EXC 2122 Session no. 2 - 19.01.

2023
From budgeted profit to expected net cash flow
Today's topics:
1. When is budgeted profit equal to net cash flow?
2. Incoming cash flows
3. Outgoing cash flows
4. Accounts Receivable and Accounts Payable
5. Changes in net working capital has an impact on cash flows
6. Value Added Tax has an impact on cash flows
7. Why should we make cash flow budgets?

© Tor Olav Nordtømme, BI Norwegian Business School 2023

1. When is budgeted profit equal to the net cash flow?
Budgeted income statement 2023 Does this mean that we have 2.5 million more on our
Sales income 35 420 000 bank account at the end of the year?
Costs of goods sold 22 680 000 No, only under the following quite unrealistic
Depreciation 640 000 assumptions:
Salaries and personnel 5 370 000 1. The balance of Accounts Receivable remains the same
Other operational costs 3 080 000 from Jan 1 to Dec 31
2. The balance of Accounts Payable remains the same from
Budgeted operational profit 3 650 000
Jan 1 to Dec 31
Financial income 50 000 3. We disregard the effect of Value Added Tax (VAT)
Financial costs 540 000 4. We pay social security contribution the same month as
Budgeted profit 2023 3 160 000 we pay our employees
Payable taxes 660 000 5. We pay holiday pay each month, together with the
Budgeted profit after taxes 2 500 000 salaries
6. We pay the corporate taxes the same year as they occur
7. We invest exactly as much as we take as depreciation
costs
8. We don't pay loan installments and have no new loans
9. We don't pay dividend and we don't emit new shares
2. Incoming cash flows
With a cash flow budgeting model, we must predict how our bank statement will look in a
defined period:
Opening balance January 1, 2023 3 265 387.89
Incoming payments 8 263 469.55
Outgoing payments 9 091 635.06
Closing balance January 31, 2023 2 437 222.38
The net cash flow in January is: 8 263 469.55 - 9 091 635,55 = - 828 165.51

Who will pay us?

• Our customers that can be split in two main groups:
• Those that pay cash
• Our credit customers that will be a part of our Accounts Receivable until the claim is settled
• Somebody we sell a fixed asset to
• A bank or another creditor, if we take up a new loan
• A bank, if we have interest-bearing deposits
• A financial institution or investor if we realize a financial gain from various derivates or sell shares in
other companies
• Our share holders, if the company emits new shares
3. Outgoing cash flows
Who do we pay?
• Our suppliers that can be grouped in three main groups:
• Suppliers of raw material and components for production
• Suppliers of goods for resale
• Suppliers of services and equipment ("other operational costs")
• Employees: Payments of net salaries and holiday pay
• The tax authorities: Payments of VAT, employer's contribution to the social security system, employees'
withheld tax (*)
• Sellers of various types of fixed assets: We may for instance buy property, machinery, IT-equipment,
furniture and fixtures or new company cars
• Banks and other creditors: We may pay back our loans
• Banks and other creditors: We may pay interest costs
• Our investors: We may pay dividend to the shareholders
• Issuers of financial instruments: We may realize a financial loss and pay for this

We will normally not include employees' withheld tax in a cash flow budget, because it is not the
(*)

company's money. The company deducts this on the payroll (PAYE) and pay on behalf of its employees.
4. Accounts Receivable and Accounts Payable
To be able to make a precise and detailed cash flow budget, we would need much information
about how our customers behave:
• How many pay on the invoices’ due dates?
• Does anyone pay before the invoice is due?
• How many pays after a week, 14 days, a month…
• Do we have budgeted costs any for credit losses or we assume that all credit customers will pay (sooner or
later)?

As a simplification we can use the average effective credit period instead. Here is an example:
• The formal credit period is 20 days, but a large portion are late payers, so the average actual credit period
is for instance 30 days
• If we assume that all months have 30 days and sales are evenly distributed over the planning period, all
sales in month 1 are paid by the end of month 2
• The balance of the Accounts Receivable will then be credit sales for the last 30 days
• If we instead assume that the customers pay after 45 days, the first half of the sales in month 1 is paid in
month 2 and second half is paid in month 3. The balance of the Accounts Receivable will then be credit
sales for the last 45 days.
4. Accounts Receivable and Accounts Payable
Same can be said about the suppliers:
• If we need to make a precise cash flow budget, we need to know the formal credit period of each of our
suppliers.
• Some may require payment after only 15 days, others after 45.

