Calculation of Cash Budget

Describe about the Management and Cost Accounting for Corporate Finance?

Uniform Ltd.

Cash Budget

For the Period October to February

Particulars Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	October	November	December	January	February
Beginning Cash Balance	£80,000	-£12,000	-£504,000	-£436,000	-£368,000
Cash Collections :
Cash Sales	£400,000		£560,000	£560,000	£560,000
Total Cash Inflow	£480,000	-£12,000	£56,000	£124,000	£192,000
Cash Payments :
Raw Materials	£112,000	£112,000	£112,000	£112,000	£112,000
Others Production Cost	£280,000	£280,000	£280,000	£280,000	£280,000
Fixed Cost	£100,000	£100,000	£100,000	£100,000	£100,000
Total Cash Payments	£492,000	£492,000	£492,000	£492,000	£492,000
Ending Cash Balance	-£12,000	-£504,000	-£436,000	-£368,000	-£300,000

Budgeting

Budgeting is the process for planning for future expenses and revenue (Bhimani, 2012). All the items of expenses and revenues are forecasted in budgeting process. Budget is prepared for future period. When the actual time comes, the budgeted figure of all costs and incomes are compared with the actual budgeted figure. The difference between the budgeted and actual figure is called Variance.

The objective of budgeting is to control and track the expenses with the available funds (Drury, 2012). It ensures that the costs should not exceed than the available resources. There are mainly two kind of Corporate Budget: Operating Budget and Capital Budget.

Capital Budget is done to forecast the expenses for capital expenditures (Epstein and Lee, 2009). The assets are acquired in capital budgeting for long-term utilization and these are highly expensive (Fields, 2011). Depreciation is applied on such kind of assets.

Operating Budget

Capital Budget

Operating budget is done to forecast the operating expenses related with the business operation (Horngren, 2011). Operating expenses of business organization is generally not changed over the period. If there is any changes happened in operation due to reduction in sales or any other obstacles.

Budget includes three basic elements which are described below:

Sales Revenue

Sales revenue is most vital elements in a budget. The futures sales should be estimated suitably as much as possible because all others figures are made on the basis of sales revenue (Wilks and Burke, 2008). It is required to check or track the past sales history for estimating the future sales figures. After determination of future target sales, it can be possible to calculate the required necessary expenses related with the sales figures.

Total Cost

Total cost involves two aspects of cost such as fixed cost and variable cost. The costs which does not vary with sales, is called fixed cost. Fixed costs become fixed whatever sales turnover increases or reduces such as factory rent. The costs which vary with the changing level of sales volume. At the time of estimation of variable cost, it is required to consider the inflation and market forces (Young, 2012).

Profit

Profit is the amount earned deducting the total costs incurred from the sales revenue. The amount of profit should be that much which can make a sufficient from the business operation.

Cash Budget

Cash budget is also a part of operating budget. Cash budget is prepared to plan and control the short-term spending (Seal, Garrison and Noreen, 2012). Cash budget is mainly done on monthly basis. But it can also be prepared on weekly, quarterly and annual basis. Cash budget includes both cash inflows and cash flows. In cash budget, the possible expenses and possible incoming of cash flows are estimated (Seal, Garrison and Noreen, 2009).  Cash budget shows how the level of cash in hand changed with the spending.

Budgeting Process

Budget is developed and implemented by the organization on periodic basis at certain intervals (Shim and Siegel, 2009). According to the norm of private industry, it is required to produce a plan in each fiscal year. Budget is also prepared by some government organization. Budgeting process is the process of planning and decision between the time of issuance a budget and the next budget (Weetman, 2010).

Budgeting

The steps of budgeting process followed by the Uniform Ltd are as follows:

The company asses the actual and estimated figures of the budget of previous year for developing the next budget.

The company should focus and identify the needs and objectives for the future period.

Certain things are needed to identify and evaluate by the organization such forecasts of revenue, current trends and risk associated. Current trends are the changes in business operation such as spending, staffing level and business volume.

It should ensure that the entire budget plan is to be developed in consistent format.

It is to be ensured that the procedures and techniques would be implemented in the plan and actual expenses and cash inflows are to be monitored.

Before developing the plan, the budget proposals are approved by the responsible person for reviewing.

The company should follow the local rules and policies to develop the budget proposals and the full package of budget proposal should cover the organizational objectives.

Planning orientation

Budget is prepared from the short-term view or daily-to-daily business operation. But it also tries to emphasize on the long-term thinking. So, the main objective of the budget is to plan for future. The objective of the budgeting still work though the management of the organization fails to achieve the goal according to the outline of the budget because it focuses at least on the competitive and financial position of the organization and on the improvement.

