Key Takeaways
- The cash budget is critical for ensuring liquidity by projecting cash inflows, outflows, and financing needs throughout the budget period.
- Pro forma income statements project expected revenues, expenses, and net income based on operating budget assumptions.
- Pro forma balance sheets project the company's financial position at the end of the budget period, showing expected assets, liabilities, and equity.
- Capital expenditure budgets plan for major long-term investments in property, plant, equipment, and other capital assets.
- Cash budgets must account for timing differences between when sales are made and cash is collected, and when expenses are incurred and paid.
Financial Budgets
Quick Answer: Financial budgets include the cash budget (projecting liquidity needs), pro forma income statement (expected profitability), pro forma balance sheet (projected financial position), and capital expenditure budget (long-term investments). These budgets are the culmination of the master budget process.
The Cash Budget
The cash budget is perhaps the most critical component of the master budget because it ensures the organization can meet its financial obligations. Even profitable companies can fail due to cash flow problems.
Purpose of the Cash Budget
| Purpose | Description |
|---|---|
| Liquidity Management | Ensure sufficient cash to pay obligations |
| Financing Planning | Identify when borrowing is needed |
| Investment Planning | Identify excess cash for investment |
| Working Capital | Manage receivables, payables, inventory |
| Performance Tracking | Compare actual to budgeted cash flows |
Cash Budget Structure
The cash budget has four main sections:
| Section | Components |
|---|---|
| Beginning Cash Balance | Cash on hand at period start |
| Cash Collections | Inflows from sales, other sources |
| Cash Disbursements | Outflows for operations, investments |
| Financing Activities | Borrowing, repayments, interest |
Cash Collections from Sales
Cash collections depend on the sales collection pattern:
| Sale Timing | Collection Pattern Example |
|---|---|
| Cash Sales | 20% collected in month of sale |
| Credit Sales | 50% collected in month following sale |
| 25% collected two months after sale | |
| 5% uncollectible (bad debt) |
Example Calculation:
If January sales are $100,000 and the collection pattern is 20% cash, 50% in 30 days, 25% in 60 days:
| Collection Month | Amount |
|---|---|
| January (20% cash) | $20,000 |
| February (50%) | $50,000 |
| March (25%) | $25,000 |
| Total Collected | $95,000 |
Cash Disbursements
| Category | Timing Considerations |
|---|---|
| Direct Materials | Payment terms (e.g., 30 days after purchase) |
| Direct Labor | Weekly or bi-weekly payroll |
| Manufacturing Overhead | Monthly payments, exclude depreciation |
| Selling & Admin | Monthly as incurred |
| Capital Expenditures | Per capital budget schedule |
| Tax Payments | Quarterly estimated payments |
| Loan Payments | Per debt schedule |
| Dividends | Per dividend policy |
Sample Cash Budget Format
| Item | January | February | March |
|---|---|---|---|
| Beginning Cash Balance | $50,000 | $42,000 | $38,000 |
| Add: Cash Collections | $180,000 | $195,000 | $210,000 |
| = Cash Available | $230,000 | $237,000 | $248,000 |
| Less: Cash Disbursements | |||
| Direct Materials | $65,000 | $70,000 | $75,000 |
| Direct Labor | $45,000 | $48,000 | $52,000 |
| Manufacturing Overhead | $35,000 | $36,000 | $37,000 |
| Selling & Administrative | $28,000 | $29,000 | $30,000 |
| Equipment Purchase | $15,000 | $0 | $0 |
| = Total Disbursements | $188,000 | $183,000 | $194,000 |
| Cash Surplus/(Deficit) | $42,000 | $54,000 | $54,000 |
| Financing Activities | |||
| Borrowing | $0 | $0 | $0 |
| Repayment | $0 | ($16,000) | $0 |
| Interest | $0 | $0 | $0 |
| Ending Cash Balance | $42,000 | $38,000 | $54,000 |
Minimum Cash Balance
Most organizations maintain a minimum cash balance as a safety cushion:
If Ending Cash < Minimum Required:
Borrowing Needed = Minimum Required − Cash Before Financing
If Ending Cash > Minimum Required + Repayment Threshold:
Repay outstanding loans
Pro Forma Income Statement
The budgeted (pro forma) income statement projects expected profitability for the budget period.
