FINANCIAL INFORMATION AND ITS ANALYSIS FROM INCOME STATEMENTS TO CASH FLOW EGADE Business School Tecnolégico de MonterreyIn the previous topic we talked about the cash flow statement, which is important to know where the company is getting cash from, and how they are using it. This analysis is done taking the information concentrated by financial accounting as a starting point, thus, itis information towards the past, and it is also information that can be available for external users of the latter. Additionally, the management of the company needs to know at different terms, the flows and cash requirements in order to anticipate any shortfall that must be covered or any excess to be invested. The tool that is used is usually a cash budget as was explained in the corresponding video. Here we will delve into this tool. A budget is nothing else but a plan that shows income and expenses of the different areas of the company. To be more specific, the cash budget shows the expected income and expenses throughout a specific period. In order to establish this budget, it is necessary to estimate the level of activity of the whole company to have a reliable estimation. Therefore, before calculating the cash budget the following budgets are needed, mainly related to the income statement: INCOME STATEMENT Sales cost * Direct materials + Direct workforce + Indirect manufacturing expenses Capital investments —_— Sales budget This budget is usually calculated either according to the profit goals of the company, or to the analysis of the marketing department. For the purpose of the current topic, data provided by the management will be taken into account. Production budget. This budget represents whatever will be produced in a given period, this is important as it tells us the level of activity required in the company, over which expenses will be calculated. In order to have this information, it is necessary to know expected sales, an expected final inventory, and theinitial inventory of the period. Considering a final inventory is relevant, that is, a surplus, in order to have a margin to increase production if the market conditions would favour it. Sometimes there are special conditions in the market which favour or hinder sales, it is important to consider these conditions in our plans. An example can be the scarcity of a substitute product which attracts More customers to our company. Sales cost budget By budgeting sales we are making an estimation of the potential income of the company, we must also estimate the expenses related to obtaining that income. Therefore, itis necessary to estimate the costs directly associated to sales. Additional to the production budget, it is necessary to have the purchase budgets, workforce, and indirect manufacturing expenses. - Purchase budgets: in order to determine the amount to be bought of each required material, the following is needed in production: The materials needed for the production according to their budget, an expected final inventory of each material, and the expected initial inventory of the period. O ‘ @- Workforce budget: according to the production level it is necessary to estimate the workforce hours that will be necessary to complete the given production. Companies usually have necessary estimated times for each product unit. - Indirect manufacturing expenses budget: these expenses are those that cannot be directly associated to each product, for instance, the electric energy of the plant, or the salaries of the supervisors and quality control. It is necessary to estimate these costs at plant level for the budget period Indirect Purchases Workforce manufacturing budget budget expenses budget Budget of finance, management and sales general expenses The company must estimate the level of necessary expenses to support the operation throughout the period included in the budget. These expenses include those that are not part of the production plant such as the wages of the management staff, sales, marketing, etc. Production Budget De ECU PCE esl feta (oS ated Sold Budget Dict a tog Cost Budget BUTTE OTT Ca Expenses Budget eto ol mel) (eersa site isThe previous budgets are part of the income statement. Additionally, the income and expenses related to capital goods must be estimated, that is, sales or purchase of long-term assets The cash budget can be developed with the previous estimations. Cash budget Cash Budget is very important as it enables management to: Know the cash shortfalls and surplus in order to take investment or finance decisions. Identify cash inflows and outflows to Eye meen io Evaluate the collection and payment policies in order to move inflows forward and delay outflows if necessary. COUR Rae CN is not idle, but it is invested while it is emer It is important to analyze cash behaviour at different terms: - Long-term: it enables to have a general vision of the company according to its expected growth. - Short-term: it enables to make an estimation of cash according to the annual profits plan, and to plan short-term investments of the surplus while they are requested. - Immediate term: it enables the treasury department to know the daily cash requirements, and avoid any non-compliance related to the lack of liquidity. Any short-term non-compliance can be covered with a revolving line of credit.| | | Long-term | | Short-term | Cash behaviour The cash budget can also diagnose liquidity problems and suggest the best financial alternatives according to the company's cash needs. Some alternatives to cover the expected shortfalls can be: - Managing the collection and payment policies. ~ Give discounts for the customers to make payments-in-advance. - Benefit from discounts to save in payments to suppliers or negotiate longer terms which will enable to collect from customers before paying suppliers. - Selling short-term investments (of previous surplus, for instance) - Selling long-term investments - This option is more complicated than the previous one and it can generate losses by having to quickly sell a long-term investment - Requesting available lines of credit ~ It is common for companies to have open lines of credit with the banks they work with to cover any unforeseen situation.XYZ SA de CV. Cash Budget For three months, ending in March 31* , 2020. Sales in cash $108,000 $124,000 $97,000 Portfolio recovery 953,200 ‘1,058,400 970,200 Interest income 24,500 Total of assets $1,061,200 $1,182,400 __ $1,091,700 Expected liabilities: Manufacturing costs payment $802,000 $771,000 $780,000 Management costs payment 160,000 165,000 145,000 Capital assets _ 274,000 a Interests expenses 22,500 _ a Taxes _ 150,000 Total of liabilities $1,210,000 _ $1,075,000 Increase(decrease) Cash “$76,700 $(27,600)_—~$16,700 *Initial cash balance 280,000 356,700 329,100 **Final cash balance $356,700 329,100 345,800 Minimum expected balance 340,000 340,000 340,000 Cash Surplus (shortfall) $16,700 $10,900) $5,800 *Initial balance: balance of the balance sheet of the previous period **Final balance: balance of the balance sheet of the current period As can be seen in the image, it is common for companies to decide on a minimum amount to have in cash in order to cover immediate expenses, as well as for any unforeseen situation.EGADE Business School Tecnoldgico de Monterrey Se prohibe la reproduccién total o parcial de esta obra por cualqluier medio sin previo y expreso consentimiento por escrito del Instituto Tecnolégico y de Estudios Superiores de Monterrey. 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