Cash Budgeting

Primary costs with selling on credit:

- Bad Debts - Bookkeeping costs - Carrying Costs

Budgeting Cash Receipts

- Historical collection patterns allow a company to forecast cash receipts. - Forecasting cash receipts is step #1 in developing a cash budget. - A cash budget allows a company to anticipate financing needs.

(Budgeting cash receipts) Over time, patterns develop with regard to:

- The ration of cash to credit sales - The timing of collections on the accounts receivable. This helps with forecasting and anticipating financing needs.

What is a common sales discount?

2/10, n/30 (two ten, net thirty), means 2 percent discount allowed if payment is made within 10 days of the invoice date. If the sales discount is not taken, the full amount is due within 30 days of the invoice date.

Peculiar Credit Policies

A company can impact the attractiveness of its offer of credit by varying the particulars of how its credit policies are implemented. Some of those particulars include: - Credit Period - Sales Discounts

A cash budget will have. . .

A number of accounts that are allocated over various months using the pattern of activity.

What accounts typically have a cash budget?

Accounts payable Accounts Receivable Inventory Purchases

Bookkeeping costs (Selling on credit)

Approving a potential customer for credit requires inquiring into their credit history and verifying their income and preexisting obligations. In addition, a billing system of some sort is required to process credit transactions, mail statements to customers, and process collections. These processes take time and money.

Sales Discounts:

Cash reductions offered to customers who purchase merchandise on account and who pay their bill early. The seller is willing to accept less cash than the agreed-upon sales price if the customer will pay within a specified time. The seller benefits because prompt payment decreases both the probability of bad debts and the need for short-term financing.

Carrying costs (selling on credit)

Costs incurred while waiting on receivables to liquidate. Cash invested in certificates of deposit or short-term investment securities can earn a return. When cash is tied up in the form of an account receivable, the opportunity to earn this return is sacrificed. In addition, until the receivable is collected, money to run the company must be obtained elsewhere, perhaps from short-term borrowing.

Credit Periods

Determines when the cash will be collected. For example, credit terms of "net 30 (n/30) indicate that the net amount of the invoice is due within 30 days of the date of sale.

Why do firms need to have cash available?

Firms need to have cash available when bills are due and plan to cover any shortages.

Credit Card Sales:

For businesses that accept bank and finance company credit cards as a form of payment, a credit card sale is the same as a cash sale. In exchange for a fee, Visa, MasterCard, American Express, or Discover will worry about collecting bad debs, covering the bookkeeping costs of tracking credit customers, and bear the finance cost of reimbursing the seller immediately and then waiting for the credit customer to pay the bill.

Granting Credit:

In theory, a firm should extend credit to all customers from whom the cash ultimately collected will (through either partial or full payment on account) exceed the total of the costs of goods sold plus other incremental selling, general, and administrative expenses.

Cash Budgeting

Involves allocating a month's cash activity in a specific account over multiple months. This allocation is pre-determined by the company's historical cash pattern.

Cash Flow Forecasting

Involves projecting cash receipts from sales and payments due on purchases to see if sales will cover purchases. If they don't, they may have to borrow or delay payments.

Bad Debts (Selling on credit)

The odds are when customers are granted credit, some of them will not pay. The result is a loss to the business because, not only does the business not collect the receivable, but often the item that was sold cannot be retrieved.

How is a Sales Discount recorded?

Using a Contra Asset account, meaning that it is a subtraction from sales.

Cash Budgeting provides. . .

Visibility to a company's projected cash inflows and outflows.

contra asset account

an account that is offset against an asset account on the balance sheet