Budgeting In budgeting, we bring together analyses of cash flows, projected income

Budgeting In budgeting, we bring together analyses of cash flows, projected income

statements, projected balance sheets. The cash flow analyses are most important, though you also need to generate the income statement and balance sheet as well.

Most firms extend or receive credit, so cash flows and net income do not coincide. Typically, you must determine cash flows from accounting information on revenues and expenses. Combining sales projections with our estimates of collections of accounts receivable results in an estimate of cash receipts.

Suppose you have the following sales projections for the next six months:

Month Sales

Month

Sales

Month Sales

July $300,000

November $300,000 August

September $900,000

December 300,000 How do you translate these sales estimates into cash receipts? First, you

need an estimate of how long it takes to collect on your accounts. You can estimate the typical time it takes to collect on your accounts using the financial ratio,

Accounts receivable

Number of days of credit = ---------------------------------------------------

Credit sales per day This tells you how long it takes, on average, to collect on accounts

receivable. Suppose the number of days credit is thirty. This means that a sale made in January is collected in February, a sale made in February is collected in March, and so on. If you had sales of $300,000 in the previ- ous June, your estimate of cash receipts for July through December is:

Month Sales Collections on Receivables

July $300,000 $300,000 ← From June sales August

September 900,000

October 600,000

November 300,000

December 300,000

Strategy and Financial Planning

An alternative, and more precise method, is to look at the aging of receivables—how long each account has been outstanding—and use this information to track collections. However, this requires a detailed esti- mate of the age of all accounts and their typical collection period.

Whether you use an overall average or an aging approach, you need to consider several factors in our cash collections estimate:

■ An estimate of bad debts—accounts that will not be collected at all; ■ An analysis of the trend in the number of days it takes customers to

pay on account; and ■ An estimate of the seasonal nature of collections of accounts; often cus- tomers’ ability to pay is influenced by the operating cycle of their own firm.

As with revenues and cash receipts, there is a relation between expenses and cash disbursements. Firms typically do not pay cash for all goods and services; purchases are generally bought on account (creating accounts payable) and wages and salaries are paid periodically (weekly, bi-monthly, or monthly). Therefore, there’s a lagged relationship between expenses and cash payments.

You can get an idea of the time it takes to pay for your purchases on account with the number of days of purchases:

Accounts payable

Number of days of purchases = ---------------------------------------------------------------

Average day’s purchases And you can determine the time it takes to pay for wages and salaries by

looking at the firm’s personnel policies. Putting these two pieces together, you can estimate how long it takes to pay for the goods and services you acquire.