Assumption Review

The process of budgeting helps to identify the objective of business and also to assume the key things regarding the business environment. It these issues are re-evaluated time-to-time, the assumptions will also alter.

Performance Evaluation

The performance of the worker can evaluated through budget. The company set the goals for a budgeting period and can also promise to pay the bonuses and incentives according to their performance. After comparing the budget and actual report, it can be appraised the performance regarding the progressing to meet their goals.

Cash Allocation

If there is limited cash available for the investment in fixed and working capital, the procedure of budgeting is very much important to determine the most worthy assets which are required to invest in business operation.

Bottleneck Analysis

Budgeting process also creates focus on the bottleneck whether to increase the capacity or to shift work.

PART B

Amount £000

Calculation of Payback

Option A

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Net Cash Flow	-1320	990	660	495	330	330
Cumulative Cash Flow	-1320	-330	330	825	1155	1485
Payback Period (year)	1.5

Option B

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Net Cash Flow	-1650	578	660	825	1073	1155
Cumulative Cash Flow	-1650	-1072	-412	413	1486	2641
Payback Period (year)	2.5

According to the payback period, Victorplc should select Option A because it has lower payback period i.e. 1.5 years.

Calculation of ARR

Option A

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Initial Investment	-1320
Cash In Flow		726	396	231	66	66
Average Accounting Income	297
ARR	23%

Option B

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Initial Investment	-1650
Cash In Flow		248	330	495	743	825
Average Accounting Income	528.2
ARR	32%

 

Option B has highest ARR i.e. 32%. So, it can give more annual income. Therefore, the company should select Option B.

Calculation of NPV

Option A

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Cash Outflow	-1320
Cash Inflow		990	660	495	330	330
Discount Rate	15%	0.8695	0.7561	0.6575	0.5717	0.4972
Present Value		860.87	499.05	325.47	188.68	164.07
Total Present Value	2038.14
Net Present Value	718.14

Option B

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Cash Outflow	-1650
Cash Inflow		578	660	825	1073	1155
Discount Rate	15%	0.8696	0.7561	0.6575	0.5717	0.4972
Present Value		502.61	499.05	542.45	613.49	574.24
Total Present Value	2731.84
Net Present Value	1081.84

Option B has NPV more than the Option a i.e. £1081840. So, option B should be selected.

Calculation of IRR

Option A

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Net Cash Flow	-1320	990	660	495	330	330
IRR	43%

Option B

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Net Cash Flow	-1650	578	660	825	1073	1155
IRR	37%

The IRR of Option A is more than the Option B i.e. 43%. Therefore, the company should select Option B.

Cash Budget

Recommendation according to the various appraisal method

Playback Period

Payback period is calculated to find out the span of time needed to recover the cost of investment (Daly and Barkakati, 2010). According to that the decision is taken whether to undertake the project or not. Longer the payback period is not suitable for investment. When two or more projects are considered in capital budgeting, the project having shortest payback period is accepted because it can recover the initial investment of project quickly

According to Payback period approach, all the cash flows are forecasted from the project which it will earn in future. The period of recovering the cost of project is calculated. This method is usually applied by the business to set a limit of time within which the cost should be recovered.

The one of the important advantage of Payback period is that it is simple to calculate. Under this method, it is not required like other methods of capital budgeting to convert all the expected cash flows into present value adjusting the discounting factor. The calculation is straightforward. All the expected cash flows are added and then the initial cost of the project is subtracted from that.

The payback period method is associated with the short time prospect. This approach implies that the project will generate cash shortly and the initial cost will recovered within the shortest time. So, the risk is lower.

Payback period method does not consider time value of money. Discounting factor is not applied to discount the expected cash inflows. But, in real economy, the value money is affected by the time. The cash flows are expected to earn but the value is expected for future may be less in present time. Also, the inflation is not adjusted in this approach. But, the inflation has greater impact on economy.

The risk of recovering cost is minimized by this method. The risk is less for short-term oriented project. But, the risk is more for long-term oriented project. The organization may earn more return from a high risky project.

According to Payback period method, the project having short payback period is better for the investment. The organization can earn any other benefits after the end of payback period which is ignored by this method. So, it does not measure profitability. If the organization a short time limit, it may miss the future benefits of the project.

Accounting Rate of Return

ARR determines the annual income that can be earned from the project (Marlowe et al., 2009). For the calculation of ARR, average accounting income is divided by the average investment of the project. If ARR is same to or more than the required rate of return, the project is selected. In the situation of mutually exclusive, the project with highest ARR is selected.

