Financial Appraisals 12-1-2012

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The Steps to Create a Cash Budget

When you are running a business, cash flow is one of

the most critical aspects of your success. Without

enough cash on hand, your business could end

prematurely, even if sales are strong. Creating a cash

budget can help you determine how much cash you

need on hand to be successful.

1. Determine Duration

o A cash budget will help you determine how

much money you will spend and bring in during a

certain period of time. When creating a cash

budget, determine the length of time that your

budget will cover. Some businesses use a cash

budget on an annual basis while others like to use a

quarterly cash budget. Some businesses go even

further and create a monthly cash budget. This

allows you to focus on a specific period in the life of

your business.

Cash Inflows

o One of the most essential parts of the cash

budget is determining how much cash you will

bring in during the specific period for the budget.

For example, if you are using a monthly budget,project how much you will be bring in during that

time. Look at how much you project for sales and

any other sources of cash that you could count on.

Expenses

o You also need to determine how much you

will have in expenses. These expenses could include

anything that you will pay with cash during the time

period. If you have to pay for it during the budget

period, you need to include it in your cash budget.

This will give you an idea of how much money is left

over if everything goes as projected.

Making Changes

o If you do a cash budget and you determine

that you will not have enough money to meet your

obligations, you have to make some changes. This

might include eliminating some expenses or

figuring a way to increase cash inflows. You might

even need to take out some type of business loan

so that you can cover your expenses during the

period of the budget. If you do not make the

necessary changes, you may be out of business

sooner than you had planned.

HOW TO CREATE A CASH BUDGET There are three

main components necessary for creating a cash

budget. They are:

y Time period

y Desired cash position

y Estimated sales and expenses

Time Period

The first decision to make when preparing a cash

budget is to decide the period of time for which your

budget will apply. That is, are you preparing abudget for the next three months, six months,

twelve months or some other period? In this

Business Builder, we will be preparing a 3-month

budget. However, the instructions given are

applicable to any time period you might select.

Cash Position

The amount of cash you wish to keep on hand will

depend on the nature of your business, the

predictability of accounts receivable and the

probability of fast-happening opportunities (or

unfortunate occurrences) that may require you to

have a significant reserve of cash.

You may want to consider your cash reserve in termsof a certain number of days' sales. Your budgeting

process will help you to determine if, at the end of

the period, you have an adequate cash reserve.

Estimated Sales and Expenses

The fundamental concept of a cash budget is

estimating all future cash receipts and cash

expenditures that will take place during the time

period. The most important estimate you will make,

however, is an estimate of sales. Once this is

decided, the rest of the cash budget can fall into

place.

If an increase in sales of, for example, 10 percent, isdesired and expected, various other accounts must

be adjusted in your budget. Raw materials, inventory

and the costs of goods sold must be revised to

reflect the increase in sales. In addition, you must

ask yourself if any additions need to be made to

selling or general and administrative expenses, or

can the increased sales be handled by current excess

capacity? Also, how will the increase in sales affect

payroll and overtime expenditures?

Instead of increasing every expense item by 10

percent, serious consideration needs to be given to

certain economies of scale that might develop. In

other words, perhaps, a supplier offers a discount if you increase the quantities in which you buy a

certain item or, perhaps, the increase in sales can be

easily accommodated by the current sales force; all

of these types of considerations must be taken into

account before you start budgeting. Each type of

expense (as shown on your income statement) must

be evaluated for its potential to increase or

decrease. Your estimates should be based on your



experience running your business and on your goals

for your business over the time frame for which the

budget is being created. At a minimum, the following

categories of expected cash receipts and expected

cash payments should be considered:

y Cash balance:

o Expected cash receipts

o Cash sales

o Collections of accounts receivable

o O

ther incomey Expected cash expenses:

o Raw material (inventory)

o Payroll

y Other direct expenses:

o Advertising

o Selling expenses

o Administrative expense

o Plant and equipment expenditures

o Other payments

What Are the Uses of Cash Budgeting Procedures?

