Accounting: The Language of Business - Vol. 1 (Part 133)

Study your accounting. As an entrepreneur, you should not make an excuse not to learn this vital subject. It is, after all, the language of business.
Abdul Malik Omar

 Budgeting (Part F)

by

Charles Lamson

Balance Sheet Budgets

Balance sheet budgets are used by managers to plan financing, investing, and cash objectives for the firm. The balance sheet budgets illustrated for Elite Accessories Inc. in the following sections are the cash budget and the capital expenditures budget.

Cash Budget

The cash budget is one of the most important elements of the budgeted balance sheet. The cash budget presents the expected receipts (inflows) and payments (outflows) of cash for a period of time.

Information from the various operating budgets, such as the sales budget, the direct materials purchases budget, and the selling and administrative expenses budget, affect the cash budget. In addition, the capital expenditures budget, dividend policies, and plans for equity or long-term debt financing also affect the cash budget.

We illustrate the monthly cash budget for January, February, and March 2023, for Elite Accessories Inc. We begin by developing the estimated cash receipt and estimated cash payments portion of the cash budget.

Estimated Cash Receipts

Estimated cash receipts are planned additions to cash from sales and other sources, such as issuing securities or collecting interest. A supporting schedule can be used in determining the collections from sales. To illustrate this schedule, assume the following information for Elite Accessories Inc.:

Accounts receivable, January 1, 2006 …………….      $370,000

Elite Accessories Inc. expects to sell 10% of its merchandise for cash. Of the remaining 90% of the sales on account, 60% are expected to be collected in the month of the sale and the remainder in the next month.

Using this information, we prepare the schedule of collections from sales, shown in Exhibit 15. The cash receipts from the sales on account are determined by adding the amounts collected from credit sales earned in the current period (60%) and the amounts accrued from sales in the previous period are accounts receivable (40%).

EXHIBIT 15 Schedule of Collections from Sales

Estimated Cash Payments

Estimated cash payments are planned reductions in cash from manufacturing costs, selling and administrative expenses, capital expenditures, and other sources, such as buying securities or paying interest or dividends. A supporting schedule can be used in estimating the cash payments for manufacturing costs. To illustrate, the schedule shown in Exhibit 16 is based on the following information for Elite Accessories:

Accounts payable, January 1, 2023 ………….     $190,000

EXHIBIT 16 Schedule of Payments for Manufacturing Costs

Depreciation expense on machines is estimated to be $24,000 per month and is included in the manufacturing costs. The accounts payable were incurred for manufacturing costs. Elite Accessories Inc. expects to pay 75% of the manufacturing costs in the month in which they are incurred and the balance in the next month.

In Exhibit 16, the cash payments are determined by adding the amounts paid from costs incurred in the current period (75%) and the amounts accrued as a liability from costs in the previous period (25%). The $24,000 of depreciation must be excluded from all calculations, since depreciation is a non-cash expense that should not be included in the cash budget.

Completing the Cash Budget

To complete the cash budget for Elite Accessories Inc., as shown in Exhibit 17, assume that Elite Accessories Inc. is expecting the following:

EXHIBIT 17  Cash Budget

In addition, monthly selling and administrative expenses, which are paid in the month incurred, are estimated as follows:

We can compare the estimated cash balance at the end of the period with the minimum balance required by operations. Assuming that the minimum cash balance for Elite Accessories Inc. is $340,000, we can determine any expected excess or deficiency.

The minimum cash balance protects against variations in estimates and for unexpected cash emergencies. For effective cash management, much of the minimum cash balance should be deposited in income-producing securities that can be readily converted to cash. U.S. Treasury Bills or Notes are examples of such securities.

Capital Expenditures Budget

The capital expenditures budget summarizes plans for acquiring fixed assets. Such expenditures are necessary as machinery and other fixed assets wear out, become obsolete, or for other reasons need to be replaced. In addition, expanding plant facilities may be necessary to meet increasing demand for a company's product.

The useful life of many fixed assets extends over long periods of time. In addition, the amount of the expenditures for such assets may vary from year to year. It is normal to project the plans for a number of periods into the future in preparing the capital expenditures budget. Exhibit 18 is a five-year capital expenditures budget for Elite Accessories Inc.

EXHIBIT 18 Capital Expenditures Budget

The capital expenditures budget should be considered in preparing the other operating budgets. For example, the estimated depreciation of new equipment affects the factory overhead cost budget and the selling and administrative expenses budget. The plans for financing the capital expenditures may also affect the cash budget.

Budgeted Balance Sheet

The budgeted balance sheet estimates the financial condition at the end of a budget.. The budgeted balance sheet assumes that all operating budgets and financing plans are met. It is similar to a balance sheet based on actual data in the accounts. For this reason, a budgeted balance sheet for Elite Accessories Inc. is not illustrated. If the budgeted balance sheet indicates a weakness in financial position, revising the financing plans or other plans may be necessary. For example, a large amount of long-term debt in relation to stockholders' equity might require revising financing plans for capital expenditures. Such revisions might include issuing equity rather than debt. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 886-889*

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