Cash Budgets & Pro Forma Statements

Overview

• What you’ll learn: How to construct a cash budget from receipts and disbursements schedules, the relationship between cash budgets and pro forma income statements and balance sheets, and why profitable companies still go bankrupt.
• Prerequisites: Lesson 1 — The Master Budget
• Estimated reading time: 17 minutes

Introduction

The Grand Historian records: Many a proud kingdom has fallen not from defeat in battle, but from an empty treasury. Profit is an opinion; cash is a fact. The income statement may sing songs of glory, but the cash budget whispers the truth — can you pay your soldiers this month?

Horngren (Chapter 6) devotes careful attention to the cash budget because it is the single document that prevents liquidity crises. A company can report record profits and still fail to make payroll if its cash collections lag behind its cash payments. The cash budget is the sentinel that warns of approaching drought.

Anatomy of the Cash Budget

The cash budget has four sections, each as essential as the four walls of a fortress:

1. Cash Receipts Schedule

Cash receipts derive from the sales budget, but with a critical adjustment: collection patterns. Not all customers pay immediately. A typical pattern might be:

The cash receipts schedule transforms accrual-basis revenue into cash-basis reality. It is the difference between “we earned it” and “we have it.”

2. Cash Disbursements Schedule

Cash disbursements include payments for materials, labor, overhead, selling expenses, administrative costs, capital expenditures, income taxes, and dividends. Each has its own payment timing:

• Material purchases: Often paid 30-60 days after purchase. The accounts payable schedule is the mirror of accounts receivable.
• Direct labor: Paid in the period incurred — workers do not grant credit.
• Fixed costs: Predictable monthly outflows — rent, insurance, salaries of the permanent garrison.
• Capital expenditures: Large, lumpy payments that can drain the treasury in a single quarter.

3. Cash Surplus or Deficiency

Beginning cash balance + Cash receipts − Cash disbursements = Cash surplus (or deficiency) before financing. If the result falls below the minimum cash balance policy, borrowing is required. If it exceeds the maximum, investments or debt repayment should be considered.

4. Financing Section

This section records borrowing, repayment, and interest. Many companies maintain a revolving credit facility — a standing arrangement with a bank to borrow up to a specified limit. The cash budget determines when to draw on this facility and when to repay.

Pro Forma Financial Statements

Budgeted Income Statement

The budgeted income statement assembles the operating budgets into a projected profit-and-loss report. It follows the standard format:

Revenue − COGS = Gross Margin − Operating Expenses = Operating Income − Interest − Taxes = Net Income

This statement allows management to test whether the planned activities will produce acceptable profitability before committing resources.

Budgeted Balance Sheet

The budgeted balance sheet projects assets, liabilities, and equity at the end of the budget period. Key items:

• Cash: From the cash budget’s ending balance.
• Accounts Receivable: Uncollected sales per the collection schedule.
• Inventory: Desired ending inventory from the production budget.
• Fixed Assets: Current assets + capital expenditures − depreciation.
• Accounts Payable: Unpaid purchases per the disbursement schedule.
• Retained Earnings: Beginning balance + Net income − Dividends.

Why Profitable Companies Go Bankrupt

太史公曰：The kingdom of Chu was wealthy in lands and title, yet fell because its granaries were empty when the siege came. So it is with companies that report profits on paper but cannot pay their debts in cash.

The culprits are typically:

• Rapid growth: Revenue doubles but cash collections lag — the company must finance inventory and receivables faster than cash arrives.
• Capital-intensive investments: A factory purchased on credit generates depreciation expense (non-cash) but requires cash debt service.
• Seasonal mismatches: Revenue concentrated in Q4 but expenses spread across all quarters.

The cash budget is the antidote to this particular poison.

Key Takeaways

• The cash budget has four sections: receipts, disbursements, surplus/deficiency, and financing.
• Collection patterns transform accrual revenue into cash reality — timing matters enormously.
• Pro forma statements (income statement and balance sheet) project the financial consequences of budgeted activities.
• Profitable companies can go bankrupt if cash flows do not support obligations — profit ≠ cash.
• Minimum cash balance policies trigger borrowing decisions in the financing section.

What’s Next

In Lesson 3, we turn from the treasury to the chain of command — responsibility accounting, cost centers, profit centers, and investment centers.