Original post byMichaelWolfe of DemandMedia

After a company has prepared its operating budget,

it will often draw up a separate cash budget as a

means of tracking income and cash expenditures

throughout the year. Such a budget has a number of

practical uses, all of which center around being able

to accurately predict when the company will be flush

and when cash flow may be restricted.

Map Inflows and Outflows

The primary use of a cash budget is that it allows a

company to map out expected inflows and outflows

of cash during a specified period of time, usually a

year. This map will take into account when the

company expects to receive revenues and when it

may need to spend those revenues on expenses not

covered in the operating budget. This serves as a

road map, giving the company a rough outline of

how much cash it will need during the year.

Predict Cash Shortages

One advantage of cash budgeting is that this method

can be used to accurately predict when the company

will have less cash on hand than it might need to runthe business. This gives the company the option to

plan ahead and either shift cash inflows or obtain

additional funds in advance. By predicting cash flow

trends, the company can avoid having a midyear

cash crunch.

Show Potential Surpluses

In addition to predicting cash shortages, cash

budgeting is an excellent tool for predicting when a

company will have more money than it would

normally expect. By detecting surpluses, particularly

long-term surpluses, the company can potentially

target other uses for this money. Investing the

money back into the business is generally more

profitable in the long term than keeping large cash

reserves.

Calculate Borrowing

If the company discovers in the course of preparing

its cash budget that it will have a cash shortage that

cannot be resolved by diverting funds from other

sources, the company may choose to borrow money.

By knowing how much cash it will have on hand, the

company will be able to ascertain how much money

it needs to borrow as well as when it will be able to

repay the loan.



How to Construct Pro Forma Statements

Pro forma financial statements are documents that

project a company's upcoming financial activity.

They are usually prepared as part of a business plan

and submitted to potential sources of financing such

as banks and investors. Pro forma statements should

be constructed to include the standard financial

projections that belong in every business plan:

balance sheet, income statement and cash flow

projection. In addition, a pro forma should include a

list of the assumptions on which it is based.

1Construct a pro forma income statement detailing

your expected business earnings and expenses

during the period covered by your business plan. For

each year, list each category of income, along with

the amount of revenue you expect it to generate.

Total your sources of income to calculate your gross

pro forma earnings.

Also list each category of expenses that your

business typically incurs, such as rent, labor and

materials, and add these figures to calculate your

gross pro forma expenses.Subtract your pro forma expenses from your pro

forma earnings to figure your net pro forma income.

o 2 Construct a pro forma cash flow projection. Use a

spreadsheet and label each column with the months

of the year, using the far left column to label your

categories of cash and expenditures. Label the top

line in the left hand column "Incoming Cash" and list

each source of revenue on the top part of the page,

including investment funds and loans, and income

from business sales. Label the bottom section of the

page "Outgoing Cash" and list each type of expense

your business incurs, including payroll, loan

payments, and interest payments. Enter the

amounts you expect your business to earn and take

in on a monthly basis in each of the categories you

have listed.

Subtract each month's outgoing cash from that

month's incoming cash, and use the resulting figure

as the available capital at the outset of the following

month.

o 3 Construct a pro forma balance sheet. Use the top

portion of the page to list all of your projected assets

at the end of the period covered by the business

plan, such as cash reserves, equipment value, and

inventory. Use the bottom portion of the page to listyour projected liabilities at the end of the period

covered by the business plan, including outstanding

debts and accounts payable. Subtract your projected

liabilities from your projected assets to calculate

your pro forma net worth.

o 4 List the assumptions you have made in

constructing your pro forma, such as projections that

your sales will increase by ten percent per year

during the period covered by the business plan.

Include details about how you believe the funds you

are requesting in your business plan will help to

generate additional income. Be specific, and quantify

each of your assumptions.

What is the difference between independent and

mutually exclusive projects?

An independent project is one in which accepting or

rejecting one project does not affect the acceptance

or rejection of other projects under consideration.

Therefore, no relationship exists between the cash

flows of one project and another. A mutually

exclusive project is one in which the acceptance of

one precludes the acceptance of other projects.



