Harbourline Services: Cash Budget and Budgeting Process
Harbourline Services provides cleaning and maintenance under rolling contracts. Existing contracts bill £200,000 per month. A new contract begins in August and adds £60,000 per month. Customers pay 70% in the month after invoicing, 28% two months after, and 2% is never collected. May and June billings were each £200,000. Wages and consumables are paid in the month and run at 55% of that month's billing. Cash overheads are £24,000 per month; this is the cash portion of a quarterly overhead budget of £90,000 that includes £18,000 of depreciation. Harbourline plans to buy equipment for £150,000 in August and to pay a tax bill of £60,000 in September. Opening cash on 1 July is £20,000. The finance director prepares the overhead budget by uplifting last year's figure by 2%, although supplier prices are running at 6%. Department managers have begun submitting inflated cost estimates and delaying maintenance into the following year.
1. Prepare a monthly cash budget for July, August and September and identify the peak funding requirement.
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Receipts
- July: June 70% (140,000) + May 28% (56,000) = 196,000
- August: July 70% (140,000) + June 28% (56,000) = 196,000
- September: August 70% (260,000 × 70% = 182,000) + July 28% (56,000) = 238,000
Payments
- Wages/consumables: July 110,000; August 143,000; September 143,000
- Cash overheads: 24,000 each month (the £18,000 depreciation is not a cash flow)
- Equipment: 150,000 in August; tax: 60,000 in September
Cash budget
| July | August | September | |
|---|---|---|---|
| Opening cash | 20,000 | 82,000 | (39,000) |
| Receipts | 196,000 | 196,000 | 238,000 |
| Wages and consumables | (110,000) | (143,000) | (143,000) |
| Cash overheads | (24,000) | (24,000) | (24,000) |
| Equipment | – | (150,000) | – |
| Tax | – | – | (60,000) |
| Closing cash | 82,000 | (39,000) | (28,000) |
Peak funding requirement: £39,000 at the end of August, and the account remains overdrawn at the end of September. Harbourline should arrange an overdraft facility of about £50,000 to leave headroom for timing differences, or defer part of the equipment purchase. Note also that 2% bad debts on £200,000 a month is £4,000 a month of permanently lost cash, and that the new contract's receipts only begin to arrive in September.
2. Evaluate the finance director's incremental approach to the overhead budget and recommend improvements.
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A blanket 2% uplift is indefensible when input prices are rising at 6%. It builds in a real cut of about 4% and, because it is applied to last year's total, it also preserves whatever waste and slack that total contained. The result is predictable: managers either overspend and blame inflation, or protect themselves by inflating next year's requests and deferring maintenance - both symptoms are already visible.
The budget is also structurally out of date. The new contract changes activity, supervision and consumable use, so a volume-driven budget is needed rather than a prior-year roll-forward. Recommended changes:
- Zero-based or activity-based budgeting for overheads. Rebuild the cost base from activities and drivers at least every three years, with a lighter review in between, so each cost must be justified rather than inherited.
- Separate price and volume effects. Uplift known contractual and supplier increases (6%) and adjust separately for activity changes (the new contract), so the two effects are not netted into one meaningless percentage.
- Rolling forecasts. Extend the cash budget continuously over 12 months, because the new contract and the equipment purchase create a short-term funding profile that an annual budget will not capture.
- Flex the budget for control. Compare actual overheads with a flexed allowance at actual activity, otherwise the contract's extra volume will generate spurious adverse variances.
- Sensitivity analysis on the 2% bad-debt rate and on the timing of the new contract's receipts, since both move the peak overdraft.
3. Discuss the behavioural and control consequences of the current budgeting process and how budgetary control should respond.
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The process is top-down and the targets are not credible. When a budget is set by an unexplained percentage, managers learn that the number is a negotiating position rather than a plan. They respond rationally by padding estimates, which destroys the informational value of the budget, and by shifting costs across the year-end, which damages the assets and service quality the budget is supposed to support. Deferred maintenance is a classic sign that the manager is optimising the reported variance rather than the operation.
There are also control weaknesses. If the overhead budget is not flexed, unfavourable variances will appear simply because activity rose with the new contract - and managers will be blamed for volume they were told to deliver. If the only reported figures are price and volume totals, planning errors such as the 6% supplier inflation stay hidden and demoralise the managers who cannot control them.
The response should combine participation with scrutiny. Involve department managers in building the zero-based overhead estimates, so targets are owned, but support the discussion with driver data and benchmarks. Report flexed variances, split planning from operational effects, and investigate variances on a threshold-and-pattern basis rather than in isolation. Set explicit rules against year-end cost shifting, for example by tracking maintenance backlog as a non-financial measure alongside the financial variance. Finally, link rewards to a balanced set of measures - cost, service quality and delivery - so that protecting the budget is not the only route to a bonus.