OCR A-level Business (H436) · Budgeting, cash flow forecasting and liquidity
Mini-Lesson
Budgeting, cash flow forecasting and liquidity
This mini-lesson covers the planning and control half of H436 Unit 5 — Finance: budgets and variance analysis, cash flow forecasting, why profit is not cash, how to fix a cash shortfall, and liquidity — the current ratio and the acid test — all with full calculations.
Work through each screen, answer the questions as you go (some are written, many are calculations) and collect ⭐ stars. Watch for the Calculate and Exam skill flags. Press Start when you're ready.
Unit 5 · Budgets
What a budget is and why firms use them
A budget is a financial plan for a future period: expected income, expected expenditure and the resulting profit. Budgets set targets, allocate resources, control spending and motivate managers held accountable for them.
Historical budgeting — start from last year's figures and adjust. Quick, but embeds past inefficiency.
Zero-based budgeting — every pound must be justified from zero each year. Efficient and forces scrutiny, but very time-consuming and can be manipulated by persuasive managers.
Delegated budgets — set by the manager who will spend them: motivating and better informed, but risks empire-building and inconsistency.
Limitation: a budget is only as good as its forecast. In a volatile market it can become fiction within weeks — which is why firms use flexed budgets and rolling forecasts.
Unit 5 · Variance
Variance analysis
variance = actual figure − budgeted figure
A variance is favourable (F) if it makes profit higher than budgeted, and adverse (A) if it makes profit lower.
Situation
Effect on profit
Type
Actual revenue above budget
Higher
Favourable
Actual revenue below budget
Lower
Adverse
Actual costs above budget
Lower
Adverse
Actual costs below budget
Higher
Favourable
Think before you judge. A favourable cost variance may mean the manager negotiated harder — or that they bought cheaper, poorer materials that will cause returns next quarter. Variances raise questions; they do not answer them.
Calculate
Your turn — revenue variance
1Budgeted revenue was £480,000; actual revenue was £456,000. Calculate the size of the revenue variance (it is adverse).
£
Hint: 480,000 − 456,000. Enter the size of the gap.
Calculate
Your turn — cost variance
2Budgeted costs were £310,000; actual costs were £298,000. Calculate the size of the cost variance (it is favourable).
£
Hint: 310,000 − 298,000. Spending less than budgeted raises profit, so this is favourable.
Quick check
Quick check
?Actual materials costs came in £18,000 below budget. This variance is:
Unit 5 · Cash flow
Cash flow is not profit
Profit is revenue minus costs over a period. Cash flow is the actual movement of money in and out of the bank. A profitable business can still fail if it runs out of cash.
Credit sales: the sale (and the profit) is recorded now, but the cash arrives in 30, 60 or 90 days.
Overtrading: growing so fast that stock and wages must be paid long before customers pay you.
Capital expenditure drains cash immediately but is charged to profit gradually as depreciation.
net cash flow = cash inflows − cash outflows
closing balance = opening balance + net cash flow
Calculate
Your turn — closing cash balance
3A firm starts the month with £18,000 in the bank. Cash receipts are £96,000 and cash payments are £109,000. Calculate the closing balance.
Improving cash flow: chase debtors and offer prompt-payment discounts (cuts margin); negotiate longer credit from suppliers (risks relationships); arrange an overdraft (flexible, expensive); use debt factoring (fast cash, but you lose part of the invoice value); sale and leaseback; cut or delay stock purchases and capital spending (may hurt growth).
Quick check
Quick check
?A profitable furniture maker cannot pay its wages this month. The most likely explanation is:
Sort it
Cash in, cash out — or neither?
Tap an item, then tap where it appears in a cash flow forecast.
⬆️ Cash inflow
⬇️ Cash outflow
🚫 Not a cash item
Unit 5 · Liquidity
Liquidity ratios
Liquidity is the ability to pay short-term debts as they fall due. It is measured from the statement of financial position.
current ratio = current assets ÷ current liabilitiesa rule of thumb is 1.5 to 2.0 : 1
acid test (quick) ratio = (current assets − inventory) ÷ current liabilitiesa rule of thumb is around 1 : 1
The acid test strips out inventory because stock is the hardest current asset to turn into cash quickly (especially if it is unfashionable or perishable).
Worked example
Current assets £240,000 (including inventory of £75,000); current liabilities £150,000.
?A retailer has a current ratio of 3.2:1. This is most likely to be a problem because:
Match it
Match the term to its meaning
Tap a card on the left, then its partner on the right.
Term
Meaning
Unit 5 · Working capital
Working capital and the cash cycle
working capital = current assets − current liabilitiesthe cash available to fund day-to-day operations
The working capital (cash) cycle is the time between paying for raw materials and receiving cash from customers. The longer it is, the more cash the business must fund.
Shorten it by: collecting from customers faster, holding less inventory, negotiating longer supplier credit.
Too little working capital → cannot pay bills → insolvency. Too much → cash and stock sitting idle earning nothing.
Calculate
Your turn — working capital
6Ashworth Ltd has current assets of £360,000 and current liabilities of £200,000. Calculate its working capital.
£
Hint: working capital = current assets − current liabilities.
Quick check
Quick check
?Which action improves cash flow but is most likely to damage a relationship the firm depends on?
🏆
Mini-lesson complete!
⭐⭐⭐
You've worked through Budgeting, cash flow forecasting and liquidity for OCR A-level Business (H436). 🎉