question

What is a cash budget?


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Answer

A cash budget is an estimation of a business's cash flows over a period of time.

Show question

Question

What are the advantages of budgets?


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Answer

  • Budgets help to manage the cash flow

  • Budgets may identify possible shortage of cash

  • Budgets allow planning

  • Budgets help to reach goals

Show question

Question

What are the disadvantages of budgets?


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Answer

  • Budgets can prevent a company from spending

  • Budgets can change and therefore be misleading

  • Budgets can eliminate rewards

  • It can be hard to estimate the amount of money to be spent and create a budget

Show question

Question

What is solvency?

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Answer

Solvency is an ability of a firm to meet long-term financial obligations.

Show question

Question

What is the difference between costs and cash outflows?

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Answer

For costs, there has been a transaction made whereas for cash outflows, there has also been cash exchanged.  

Show question

Question

What is a cash inflow?

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Answer

Cash sales made to customers 

Show question

Question

What is a depreciation?

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Answer

Depreciation refers to allocating costs of assets over their life expectancy.

Show question

Question

What are receivables?

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Answer

money owed to a firm by its customers

Show question

Question

What are payables?

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Answer

Payables refer to money owed by a firm to its suppliers.

Show question

Question

What is a balanced budget?

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Answer

A balanced budget is when revenues are equal to expenses.

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Cash flow is defined as...

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a movement of money.

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An ability of a firm to meet long-term financial obligations is called...

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solvency.

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 Financial planning and forecasting are referred to as...


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budget.

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When consumers buy products on credit, businesses receive cash. 

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False

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Depreciation refers to allocating ___ over their life expectancy.


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Answer

costs of assets  

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In 2021 a customer bought something on credit. The credit will be paid in 2022. When will a business receive cash inflows?

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2022

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If operating cash flow is £22,700 and capital expenditures are £15,000, then the free cash flow is...


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Answer

£7,700.

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Cash sales made to customers are...

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Answer

both revenues and cash inflows. 

Show question

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Credit payments to suppliers are...

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costs.

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A budget surplus occurs when...


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revenues exceed expenses.

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