We may also here simplify and make an estimation of the average actual credit period instead:
• If we assume that we pay all our suppliers after 30 days and assume that all months in the planning
period have 30 days and that the purchases are evenly distributed over the planning period, what we
buy in month 1 is paid in full by the end of month 2
• The balance of the Accounts Payable will then be all the credit purchases for the last 30 days
5. Changes in net working capital has an impact on cash flows
The net working capital is the difference between the current assets and the short-term liability:
Current assets Short-term liabilities
Inventory Accounts Payable
Accounts Receivable Payable taxes
Other short-term liabilities Other short-term liabilities
Bank deposits
A high net working capital helps to secure the company's operations, but there are two things we
need to consider:
1. If we want to increase the average net working capital over a defined period, this will have a
negative impact on the net cash flow. We shall investigate this further next week.
2. The current assets don't normally contribute much to the value creation of the company:
• We shall try to optimize inventory levels
• We would rather have the money on our bank account than having them tied up in
Accounts Receivable
• And we don't get much interest on a bank deposit nowadays anyway.
5. Changes in net working capital has an impact on cash flows
Because the size of the balance sheet has a direct impact on the Return on Investment-ratio, we
need to be careful that the various balance sheet items don't grow out of control:
• What is the optimal net working capital?
• What is sufficient bank deposit balance?
• What is the optimal level of equity?

If we want to improve our Return on Investment (ROI), we have two different approaches:
1. Main emphasize on income, costs and revenues, by trying to improve the rate on return of sales,
without increasing the capital turnover rate too much
2. Main emphasize on the balance sheet, by trying to reduce the capital turnover rate, at the same time
we try to maintain the relative profits
The DuPont model was presented for the first time 100 years ago, but it is still valid:
6. Value Added Tax has an impact on cash flows
The Value Added Tax (VAT) system is a way to tax private consumption of goods and services,
which currently is employed by 193 countries in the world, including all EU and OECD countries,
except USA. In some countries, such as France, VAT is the major source of public revenue.
The VAT system is based on the following structure:
• When a company sells goods or services that are VAT liable, it is mandatory to register for VAT, and to
charge VAT to the customers when sales of goods and/or services are registered. We call this output
VAT: The VAT that is a part of an outgoing invoice or sales receipt.
• The VAT registration also gives the company the right to deduct VAT on purchases and investments. We
call this input VAT: The VAT that is a part of an incoming invoice or sales receipt.
• When the company reports VAT to the tax authorities it is the difference between the output and the
input tax that is payable, and the tax will therefore be calculated on the basis on the net value creation
that takes place in the company.
• If the company engages in investment activities and/or increases the level of inventory significantly, the
input VAT may exceed the output and the company will have a VAT claim against the authorities
• Because it is only the VAT registered companies that are entitled to a deduction of input VAT, the VAT
finally becomes a tax on private consumption.
6. Value Added Tax has an impact on cash flows
How do we book the VAT?
• The output VAT is a short-term liability to the VAT authorities
• The input VAT is a short-term claim towards the VAT authorities
• We report and pay the net amount
Here is an example:
• The company issues an invoice to one of our customers of kr 125 000 incl VAT
• We will then credit the sales income with kr 100 000 (net amount), the customer in the Accounts
Receivable kr 125 000 (gross amount) and kr 25 000 as output VAT (balance sheet account)
• The company receives an invoice from one of our suppliers of kr 50 000 incl VAT
• We will then debit the appropriate cost account with kr 40 000 (net amount), the supplier in the
Accounts Payable kr 50 000 (gross amount) and kr 10 000 as input VAT (balance sheet account)
In Norway, companies need to register for VAT if VAT liable sales exceed kr 50 000 over a 12-month period.
The standard reporting structure is bi-monthly, where we report and pay VAT on 10 April for January and
February, 10 June for March and April and so on.
How is this in your home country?
6. Value Added Tax has an impact on cash flows
From a company's financial statements, we can subtract the following information from
November and December 2022:
• Sales income 2 386 202
• Costs of goods sold 1 238 809
• Increase of inventory 208 376
• Other operational costs (*) 726 204
(*) Of which 80% are costs where the VAT is deductible

Question to class:
What is the payable VAT for the VAT term 6/2022 (November and December)?
7. Why should we make cash flow budgets?
One of the most important management tasks is to make sure that the company has sufficient
cash reserves:
• To reduce operational risk: The purpose of the cash flow planning is to avoid situations where the
company will fail to pay its creditors on time:
• Salaries
• Trade creditors (suppliers of goods, services and equipment)
• Financial creditors (mainly banks)
• The authorities (VAT, social security contribution and corporate tax)
• To fund organic growth: The purpose of the cash flow planning is then to secure sufficient net working
capital. The growth phase will normally require an increase of the net working capital
• To fund investments: The purpose of the cash flow planning will then be to reduce the likelihood of not
having sufficient funds for purchase of new fixed assets and/or acquisitions of other companies
The goal is normally not to have as much cash as possible, but to determine the optimal cash reserve. The
opportunity cost of a large cash reserve may be high, and we should consider alternative use for our surplus
cash, such as new investments or dividend to our shareholders.