Advantages

ARR is also simple to calculate like payback period method.

ARR considers the profitability factor.

Disadvantages

Likewise Payback period, it also does not consider time value of money.

The calculation of ARR can be done in various ways. Consistency is the problem of ARR.

In ARR method, accounting is used except the cash flow. If the maintenance costs of a project are high, it is not perfect for the investment because cash inflows influence the viability.

NPV

Net Present Value is the current value of future cash flows expected from an investment option including residual value, if any, less the initial outlay of the project (Peterson and Fabozzi, 2002). In capital budgeting, the profitability of an investment option is measured by the NPV. It is one of the most reliable methods because time value of money is adjusted by using discounted cash inflows.

To calculate the NPV, first the expected cash inflows are converted into present value with discounting factor. The net cash flows may be equal or may different. If they are equal, annuity formula is used to calculate the present value. In case of different cash flows, all the cash inflows are converted in present value individually.

Budgeting Process

Strengths

The strength of the Net Present Value is NPV always gives importance to the value of money in respect to time. NPV always calculate the cash inflow of the present value. In Net Present Value, it calculates both the cash flow to find out whether to invest in the project or not. The Net Present Value always gives high priority to the profitability (Pike and Neale, 2009). If the financial analyst calculate and found that the project return is less, the financial analyst will not allow investing in that project. It also gives high priority to the risk factor of the project.

Limitation

The cash flows for the future are estimated and it may different from the actual figures (Wyatt, 2012). It is the main drawback of NPV. This is due to the assumption of discounting rate. The use of Net Present Value is very difficult. In the Net Present Value, it is very difficult to find the accurate discount rate. The Net Present Value sometimes does not give the correct calculation, when the life of the project is unequal.

IRR

It is known that IRR can be employed if the company knows the investment cost and annual cash flows. Therefore, the company can determine the accurate rate of earnings that can deliver the expected return at some point of time that is five years. The company, Victorplc by applying IRR can disclose the high rate of return that can be generated from the project. Apart from that, the company need to study the market condition to whether the market feasible for the production of proposed project or not. The market will let know about the cost of raw materials, labour cost, numbers of competitors, etc. Therefore, it will help the company to take effective decision and gain much expected higher benefit from the project. On the other side, in order to improve the analysis, the company may need to acknowledge all the cost related to building cost, installation cost, raw material cost, manufacturing cost, etc so that exact return can be evaluated in order to be sure that production of the machines can ensure expected return.

Moreover, in accounting IRR methods, the company need to determine the value of cash flow after tax so that exact valuation can be identified and ensuring effective return rate (Berk and DeMarzo, 2009).  Apart from that, cash flow analysis can be useful in analysing decision. The company may need to estimate the cash outflow that is expenditure and also the cash inflows that is revenue which will help in analysing the net cash that may be available in the project. Therefore, the company can be able to take decision on the available projects.

It is known that investment decision technique is effective for any business to take identify the project that can ensure high return. Therefore, in order to analyse the decision two capital budgeting techniques has been used that are discounting method which relate with the Net Present Value and the non-discounting method which relate to Pay Back period (Pogue, 2010). The discounted method is effective in determining the stock value and the also provide details that how much company can accumulate cash after meeting all financial obligations. Apart from that, non-discounted method can be too effective in analysing the project decisions and the company can be able to know the expected time period to recover the invested amount. On the other hand, both the capital budgeting methods comprises some strengths and weakness that can be related with the investment decision. Therefore, the company may need to consider the major weakness before making up any decision so that higher benefit can be received and increasing cost can be controlled. Thus, the strength and limitation of the payback will be discussed along with the strength and restriction of net present value so that extracted analysis can be improved.

In case of independent project or a single conventional project both IRR and NPV provide same indicator about whether to accept or reject the project (Smart, Megginson and Graham, 2010). But the conflict arises for mutually exclusive project. It can be observed that one project higher NPV while the other has a higher IRR. The relative size of the project and the cash flows distribution of project are different. So, the conflict arises. When facing such situation, the higher NPV project should be accepted because NPV is an absolute measure (Watson and Head, 2011). Through NPV, the investment options can be ranked in terms of exact monetary value. According IRR, the investment options can be ranked in terms of best investment return. So, it is a relative measure.  On the other hand, firm or organization can employ Internal Rate Return (IRR) to avoid the drawback of NPV which arises due to discounting factor. So, for the budgetary process, organization needs use both NPV and IRR as investment appraisal process.

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