Pro Forma Income Statement Sources
| Line Item | Source Budget |
|---|---|
| Sales Revenue | Sales Budget |
| Cost of Goods Sold | Production, Materials, Labor, OH Budgets |
| Gross Margin | Sales − COGS |
| Operating Expenses | Selling & Administrative Budget |
| Operating Income | Gross Margin − Operating Expenses |
| Interest Expense | Cash Budget (financing section) |
| Income Tax Expense | Calculated on pre-tax income |
| Net Income | Final result |
Sample Pro Forma Income Statement
| Item | Amount |
|---|---|
| Sales Revenue | $2,500,000 |
| Cost of Goods Sold: | |
| Direct Materials | $300,000 |
| Direct Labor | $450,000 |
| Manufacturing Overhead | $350,000 |
| Total COGS | $1,100,000 |
| Gross Margin | $1,400,000 |
| Operating Expenses: | |
| Selling Expenses | $320,000 |
| Administrative Expenses | $280,000 |
| Total Operating Expenses | $600,000 |
| Operating Income | $800,000 |
| Interest Expense | $25,000 |
| Income Before Taxes | $775,000 |
| Income Tax Expense (25%) | $193,750 |
| Net Income | $581,250 |
Pro Forma Balance Sheet
The budgeted balance sheet projects the company's financial position at the end of the budget period.
Building the Pro Forma Balance Sheet
| Balance Sheet Item | Source/Calculation |
|---|---|
| Cash | Ending balance from cash budget |
| Accounts Receivable | Uncollected sales per collection pattern |
| Inventory | Ending inventory per production/materials budgets |
| Property, Plant & Equipment | Prior balance + Capital additions − Disposals |
| Accumulated Depreciation | Prior balance + Depreciation expense |
| Accounts Payable | Unpaid purchases per payment pattern |
| Notes Payable | Ending balance from cash budget |
| Retained Earnings | Prior balance + Net Income − Dividends |
Sample Pro Forma Balance Sheet
| Assets | Amount | Liabilities & Equity | Amount |
|---|---|---|---|
| Cash | $54,000 | Accounts Payable | $85,000 |
| Accounts Receivable | $210,000 | Notes Payable | $50,000 |
| Inventory | $125,000 | Accrued Expenses | $35,000 |
| Prepaid Expenses | $15,000 | Total Current Liab | $170,000 |
| Total Current Assets | $404,000 | Long-term Debt | $200,000 |
| Property & Equipment | $850,000 | Total Liabilities | $370,000 |
| Less: Accum Deprec | ($320,000) | Common Stock | $400,000 |
| Net PP&E | $530,000 | Retained Earnings | $164,000 |
| Total Assets | $934,000 | Total Equity | $564,000 |
| Total L & E | $934,000 |
Capital Expenditure Budget
The capital expenditure (CapEx) budget plans for long-term investments in property, plant, equipment, and other capital assets.
Types of Capital Expenditures
| Type | Description | Examples |
|---|---|---|
| Replacement | Replace worn or obsolete assets | New production equipment |
| Expansion | Increase capacity | Additional manufacturing line |
| Strategic | New products or markets | R&D facilities, acquisitions |
| Regulatory | Compliance requirements | Environmental equipment |
| Cost Reduction | Improve efficiency | Automation systems |
Capital Budget Process
| Step | Activity |
|---|---|
| 1. Project Identification | Identify potential investments |
| 2. Project Evaluation | Analyze financial viability (NPV, IRR) |
| 3. Project Selection | Choose projects within budget constraints |
| 4. Implementation | Execute approved projects |
| 5. Post-Audit | Review actual vs. expected results |
Capital Budget Integration
The capital budget affects other budgets:
| Impact On | Effect |
|---|---|
| Cash Budget | Cash outflows for purchases |
| Pro Forma Balance Sheet | Increase in fixed assets |
| Manufacturing Overhead | Depreciation expense, maintenance |
| Operating Budgets | Capacity for production |
Sample Capital Expenditure Budget
| Project | Q1 | Q2 | Q3 | Q4 | Total |
|---|---|---|---|---|---|
| New Equipment | $150,000 | $0 | $0 | $0 | $150,000 |
| Building Expansion | $0 | $200,000 | $300,000 | $0 | $500,000 |
| Computer Systems | $50,000 | $25,000 | $0 | $0 | $75,000 |
| Vehicle Fleet | $0 | $0 | $0 | $80,000 | $80,000 |
| Total CapEx | $200,000 | $225,000 | $300,000 | $80,000 | $805,000 |
Budgeted Statement of Cash Flows
Some organizations also prepare a budgeted statement of cash flows using the indirect method:
| Section | Key Items |
|---|---|
| Operating Activities | Net income, depreciation, working capital changes |
| Investing Activities | Capital expenditures, asset sales |
| Financing Activities | Borrowing, repayments, dividends, stock issuance |
This provides a comprehensive view of expected cash sources and uses aligned with financial reporting standards.
A company has sales of $200,000 in January. The collection pattern is 30% in the month of sale, 50% in the following month, and 18% in the second following month. What amount will be collected in March from January sales?
Which of the following items would NOT be included as a cash disbursement in the cash budget?
The ending Retained Earnings balance on the pro forma balance sheet equals:
If a company has a minimum required cash balance of $25,000 and the cash budget shows an ending balance of $18,000 before financing, the company must:
Which budget serves as the primary source for determining Cost of Goods Sold on the pro forma income statement?