Finance illustration Finance theory

Budgeting and cash flow

Budgets are statements setting out the planned performance of a business typically in a table made up of numbers. Usually these plans deal with money units (£'s/pence) but they can also consist of other measurable units e.g. units of output. Creating a budget enables an organisation (like Kraft) to plan ahead and then to check on its performance against budgeted figures.

The difference between budgeted figures and actual figures is termed a variance.

Variance is an important management tool because it enables businesses to manage their business - i.e. to take informed decisions based on management information (i.e. how actual performance compares with budgeted performance).eg; either favourable or unfavourable. A favourable variance is one where actual business performance proves to be better than what was budgeted for.

A variance is a difference between what actually happens and what is budgeted to happen.

Arsenal Football Club has budgeted for the following gate receipts from its' next three matches:

You can see that there were positive variances for the match against Wolverhampton (£100,000). There was a disappointing negative variance for the cup match against Hull (-200,000), but the Manchester United game yielded the expected revenue.

As you can see in the table below, the variance may be favourable or adverse.

Budgeting is an important management tool because it enables businesses to manage their business - i.e. to take informed decisions based on management information (i.e. how actual performance compares with budgeted performance).

Advantages of budgeting

1. It gives managers greater control. They can make decisions based on variance analysis. For example, if they spot unfavourable variances they can take actions such as:

  • costs too high - cut out waste or change supplier
  • sales too low - increase advertising/promotion/sales effort
  • production too low - look to remove bottlenecks, labour efficiency etc.

2. It enables forward planning and the setting of targets to work towards. These targets can be set for the various components (e.g. departments) of an organisation.

3. It provides a means of measuring performance - i.e. the budgeted figure is the desired performance. A favourable variance shows that we are exceeding performance targets. An adverse variance shows poor performance.

4. A budget sets motivating targets for everyone to work towards achieving.

Budgets don't have to be set in tablets of stone. Some budgets can be 'flexed' i.e. allowed to be flexible to take account of changing circumstances. A flexible budget is therefore a plan that can be revised in the course of time.

Budgets need to be regularly monitored (i.e. checked) to see if action needs to be taken. There are thus three main stages in budgeting:

A forecast is different to a budget in that :

  • a forecast is an estimate based on past experience
  • a budget is a plan for the future.

Therefore whereas a forecast is passive, a budget is active in that it will probably seek to make changes to what has happened in the past.

Cash flow budget

For example, we can differentiate between a cash flow forecast and a cash flow budget. The cash flow forecast - is a forecast of cash coming into and going out of a business based on previous experience e.g. last month, or last year. A cash flow budget, is a plan usually to generate more cash coming into a business than going out.

In order to prepare a cash budget the accountant needs to know what receipts and payments are likely to take place in the future and the dates when they will happen. It is important find the length of lead time between incurring an expense and paying for it as well as the time lag between making a sale and collecting from debtors. The art of successful cash budgeting is to be able to plan and calculate accurately receipts and expenditures.

A cash-flow forecast is a table estimating (on the basis of previous experience) the amounts of money coming into and going out of a bank account each month.

Usually the cash flow forecast sets out in rows and columns:

1. A totaled up summary of money expected to come into a bank account

2. A totaled up summary of money expected to be paid out of the account

3. The expected bank balance at the end of a period e.g. week, month.

Cash flow forecast for High Street Retailer Ltd For January 2004:

_______________________________________

Opening Balance at 1st January £50,000

Total reciepts for January £6,000

Total payments for January £8,000

Closing balance at end of January £48,000

________________________________________

Supporting Documents

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