Operating and cash budgets

Learning goals

• Explain how sales, production, materials, labour, overhead, and cash budgets connect.
• Prepare production and direct-material purchases budgets.
• Build collection and payment schedules.
• Identify a financing need even when budgeted operations are profitable.
• Evaluate assumptions, participation, slack, ethics, and scenario risk.

Prerequisite check

1. Why does a sales budget not equal cash collections?
2. What inventory equation resembles beginning + purchases/production − ending?

Vocabulary

• Master budget: coordinated set of operating and financial plans.
• Sales budget: expected sales units and revenue.
• Production budget: units to produce to meet sales and inventory policy.
• Direct-material purchases budget: material needed plus desired ending less beginning material.
• Cash budget: expected receipts, payments, financing, and cash balance.
• Budget slack: intentional understatement of revenue/capacity or overstatement of cost.
• Rolling forecast: plan updated by adding future periods as time passes.
• Scenario: internally consistent set of assumptions, such as base, downside, and upside.

Core idea

Budgets are linked equations:

Production = Sales + Desired ending FG − Beginning FG

Material purchases = Material for production + Desired ending material − Beginning material

Cash schedules then translate revenue/purchases into collection/payment timing. A profitable plan can need financing because customers pay later, inventory is built first, or equipment is purchased.

Why this treatment makes sense

Operations share resources. A sales target without production, labour, material, and cash consequences is not an executable plan. Participation can improve local knowledge and ownership, but pressure and poorly designed incentives can create slack or unsafe targets. A budget is a decision hypothesis to update, not a promise.

A repeatable method

Use ASSUME–LINK–TIME–FINANCE–CHALLENGE:

1. Document price, volume, inventory, productivity, payment, capacity, and economic assumptions.
2. Link sales → production → resources → expenses.
3. Time collections and payments separately from recognition.
4. Add opening cash, minimum balance, borrowing/repayment, interest, and capital spending.
5. Challenge with capacity checks, downside scenarios, owners, approvals, and actual follow-up.

Worked example

Snowline Bottles expects sales of 1,000, 1,200, 1,400, and 1,600 units from January to April at $50. Desired ending finished goods are 20% of next month's sales; January begins with 200 units.

Each unit needs 3 kg of material at $4/kg. Ending material is 10% of next month's production needs; beginning January material is 312 kg. April production is 1,640 units (given May sales 1,800 and the same FG policy).

Collections are 60% in month of sale and 40% next month; December receivables collected in January are $18,000. Collections: Jan $48,000; Feb $56,000; Mar $66,000.

Materials are paid 50% current/50% next; December payable is $5,000. Payments: Jan $11,360; Feb $13,920; Mar $16,320. Direct labour is $8 per unit produced; cash overhead is $5,000 + $2 per unit; cash selling/admin is $4,000 + 5% of sales. Equipment costing $20,000 is paid in March. Opening cash is $15,000.

No borrowing is needed for a $10,000 minimum under the base case, but a downside collection delay could change that conclusion.

Journal, ledger, and statement connection

Budgets do not post to the financial ledger. They provide approved expectations for purchase orders, staffing, and cash planning. Actual sales, production, payroll, purchases, and equipment enter the ledger; budget-versus-actual reports then use one consistent mapping. Budgeted profit and cash differ because of inventory, receivables, payables, non-cash expenses, and capital spending.

Common mistakes

• Using sales units as production units despite an inventory policy.
• Forgetting that one month's ending balance is next month's beginning balance.
• Budgeting material usage as material purchases.
• Applying collection percentages to the wrong month's sales.
• Including depreciation as a cash payment.
• Omitting sales tax, payroll remittances, loan interest, capital spending, or minimum cash in a real budget.
• Forcing an aspirational sales target into every schedule without capacity/evidence checks.

Guided practice

Sales are April 2,000 units and May 2,400. Desired ending FG is 25% of next month; April begins with 500. Each unit uses 2.5 kg; desired ending material is 15% of next month's production needs. If May production is 2,500 and April begins with 700 kg, compute April production and material purchases.

Independent practice

A subscription business forecasts billings of $80,000, $100,000, and $120,000 for Q1. Collections are 70% current, 25% next month, and 5% uncollectible; December receivable collectible in January is $20,000. Cash operating payments are 55% of current billings plus fixed $18,000 monthly, paid currently. Equipment of $35,000 is paid in February. Opening cash is $12,000 and minimum cash $10,000. Prepare the cash budget before financing and determine borrowing needed at each month-end if borrowing occurs in $1,000 increments. Ignore interest, and do not repay borrowing within the quarter.

Self-check and solutions

Guided: April production = 2,000 + 600 − 500 = 2,100 units. Production material = 5,250 kg. Desired ending material = 15% × May needs 6,250 = 937.5 kg. Purchases = 5,250 + 937.5 − 700 = 5,487.5 kg. Check whether fractional kg purchase units are feasible.

Independent: Collections: Jan 70%($80,000)+$20,000 = $76,000; Feb 70%($100,000)+25%($80,000)=$90,000; Mar 70%($120,000)+25%($100,000)= $109,000. Payments excluding equipment: $62,000; $73,000; $84,000.

Jan pre-financing ending = $12,000+$76,000−$62,000 = $26,000, no borrowing. Feb = $26,000+$90,000−$73,000−$35,000 = $8,000, so borrow $2,000 to reach $10,000. March opening including borrowing $10,000; ending = $10,000 + $109,000 − $84,000 = $35,000. Borrowing remains $2,000 because repayment was disallowed. The 5% uncollectible amount affects expected cash and should also be considered in revenue/impairment planning under the reporting basis.

Retrieval practice

1. Write the production and materials-purchase equations.
2. Why can profitable growth create a cash shortfall?
3. Name four assumptions a cash budget needs.
4. Contrast a static budget with a rolling forecast.

Exam-style application

Sales in June and July are 5,000 and 6,000 units. Desired June ending FG is 30% of July sales; beginning FG is 1,400. A student budgets June production at 5,000. Find correct production and explain the error.

Target: 5,000 + 1,800 − 1,400 = 5,400 units. The student ignored the 400-unit planned increase in finished goods.

Lesson summary

A useful budget links sales to resources and times cash separately. Make every balance roll, expose financing needs, and challenge assumptions before the plan drives hiring, purchasing, or performance pressure.