Budgeting (Grade 11 NSC Matric Accounting): Revision Notes
Purpose of a Budget
Introduction to budgets
Understanding budgets is essential for any business owner or manager. A budget helps you plan ahead and make informed financial decisions. Let's explore what budgets are and why they matter for business success.
What is a cash budget?
A cash budget is a financial planning tool that estimates the amounts of money a business expects to receive and pay out during a specific time period. Think of it as a financial roadmap that shows where money will come from and where it will go. This tool is crucial for effective management and helps businesses maintain control over their finances.
A cash budget focuses specifically on cash transactions – money that actually moves in and out of the business bank account. This makes it different from other financial statements that may include non-cash items.
The difference between projected income statements and cash budgets
While both are planning tools, they serve different purposes:
A projected income statement helps a business decide whether it can continue operating based on expected income and expenses. It forecasts future financial performance and shows what the business expects to earn and spend. This differs from a regular income statement, which records what actually happened during a past financial period.
A cash budget, on the other hand, focuses specifically on cash flow – when money actually enters or leaves the business.
Critical Timing Difference
A business might be profitable on paper but still run out of cash if money comes in too slowly or goes out too quickly. The timing of cash movements is crucial for business survival.
Why businesses need budgets
Budgets serve three main purposes that help businesses succeed:
1. Staying within financial limits
Budgets help ensure that businesses don't spend more money than they have available. By planning expenses in advance, business owners can see whether their expected income will cover their costs. This prevents overspending and helps maintain financial stability.
2. Identifying risks
When creating a budget, businesses must think carefully about future income and expenses. This planning process helps identify potential financial problems before they occur. For example, a business might realise that expenses will exceed income during certain months, allowing them to prepare solutions in advance.
3. Finding funding when necessary
Budgets provide evidence that can help businesses secure loans or investments. When approaching a bank or investor, a well-prepared budget demonstrates that the business has a clear financial plan and understands its funding needs. This makes lenders more confident about providing financial support.
Components of a cash budget
A cash budget has two main sections: receipts (money coming in) and payments (money going out). Let's examine each category in detail.
Cash receipts (money coming in)
These are all the ways cash enters the business. Common examples include:
- Cash sales: Money received immediately when selling goods or services
- Debtors collection: Payments received from customers who bought on credit
- Interest received: Earnings from investments or bank accounts that pay interest
- Disposal of assets: Cash received when selling business assets like equipment or vehicles
- Investment maturity: Money received when investments reach their maturity date and are paid out
- Rent income: Cash received from renting out property or equipment owned by the business
- Bad debts recovered: Money collected from debts that were previously written off as uncollectable
Cash receipts represent actual money flowing into your business bank account. They don't include promises to pay or amounts owed to you – only actual cash received.
Cash payments (money going out)
These are all the ways cash leaves the business. Common examples include:
- Cash purchases: Immediate payment for stock or supplies
- Payments to creditors: Paying suppliers for goods purchased on credit
- Operating expenses: Regular monthly costs like rent, salaries, utilities, and insurance
- Loan repayments: Money paid to reduce outstanding loans
- Cash purchase of fixed assets: Buying equipment, vehicles, or property with cash
- Investments: Money spent on purchasing investments
- Money withdrawn by owner: Cash taken by the business owner for personal use (drawings)
What doesn't appear in a cash budget
This is extremely important to understand: certain items appear in income statements but never in cash budgets because they don't involve actual cash movement.
Non-Cash Items Never Appear in Cash Budgets
These non-cash items are excluded because no actual money changes hands:
Items excluded from cash budgets:
| Non-cash item | Explanation |
|---|---|
| Depreciation | This is the decrease in value of assets over time. It's an accounting expense but no money actually leaves the business |
| Discount allowed | While this reduces the amount received from debtors, it's already reflected in the lower cash collection amount |
| Discount received | Similarly, this reduces what you pay creditors and is reflected in the lower payment amount |
| Bad debts | These are debts written off as uncollectable. Since no cash is received, they don't appear in the cash budget |
| Trading stock withdrawn by owner | When owners take stock for personal use without paying cash, no cash transaction occurs |
Special note about stock withdrawn by owner
If the business owner regularly takes stock for personal use each month, this must be replaced through purchases. In this case, the replacement stock appears as a purchase in the cash budget. The original withdrawal itself doesn't appear because no cash changed hands at that moment.
