ML is a rapidly growing company which produces luxury food for upmarket cat owners. The owner and director, Mr P, is trying to produce a cash flow forecast to ensure he can afford to invest in a brand-new cat food machine that will be installed in his factory in Northern Ireland. The purchase of the cat food machine will cost £150,000, and Mr P intends to buy it for cash in March. ML has retail customers from its own private shop as well as large supermarket contracts. These customers pay by cash or credit. On average 20% of customers pay by cash while the remaining customers pay by credit. Of the credit customers, one quarter pay in the current month and the remaining three quarters of credit customers pay one month after sale. As Mr P believes the root of his success is his ingredients in the food, he ensures he keeps good relations with the suppliers and tries to pay them in the month of purchase. In reality, he pays 80% in the month of purchase and the balance one month after the purchase. The extension of credit for those he pays one month late carries an additional interest charge of 2% on the balance which is paid at the same time. Months Sales £ Purchases £ Expenses £ Jan 100000 55000 16000 Feb 120000 60000 13000 Mar 200000 80000 14000 Apr 250000 100000 15000 Within expenses Mr P includes £5,000 per month of salary costs, which are paid at the end of month in which they are incurred. The remaining expenses are paid one month after they are incurred and includes depreciation of £1,000 per month. The deprecation relates to a retail van which was bought at £34,000 (cost). It is depreciated monthly on a straight-line basis. On 1 February ML has an opening overdraft balance of £20,000 and an approved overdraft limit of £35,000. Required: (a) Prepare a monthly cash budget for the period February to April inclusive. (b) Using the results of your cash budget, explain what Mr P could do to resolve any overdraft overruns that may arise. (c) Using four examples from the question or from your cash budget, why there are differences between items included in cash budget and those included in the income statement.

Preparing a cash budget allows Mr. P to forecast and monitor the cash inflows and outflows of ML. To resolve potential overdraft overruns, Mr. P can focus on increasing cash inflows, negotiating better credit terms with suppliers, optimizing inventory management, or seeking additional financing.

(a) Monthly Cash Budget for February to April:

February March April

Opening Balance £20,000 £18,000 £32,000

Cash Inflows:

Sales (80% credit) £96,000 £160,000 £200,000

Cash Sales (20% cash) £20,000 £40,000 £50,000

Total Cash Inflows £116,000 £200,000 £250,000

Cash Outflows:

Purchases £60,000 £80,000 £100,000

Expenses £13,000 £14,000 £15,000

Salary Payments £5,000 £5,000 £5,000

Depreciation £1,000 £1,000 £1,000

Cat Food Machine Purchase £150,000

Suppliers (80% credit) £16,000 £20,000

Suppliers (late payment) £4,000

Interest on Late Payment £80

Total Cash Outflows £79,000 £250,000 £125,080

Net Cash Flow £37,000 -£50,000 £124,920

Closing Balance £57,000 £8,000 £157,920

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(b) To resolve any overdraft overruns that may arise, Mr. P can consider the following options:

1. Increase cash inflows: Mr. P can focus on increasing sales by implementing marketing strategies, offering promotions, or expanding the customer base. Encouraging more cash sales would also help improve the cash position.

2. Negotiate better credit terms with suppliers: Mr. P can negotiate with suppliers to extend payment terms or request early payment discounts. This would provide more flexibility in managing cash outflows.

3. Optimize inventory management: ML can adopt efficient inventory management practices to minimize stock holding costs and ensure the right amount of inventory is available to meet customer demand without excessive tied-up capital.

4. Seek additional financing: If the cash flow shortfall is significant, Mr. P could explore short-term financing options such as bank loans, trade credit, or equity investment to cover the temporary cash-flow gap and avoid overdraft overruns.

(c) Differences between items included in the cash budget and those included in the income statement can arise due to:

1. Depreciation: Depreciation is a non-cash expense included in the income statement to account for the wear and tear of assets over time. It does not involve actual cash outflow, so it is not included in the cash budget.

2. Credit sales: The income statement includes revenue from credit sales, which represents the total sales made during the period, including credit sales. However, the cash budget considers only the cash inflows from credit sales received in the respective months.

3. Late payment interest: The income statement does not include interest charges incurred on late payments to suppliers, while the cash budget includes such expenses when they are paid.

4. Cat food machine purchase: The income statement does not directly reflect the one-time purchase cost of the cat food machine. However, it affects future cash outflows in the cash budget when the machine is bought for cash in March.

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