Master Budget

1. The cash budget — the planned cash receipts and payments and the closing cash balance. 2. The budgeted statement of profit or loss — the planned profit for the period. 3. The budgeted statement of financial position — the planned assets, liabilities and capital at the period end.

(a) Depreciation → No (non-cash). (b) Cash from credit customers → Yes (a receipt, when received). (c) Purchase of a delivery van → Yes (a capital payment). (d) Drawings → Yes (a cash payment).

Closing cash = 6,000 + 48,000 − 54,500 = −$500. A negative balance indicates the business will be overdrawn and needs $500 of finance (e.g. an overdraft) to cover the shortfall.

March: closing cash = 4,000 + 60,000 − 55,000 = $9,000. April: opening cash = $9,000 (carried forward); closing cash = 9,000 + 58,000 − 66,000 = $1,000.

Comment on April: receipts ($58,000) were less than payments ($66,000), so the business had a net cash outflow of $8,000 in April. It avoided going overdrawn only because of the $9,000 brought forward from March, ending with a small $1,000 balance. This is a warning sign: if April's pattern continued, the business would soon run out of cash, so it should plan to improve cash flow or arrange finance for the following months.

May's receipts = March's credit sales (two-month credit) = $40,000. May's payments = wages 15,000 + equipment 20,000 = $35,000. Closing cash = 30,000 + 40,000 − 35,000 = $35,000.

Depreciation is the spreading of an asset's cost over its useful life — it is a non-cash expense, so no cash leaves the business when it is charged. The budgeted statement of profit or loss is prepared on the accruals basis and must include depreciation as an expense to match the using-up of the asset against the period's revenue, so it appears there. The cash budget, however, records only actual cash movements, and since depreciation involves no cash flow, it is excluded. (The cash outflow occurred when the asset was bought, which appears in the cash budget at that time.)

This is possible because profit and cash are not the same thing. The budgeted statement of profit or loss is prepared on the accruals basis, so a healthy budgeted profit does not guarantee cash. Cash can be drained even while profit is good because: profits are tied up in rising inventory and receivables (credit customers pay later than the sale); the business may be spending cash on non-current assets (capital expenditure) and loan repayments, which reduce cash but not profit; drawings or dividends take cash out; and depreciation reduces profit without using cash. The cash budget captures the timing of all these cash flows and so reveals the shortage that the profit figure hides.

To deal with the forecast shortage, the business should act in advance: arrange finance such as a bank overdraft or short-term loan to cover the gap; speed up cash inflows by tightening credit control or offering prompt-payment discounts; delay cash outflows by postponing capital spending or taking the full credit period from suppliers; and possibly reduce drawings/dividends temporarily. The key advantage of the cash budget is that it gives this early warning, allowing the problem to be managed before it becomes a crisis.

1. Identifies cash shortages in advance — by scheduling receipts and payments period by period, the cash budget shows when the business may run short of cash, so it can arrange finance (e.g. an overdraft) or adjust the timing of spending before the problem occurs. 2. Identifies cash surpluses — it also shows when the business will have surplus cash, which can be invested or used to repay debt or fund expansion rather than sitting idle. (It also aids planning and control of cash flow.)

The functional budgets are the building blocks of the master budget. The sales, production, purchases, labour and overhead budgets provide the figures for the budgeted statement of profit or loss (revenue and costs → budgeted profit). The receivables, payables, sales and purchases budgets provide the timing of cash flows and the closing balances used in the cash budget. The closing balances from all the budgets — inventory, receivables, payables, cash and non-current assets — together with the budgeted profit, are then used to construct the budgeted statement of financial position. So every functional budget flows into one or more of the three master-budget components, producing a single coordinated financial plan.

The cash budget is regarded as especially important because it shows, period by period, whether the business will have enough cash to meet its commitments — it reveals cash shortages or surpluses in advance. This allows management to act early, for example by arranging an overdraft or loan to cover a forecast shortage, or investing a surplus. Since a business can be profitable yet still fail through a lack of cash, the cash budget provides the early warning needed to manage liquidity and avoid a cash crisis.