Worked example: Mulaudzi Spaza monthly income forecast
Let's look at how to prepare a projected income statement using actual business data. This helps illustrate how budgets work in practice.
Worked Example: Preparing a Projected Income Statement
Business background
Mulaudzi Spaza is a small retail business. The owner needs to project income for April and May 20.7 to plan for upcoming changes in the business. The business ended the previous year (31 March 20.7) with the following annual results:
- Turnover: R585,000
- Gross profit: R195,000
- Operating profit: R140,204
- Net profit: R127,004
Planning for April and May
The business expects several changes during these two months:
Sales changes:
- April sales will decrease by 20% compared to the monthly average
- May sales will increase by 28% compared to the monthly average
Income items:
- The gross profit margin (relationship between sales and cost of sales) will remain the same
- Monthly rent income will increase by 7% from 1 April 20.7
- Discount received will stay constant at the same monthly level
Expense changes:
- Bad debts will increase by R100 in May 20.7
- Insurance premium increases by 10% annually on 1 April
- Water and electricity expenses will remain the same
- Easter promotion campaign from 2-10 April will cost R2,000
- Employees receive a 7% salary increase from 1 May 20.7
- New employee medical aid contribution starts 1 May 20.7: R428
Other information:
- No fixed assets will be purchased or sold
- Depreciation: 20% per annum on cost of fixed assets
- Fixed deposit investment: R30,000 invested on 30 April for 3 years at 6% per annum
- Loan repayments: R18,000 on 1 April each year, with outstanding balance of R120,000 at 31 March 20.7, at 11% interest per annum
How to approach this problem
To create the monthly forecast, you need to:
- Calculate monthly averages from the annual figures by dividing by 12
- Apply the percentage changes for April and May sales
- Maintain the gross profit margin to calculate cost of sales
- Adjust each expense according to the given information
- Calculate interest on the loan and investment where applicable
This example demonstrates how businesses use historical data and expected changes to create realistic projections for planning purposes.
Practical tips for budgeting
Exam Tips:
- Read carefully: Always check whether you're preparing a cash budget or a projected income statement – they're different!
- Watch the dates: Pay attention to when changes take effect (like the 1st of a month)
- Remember non-cash items: Don't include depreciation, bad debts, or discounts in cash budgets
- Show your calculations: In exams, show how you arrived at figures for partial marks
- Check your gross profit: Ensure your gross profit margin calculation is consistent
Common Mistakes to Avoid:
- Including depreciation in cash budgets
- Forgetting to adjust for percentage increases or decreases
- Mixing up receipts and payments
- Ignoring the timing of when cash is actually received or paid
- Confusing discount allowed with discount received
Summary of key concepts
Understanding budgets helps businesses make better financial decisions. Here's what you need to remember:
Key Concepts to Remember:
Definition: A cash budget projects estimated cash receipts and payments for a specific period, serving as a management and control tool.
Purpose: Budgets help businesses stay within financial limits, identify potential problems, and secure funding when needed.
Components: Cash budgets include all cash receipts (money in) and cash payments (money out), but exclude non-cash items like depreciation and bad debts.
Planning value: Projected income statements help businesses forecast profitability and decide whether operations can continue profitably.
Remember These Critical Points:
- A cash budget only includes actual cash transactions – money that moves in or out of the bank account
- The three main purposes of budgets are: staying within limits, identifying risks, and finding funding
- Depreciation, discounts, and bad debts are non-cash items that never appear in cash budgets
- Projected income statements and cash budgets serve different purposes – know which one you're preparing
- Good budgeting requires careful attention to timing – when does money actually change hands?