Cash budget and receivables policy decision
Matai Retail is preparing a cash budget for the June quarter. Opening cash is $12,000. Budgeted sales: April $80,000, May $90,000, June $100,000, July $110,000. Historically 50% of sales are cash and 50% on credit. Credit customers pay 60% in the month after sale and 40% two months after sale. Bad debts are negligible. Purchases are 60% of the following month's sales and are paid in the month of purchase. Operating expenses are $18,000 per month, paid in the month incurred. A tax payment of $25,000 is due in June. Equipment of $40,000 will be bought in May. The bank requires a minimum cash balance of $10,000 each month. Opening receivables from March credit sales are $20,000, collectable in April.
1. Prepare the cash budget for April, May and June, and identify any month where the minimum balance is breached.
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Cash receipts
Credit sales: April 40,000; May 45,000; June 50,000.
- April: cash sales 40,000 + 60% of March credit (20,000 x 60% = 12,000) + 40% of February credit (not given, assume nil) = $52,000.
- May: cash sales 45,000 + 60% of April (24,000) + 40% of March (8,000) = $77,000.
- June: cash sales 50,000 + 60% of May (27,000) + 40% of April (16,000) = $93,000.
Payments
Purchases: April = 60% of May sales 90,000 = 54,000; May = 60% of June 100,000 = 60,000; June = 60% of July 110,000 = 66,000.
- April: 54,000 + 18,000 = $72,000.
- May: 60,000 + 18,000 + 40,000 = $118,000.
- June: 66,000 + 18,000 + 25,000 = $109,000.
Closing cash
- April: 12,000 + 52,000 - 72,000 = -$8,000 (breach).
- May: -8,000 + 77,000 - 118,000 = -$49,000 (breach).
- June: -49,000 + 93,000 - 109,000 = -$65,000 (breach).
The $10,000 minimum is breached in every month; the position deteriorates sharply in May due to the equipment purchase.
2. Recommend actions to maintain the minimum cash balance, and evaluate the trade-offs of each.
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Options
- Delay the equipment purchase to July. This removes $40,000 from May, improving May and June closing cash to -$9,000 and -$25,000. Trade-off: may delay operations or incur a higher price; still does not solve the deficit.
- Arrange an overdraft or short-term loan. The peak deficit is about $65,000 plus the $10,000 buffer, so a facility of roughly $75,000 is needed. Trade-off: interest cost and covenant conditions.
- Accelerate receivables via early-settlement discount or stricter credit control. Collecting 40% of April credit (16,000) in May rather than June shifts $16,000 earlier. Trade-off: discount cost reduces margin.
- Negotiate tax instalment timing with the tax office. Trade-off: may not be permitted; penalties.
- Reduce purchases by holding less inventory. Trade-off: stock-out risk and lost sales.
Recommendation: Arrange a $75,000 overdraft as the primary measure, since the deficit is timing-related and reverses when July sales (110,000) and collections rise. Combine with tighter receivables follow-up. Delaying equipment is a secondary lever only if operations allow.
3. Explain why a profitable business can still breach its cash requirements, using the figures.
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Profit vs cash
Sales for the quarter are $270,000. Assume a gross margin; even if profitable, cash is absorbed by:
- Credit sales timing: 50% of sales are collected later, so April cash receipts ($52,000) are far below April sales ($80,000).
- Purchases paid in the month of purchase while sales are collected over two months - a mismatch that drains cash as sales grow.
- Capital expenditure of $40,000 is a cash outflow but is not an expense in the same period (it is capitalised and depreciated), so profit does not fall by $40,000.
- Tax payment of $25,000 is a cash outflow that may relate to prior profit.
Conclusion: Profit measures accrual performance; cash measures timing. Growth in sales increases working capital (receivables and inventory), consuming cash. The business needs a funding buffer sized to its peak deficit, not just a profitable income statement.