Question

Stanley has been operating as a sole trader for many years with a year end of 31 December. He is preparing a cash budget and provides the following information for the three-month period from July 2019 to September 2019 1 Total income of $120 000 from trade receivables for credit sales will be collected in equal amounts over the three-month period. 2 Cash sales are expected to be 25% of the cash collected each month from credit sales. There will be no trade receivables at 1 July 2019. 3 Total credit purchases of $75 000 will be paid for in equal amounts over the three-month period. 4 Cash purchases are expected to be 20% of the cash paid each month for credit purchases. There will be no trade payables at 1 July 2019. 5 The bank balance on 1 July 2019 is expected to be $3500. Stanley is expected to receive a bank loan of $30 000 on 1 August 2019. Interest will be payable monthly in arrears at 5% per annum. No capital will be repaid until July 2020. New machinery costing $60 000 will be purchased by cheque on 15 August 2019. Stanley's policy is to depreciate machinery at 25% per annum using the straight-line method. A full year's depreciation is charged in the year of acquisition. 8 Stanley rents part of his business premises for $6000 per annum and receives this rental income on a monthly basis. 9 General expenses are paid for in the month following that in which they are incurred. General expenses incurred in June amounted to $6000. These are expected to increase by 5% in July 2019 and a further 5% in August 2019. 10 Stanley makes annual cash drawings of $15000 in equal instalments on 1 January and 1 July each year. Answer the following questions in the Question Paper. Questions are printed here for reference only. (a) Explain three advantages of preparing a cash budget. (b) Prepare the cash budget for each of the three months beginning on 1 July 2019. Additional information Stanley has calculated the payback period for the new machine as 4 years. He has been advised to evaluate his purchase using the net present value (NPV) method. (c) Discuss how the NPV method might give Stanley a more accurate evaluation compared to the payback method.

Answer 1

Cash Budget
		July	August	September
beginning cash balance		3500	3000	17200
cash receipts from accounts receivables		40000	40000	40000
cash receipts from cash sales-25% of cash receipts from credit sales		10000	10000	10000
rental income		500	500	500
total cash available		54000	53500	67700
Payments:
payment to creditor for supplies		25000	25000	25000
cash purchase-20% of credit purchase payment		5000	5000	5000
payment of interest-30000*5%*1/12				125
purchase of machinary
general expense		6000	6300	6615
annual drawing		15000
total cash payment		51000	36300	36740
excess or shortage of cash		3000	17200	30960
Note: Purchase of machinary is not considered in the cash budget as its payment is done by Check.
Advantages of cash budget	(1) it is a planning tool that helps us to know the requirement of cash in coming future
	(2) it helps in proper investment of excess cash into marketable securities so that additional return can be earned on idle cash
	(3) it helps us to know the timing of cash inflow and outflow and requirement of cash at a particular time
	Yes NPV is a better method of capital budgeting as it tells us the net benefits in monetary term for undertaking the project. It takes into account the concept of time value of money while payback period only tells the time required to cover the initial investment. it does not focus on the profitability of the project. it also ignores cash flow after the recovery of initial investment. so we can say npv is a better method