Effective cash budgeting: A pre-requisite to business survival   Leave a comment

THE ACADEMY OF BUSINESS STRATEGY

FINANCIAL BUDGET MANAGEMENT BLOG
Effective cash budgeting: A pre-requisite to business survival

AUTHOR
Oluseun Adu (CBS) MBA BS ACA

Sometimes ago I read in an article that Warren Buffet knows a company with growth potentials when he sees it. What he looks at is the company’s ‘intrinsic value’ not necessarily the immediate profitability. What this means is that he focuses on cash flows rather than accounting profit.

The intrinsic value of any business is simply the net present value (NPV) of the future stream of cash flows expected from its operations. Most executives and investors adopt the same perspective when considering acquisitions, mergers and even divestments. If projected cash flows are insufficient to justify the proposed price, they know they should back out of the deal. When it comes to investment decisions and corporate survival, cash flow analysis is never pushed to the background.

In organisations, various types of budgets are prepared for various purposes, but the importance of cash to business continuity makes cash budget perhaps the most important and most sensitive of all other kinds of budget. Much as this may be argued, everyone agrees that no organisation can be run without cash, especially the small, newly established business. Among many other possibilities, the bank will want to examine the cash forecasts of a new b business, and will almost certainly insist on a cash budget before authorizing a loan for a new business. However, I don’t want to give the impression that it is only new, small businesses which find cash budgets important. Organizations, large and small, use them, and so do charities and social clubs. Everyone needs cash.

The Chartered Institute of Management Accountants (CIMA) defines cash budget as “simply a memo statement of estimated cash receipts and expenditure showing deficit or surplus for the period in focus.

Once sales value has been determined, managers translate revenue information into cash receipts through the use of an expected collection pattern. This pattern considers the collection patterns experienced in the recent past and management’s judgment about changes that could disturb current collection patterns. For example, changes that could weaken current collection patterns include recessionary conditions, increases in interest rates, less strict credit granting practices, or ineffective collection practices. In specifying collection patterns, managers should recognize that different types of customers pay in different ways. Any sizable, unique category of clientele should be segregated.

In the same manner, as in estimation of receipts, management must prepare cash disbursement schedule projected into the future. The forecast will include payables to suppliers, rates, rents, salaries and all other activities that involve outflow of real cash.

Although budgeting is not an exact science, neither is it random predictions about future events. Significant care must be taken with underlying assumptions and analysis of future economic c conditions, especially in cash budgeting.

In joint venture (JV) arrangements involving multinational oil corporations (Shell, Chevron, Exxon Mobil et.c) and the host governments, regular cash calls are made by the Operators of the ventures for the running of the business. In most cases, the cash is paid two months in advance based on submitted work programme and phased plan of activities already approved. This way effective budgeting aids the cash call process.

WHAT BENEFITS DO ORGANISATIONS DERIVE
Through effective cash budgeting, companies easily identify periods of potential deficit or surplus. Appropriate actions can then be taken to plan ahead for cost-effective ways of sourcing funds or the best alternative in investing the surplus. Credits or loans hurriedly sourced will not allow for good bargaining and the costs are always high, having adverse effects on the bottom line.

Financial feasibility of plans can easily be ascertained through effective cash budgeting. Earlier alterations or management intervention as the case may be will prevent cases of abandoned projects and ultimately eliminate wastages

Effective cash budgeting helps to drive home the financial implications of policies within the organisation, especially to the non-finance managers. It is an ideal mechanism for instance to demonstrate the effects of obtaining payment from customers in good time or convincing creditors to extend credit periods on favourable terms.

Cash budget provides the basis for monitoring actual activity execution. The frequent comparison of actual cash flow with the budgeted cash flow will enable up to date information to be incorporated into budget revisions.

The information found on the cash budget, coupled with the income statement, and balance sheet, is also used to prepare a Statement of Cash Flows (SCF). This statement can assist managers in judging the company’s ability to handle fixed cash outflow commitments, adapt to adverse changes in business conditions, and undertake new commitments. Further, because the SCF identifies the relationship between net income and net cash flow from operations, it assists managers in judging the quality of the company’s earnings.

Whereas the cash budget is essential to current cash management, the budgeted SCF gives managers a more global view of cash flows by rearranging them into three distinct major activities (operating, investing, and financing). Such a rearrangement permits management to judge whether the specific anticipated flows are consistent with the company’s strategic plans. The beginning point for this however, is an effecting cash budget preparation and management.

Given all the advantages and criticality of cash budgets to business survival and continuity, managers should embrace the preparation, use and continuous improvement on the cash budgeting system. It is too important to be ignored or relegated to the background. It must not be an afterthought, but a proactive way of managing the business.

ABOUT THE AUTHOR
Oluseun Adu (CBS) MBA BS ACA is an approved Certified Business Specialist (CBS) with the Academy of Business Strategy and his specialist subject is financial budget management. He has achieved an MBA from Obafemi Awolowo University, a BS in Accounting from Ilorin University and is an Associate of the Institute of Chartered Accountants of Nigeria (ACA). He is also a Certified Information Systems Auditor (CISA), certification awarded by the Information Systems Audit and Control Association (ISACA). He has been employed as a Senior Asset Accountant and an Operations Manager for various companies and has experience within the oil and gas, manufacturing, banking and financial service industries. His clients or employers have included Shell Petroleum Development Co Ltd, Zenith International Bank Plc and the United Bank for Africa Plc. He has geographical working experience in Nigeria and he speaks English and Yoruba. His service skills incorporate financial budget management, operations, facilitation, communication and management.

To contact Oluseun Adu, please contact the Academy of Business Strategy by forwarding an email.

Posted April 28, 2010 by Susan Lyle in Oluseun Adu (CBS)

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