Capital Expenditure Authorization (CEA) Process

Capital Expenditures

A Capital Expenditure is the amount used during a

particular period to acquire or improve long-term

assets such as property, plant or equipment.

A Capital Asset is a long-term asset that is not

purchased or sold in the normal course of business.

Generally, it includes fixed assets, e.g., land,

buildings, furniture, equipment, fixtures and

furniture. The university accounts for these

expenses as assets rather than operating expenses,

because they are resources which have extended,

useful lives. For example, a classroom will be utilized

for many years, whereas office supplies will not.

Capital ExpenditureAuthorization Process

The Capital Expenditure Authorization (CEA) Process

begins when a department or school identifies the

need for a specific project or capital equipment

purchase. Capital Authorization Requests are

requested, authorized and managed in an electronic

web-based system.

1. Department or school representative

determines a need for a Capital ExpenditureAuthorization (CEA).

2. Department or school representative gathers

information and documents specific, written

details of what the expenditure will constitute,

accompanied by a justification addressing the

necessity of the expenditure.

3. Department or school representative must

contact the Budget and Fiscal Officer (BFO) of

their respective school, prompting the need for

processing a CEA request.

4. In doing so, one must forward all related

information as an attachment, including:

o Name of Individual Requesting

o Name of Individual Responsible (for

managing project)

o Associated department/school

o Location of the project (campus)

o Project Title

o Cost/Expenditure breakout

o Equipment Type (if applicable)

o Justification of its need and all

recommended funding sources (if

known)

5. The BFO then performs a needs assessment of

the request. If the request meets all associated

requirements and is deemed fiscally prudent,

he/she will move to designate the funding

source(s) and record the request into the Tufts

University CEA System.

6. Once recorded into the University CEA System,

the request routes through a system generated

approval workflow (which varies, depending

upon CEA type, project location, funding sources

and amounts)

7. Once all approvals have been gained, the

request becomes a project and representatives

within the General AccountingOffice will

systematically assign a Project/Grantnumber and authorize its budget within the

PeopleSoft Financials system.

8. All capitalized expenses related to the CEA

can then be charged to the Project/Grant

number assigned and managed/tracked

within PeopleSoft.



The Capital Expenditure Process

Capital expenditures are expenditures that will help

a business produce revenues in more than one time

period. In contrast with revenue expenditures that

are recorded as single-period expenses, capital

expenditures are recorded as assets so that their

values can be amortized over time in much the same

manner as normal assets. Capitalized expenditures

possess residual values, useful lifespans and aredisposed of at the end of their usefulness in the

same manner as normal assets.

Matching Principle

Matching principle in accrual basis accounting

requires that costs be recognized in the same time

period as the revenues that their occurrence helped

produce. Capital expenditures exist because their

occurrences help produce revenues across multiple

time periods, meaning that their values should be

spread out and recorded as expensew in each of the

periods in which their occurrence helped produce

revenue.

CapitalizationCapitalization is the act of recording an expenditure

as an asset rather than an expense. Capital

expenditures have their entire values recorded as

assets upon capitalization. For example, $100,000 in

research and development costs for a patent is

recorded as $100,000 in patent when capitalized.

Amortization

Capitalized expenditures have their values written

off as amortization expense over the multiple time

periods of their usefulness. Accountants amortizing

capitalized expenditures can choose to either write

amortization expenses in each period as a directdetriment to the asset or accumulate it as a contra-

asset that represents how much the asset has lost in

value.

End of Usefulness

Capitalized expenditures have their values reduced

to zero at the end of their usefulness in the same

manner as other assets that are either depreciated

or amortized. If the accountant chose to record

amortization expense as a direct detriment to the

asset, that asset should have the last of its value

written off as the amortization expense of its last

period, and no further accounting is required. If the

accountant chose to record the expenses as acontra-asset, then both the asset and the contra-

asset are written off completely at the end of the

asset's usefulness, thus preventing a one-time

single-period loss from the asset's disposal that

would distort the business's income statement.

Documents

Financial Appraisals 12-1-2012