How is it used and applied?
The forecasting of cash collections is important in predicting whether sufficient cash will be available to meet expenditure needs. Further, the more quickly cash is received from customers, the less is the risk of noncollection. In addition, a return can be earned on the cash received early.
13. “What-if” Analysis
Introduction
Managers make decisions in the fact of uncertainty or risk. The environments in which they operate are subject to change without notice. It is therefore advisable to set up “what-if: scenarios and analyze them with the aid of computer software.
How is it computed?
Many “what-if” scenarios can be evaluated using the concepts of contribution margin as a tool for profit planning. Contribution margin is the difference between sales and the variable cost of a product or service; it is the amount of money available to cover fixed costs and generate profits.
Example 1
To illustrate a ‘what-if: analysis, consider the following data for the Allison Toy Store:
Let us suppose that, in an effort to stimulate sales, the owner is considering cutting the unit price by $5 and increasing the advertising budget by $1000. If these two steps be taken? To answer the question, you may construct a proposed income statement as follows:
The answer is yes, since these two steps will increase net income by $500.
Example 2
Delta Gamma Manufacturing wishes to prepare a 3-year projection on net income using the following information:
1.20×8 base-year amounts are as follows:
| Sales revenues | $4,500,000 |
| Cost of sales | 2,900,000 |
| Selling and administrative expenses | 800,000 |
| Net income before taxes | 800,000 |
2.Using the following “what-if: assumptions:
Figure 13.1 shows a spreadsheet for the pro forma income statement for the next 3 years. Using a spreadsheet program such as Excel allows managers to evaluate various “what-if” scenarios.
Figure 13.1: Delta Gamma Manufactures: three-year income projections (20×8-20×11)
Can a Computer Help?
Performing “what-if: analyses without the aid of a computer is almost impossible. “What-if” software includes:
1.Spreadsheet programs such as: Lotus 1-2-3, Microsoft’s Excel, and Quattro Pro.
2.Cash management and accounting software such as Quicken and Up Your Cash Flow.
3.Decision-support and budgeting software such as: Adaptive Planning, ®Risk, and BudgetMaestro.
How is it used and applied?
The cash budget would be incomplete if it were based on only one set of estimated cash inflows and cash outflows. These figures may well be expected cash flows or even most likely estimates, but we need to consider the possibility of errors or variability in cash flow estimates. Table 13.2 lists the principal known and uncertain cash flows.
The variability in cash flows can be handled by ‘what-if” analysis or by optimistic/ pessimistic forecasts. For example, what if your cash sales were, say, 10 percent higher, or lower, than originally expected? A cash budget prepared for a worst-case scenario might be quite useful. It may also allow you to plan better for difficult times.
Table 13.1: Certain and Uncertain Cash Flows
| Known cash flow | Uncertain cash flow |
| Interest receipts | Cash sales |
| Rent | Collections |
| Payroll | Payable payments |
| Tax Payments | |
| Interest Payments | |
| Loan repayments | |
| Purchase of long-term assets |
14. Budget Accuracy Ratios
Introduction
The accuracy of a budget may be evaluated by comparing budget figures to actual figures. The closer the actual amounts are to the estimates, the better is the budget process and the greater is the reliance that may be placed on future projections.
How is it computed?
Example
An owner budgeted profit for $800,000, but the business actually earned $1,000,000. The reasons for this favorable result might be one or more of the following:
How is it used and applied?
There is no assurance that a plan designed to increase earnings will in fact do so. However, if actual profits exceeds budgeted profits, the owner has achieved the profit goal. This may arise because of greater revenue than expected, or better control over costs than anticipated.
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