## **Learning Outcomes**

After completing this article, you will be able to prepare and interpret cash budgets and forecasts, recognize the importance of scenario and sensitivity analysis in cash planning, and assess the impact of potential changes on an organisation’s cash position. You will also develop the ability to use cash forecasts to support decision-making and anticipate liquidity challenges for the ACCA Foundations in Financial Management (FFM) exam.

## **ACCA Foundations in Financial Management (FFM) Syllabus**

For ACCA Foundations in Financial Management (FFM), you are required to understand the principles and application of cash planning and forecasting. In particular, you should be confident in:

- Defining and preparing cash budgets for short-term financial management
- Distinguishing between receipts and payments within the budgeting process
- Describing the role of scenario analysis in evaluating cash forecasts under different business circumstances
- Applying sensitivity analysis to assess the effect of changes in assumptions and drivers on cash flows
- Interpreting the outcomes of scenario and sensitivity analysis to support decision-making and ensure sufficient liquidity

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. What is the main objective of preparing a cash budget for an organisation?
2. How does scenario analysis differ from sensitivity analysis in the context of cash budgeting?
3. If receipts from customers are delayed by one month, what is the possible impact on the cash budget?
4. What actions might management take if cash forecasts indicate regular negative balances?

## **Introduction**

Effective cash management is essential for every business. Unlike revenue and profit, cash must be available when needed to pay suppliers, employees, and other obligations. Cash shortages can disrupt operations, even in otherwise profitable businesses. Forecasting cash flows through cash budgets allows organisations to anticipate shortfalls and plan for changing business conditions.

This article examines how to construct and interpret cash budgets and forecasts, and highlights the importance of scenario and sensitivity analysis for robust cash planning.

> **Key Term: Cash Budget**
> A financial plan that estimates expected cash inflows and outflows over a specific period, helping organisations manage liquidity and identify funding needs.

## **CASH BUDGETS AND FORECASTS**

Cash budgets are key management tools for predicting the timing and size of cash surpluses and deficits. Unlike profit forecasts, cash budgets track only actual payments and receipts—excluding non-cash accounting entries.

### Structure of a Cash Budget

A typical cash budget includes:

- Opening cash balance
- Expected cash receipts (from sales, loans, asset sales, etc.)
- Expected cash payments (for purchases, wages, interest, etc.)
- Closing cash balance for each budgeted period

Cash budgets are usually prepared on a monthly basis, although weekly or quarterly versions may be used.

> **Key Term: Cash Forecast**
> A projection of future cash inflows and outflows based on expected business activities and assumptions, used for planning and decision-making.

### Uses of Cash Budgets and Forecasts

Cash budgets and forecasts help managers:

- Plan for periods of cash shortage or surplus
- Arrange necessary finance (e.g., overdrafts, loans)
- Make decisions about investment or expenditure timing
- Monitor actual cash movements against projections

## **SCENARIO ANALYSIS IN CASH PLANNING**

Scenario analysis involves preparing different versions of the cash budget based on varying sets of assumptions. Each scenario reflects a possible set of future circumstances—such as optimistic, most likely, and pessimistic cases.

Scenarios often consider factors like:

- Changes in sales volumes or selling prices
- Delays in customer payments
- Variations in supplier credit terms
- Economic or market shocks

This approach equips management to understand the range of possible outcomes and prepare contingency plans.

> **Key Term: Scenario Analysis**
> The evaluation of alternative future conditions by developing multiple versions of a budget or forecast, each based on different sets of assumptions.

### **Worked Example 1.1**

A company expects monthly cash receipts of \$80,000 and cash payments of \$70,000. Management is concerned about potential delays in customer payments due to market uncertainty. They prepare three cash flow scenarios:

- Base case (as planned)
- Delayed receipts (receipts fall to \$65,000)
- Accelerated supplier payments (payments increase to \$80,000)

**Question:** What is the monthly closing cash position in each scenario if the opening cash balance is \$10,000?

> **Answer:**
>
> - Base case: \$10,000 (opening) + \$80,000 (receipts) – \$70,000 (payments) = \$20,000
> - Delayed receipts: \$10,000 + \$65,000 – \$70,000 = \$5,000
> - Accelerated payments: \$10,000 + \$80,000 – \$80,000 = \$10,000

Management sees that a negative scenario could reduce cash reserves rapidly.

## **SENSITIVITY ANALYSIS FOR CASH PLANNING**

While scenario analysis evaluates whole sets of assumptions, sensitivity analysis tests the impact of changing one variable at a time. This helps identify which assumptions have the greatest effect on cash flows and where risks are highest.

For example, management may analyse:

- How will a 10% fall in sales impact cash flow?
- What is the effect if accounts receivable settle later than planned?
- How does a supplier price increase affect cash outflow?

Sensitivity analysis supports risk management and can prompt review of key assumptions.

> **Key Term: Sensitivity Analysis**
> A technique that examines how the outcome of a forecast changes when a single variable or assumption is altered, keeping others constant.

### **Worked Example 1.2**

A retailer forecasts cash sales of \$50,000 and credit sales of \$100,000 per month. Credit customers are expected to pay in the month after sale. What is the impact on cash receipts if 20% of credit customers delay payment by an extra month?

> **Answer:**
>
> Normally, cash receipts for Month 2 = \$50,000 (cash sales) + \$100,000 (prior month's credit sales).
>
> If 20% of credit customers delay payment, then only \$80,000 (80% × \$100,000) is received from prior month's credit sales in Month 2; \$20,000 is delayed until Month 3.
>
> Thus, actual receipts in Month 2 = \$50,000 + \$80,000 = \$130,000.

This highlights the effect of customer payment patterns on cash flow.

## **INTERPRETING CASH BUDGET VARIANCES**

Once actual cash flows are known, they should be compared with those forecasted to identify variances. Unfavourable variances may prompt investigation, such as higher-than-expected expenses or delays in receipts, and lead to corrective action.

Cash budgets are not static—they should be updated and revised as business circumstances change.

### **Worked Example 1.3**

A company forecasted total cash outflows of \$40,000 for the month, but actual payments amounted to \$48,000. On review, the excess was due to unplanned repairs costing \$8,000. How should management respond?

> **Answer:**
>
> Management should assess whether the repair expense will be recurring and update future cash budgets. If the cash shortage was covered by overdraft, they may need to arrange additional finance.

### **Revision Tip**

Regularly compare budgeted and actual cash flows. Investigate large or recurring variances promptly to maintain control over liquidity.

## **Summary**

Cash budgets and forecasts are essential for short-term planning, providing a clear picture of expected cash movements. Scenario and sensitivity analysis strengthen forecasts by allowing businesses to prepare for a range of possible outcomes. Together, these techniques help organisations avoid liquidity problems and support informed management decisions.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Define and prepare a cash budget identifying receipts, payments, and balances
- Distinguish between scenario and sensitivity analysis in cash forecasting
- Apply scenario analysis to model different possible business conditions
- Use sensitivity analysis to measure the impact of critical variables on cash flow
- Interpret variances between forecast and actual cash flows, and revise forecasts as needed

## **Key Terms and Concepts**

- Cash Budget
- Cash Forecast
- Scenario Analysis
- Sensitivity Analysis

Cash budgets and forecasts - Scenario and sensitivity analysis for cash planning