Why the income statement cannot save you
In the previous guide you assembled the master budget — the linked chain of plans that begins with a sales forecast and flows into a production budget, a materials budget, a labour budget, and finally a budgeted income statement. That budgeted income statement is a beautiful thing: it tells you whether the plan, if it all comes true, will be *profitable*. But it harbours a quiet, dangerous gap. Profit is not cash, and a company can plan its way to a handsome paper profit while quietly planning its way into an empty bank account. This guide closes that gap.
The reason traces back to accrual accounting, which you met long ago on the ladder. Revenue is recorded when it is *earned*, not when the customer actually pays; an expense is recorded when it is *incurred*, not when you actually hand over the money. So a sale on credit lands on the income statement in March as revenue and profit, even though the cash may not arrive until May. A purchase of inventory drains your bank account today but only becomes an expense weeks later when the goods are sold. The income statement and the bank statement are telling two different stories about two different things — earnings versus money — and the difference between them is exactly the profit-is-not-cash problem.
The shape of a cash budget
The cash budget has one job: to project the actual movement of money into and out of the bank account, month by month, so the company can see a shortfall coming while there is still time to act. Its whole logic fits in one honest little equation that you could explain to a child managing an allowance. Take the cash you start the month with, add every dollar you expect to actually *collect*, subtract every dollar you expect to actually *pay out*, and what remains is the cash you end the month with — which then becomes next month's starting cash. That ending balance, carried forward, is what stitches the months into a continuous story.
THE CASH BUDGET, ONE MONTH
Beginning cash balance
+ Cash receipts (money actually collected)
----------------------------------------------------
= Cash available
- Cash disbursements (money actually paid out)
----------------------------------------------------
= Ending cash balance ---> becomes next month's
beginning cash balance
Notice what is NOT here: depreciation, credit sales not
yet collected, expenses incurred but not yet paid.
None of those move cash, so none of them belong.Read that skeleton carefully and notice what it deliberately leaves out. Depreciation — that large, steady expense on the income statement — is nowhere in the cash budget, because depreciation never moves a single dollar out of the bank; the cash left the company years ago when the asset was bought. A credit sale that has not yet been collected is also absent, because no money has actually arrived. An expense incurred but not yet paid is absent too. The cash budget is gloriously literal: if a transaction does not put money in or take money out *this month*, it simply has no place here. That literalness is its whole power.
Receipts: the receivables schedule
The hardest part of a cash budget is the receipts line, because most sales are not paid for the instant they happen. When a company sells on credit, the sale becomes revenue immediately but the cash trickles in over the following weeks as customers settle their bills — and that timing lag is held by the accounts receivable account. To budget receipts you must therefore translate the sales forecast into a *collection* forecast, answering a different question: not 'how much will we sell each month?' but 'how much will we actually be paid each month?'.
In practice you build this from a *collection pattern* — an honest estimate, drawn from history, of how customers pay over time. Suppose a company knows that of any month's sales, 60% is collected in the month of sale and the remaining 40% is collected in the following month. Now picture sales of 100,000 in March and 150,000 in April. April's cash receipts are not 150,000; they are 40% of March's sales (40,000) collected late, plus 60% of April's own sales (90,000) collected on time — a total of 130,000. The shape of collections, governed by your credit terms, can differ sharply from the shape of sales, and the cash budget cares only about collections.
This is why the cash budget cannot be built in isolation: it leans directly on a receivables schedule that ages each month's sales into the months they will actually be collected. The same logic, run in reverse, also tells you the *closing* receivables balance — the part of recent sales not yet collected — which is exactly the figure you will need later for the budgeted balance sheet. Two outputs, one schedule: the timing it imposes feeds the cash budget's receipts line, and the leftover it predicts becomes the accounts-receivable figure in the budgeted financial statements.
Disbursements: the payables schedule
The disbursements line is the mirror image, and it is friendlier, because here *you* are the customer choosing when to pay. Your suppliers extend you credit too, so the inventory and materials you buy this month are often paid for next month — the lag living in the accounts payable account. Just as you aged your sales into collections, you age your purchases into payments. If a company pays for 30% of each month's purchases in the month of purchase and 70% in the month after, then a month with 80,000 of purchases throws off only 24,000 of cash now, leaving 56,000 to be paid next month.
But disbursements include far more than payments to suppliers, and a common beginner's error is to forget the cash outflows that never pass through accounts payable at all. Wages and salaries are usually paid in the period worked or very close to it. Rent, utilities, interest on loans, and tax instalments each have their own payment rhythm. And then there are the disbursements that the income statement never even shows as expenses: buying a new machine or vehicle is a huge cash outflow this month, yet on the income statement it appears only as depreciation, spread thin over many future years. The cash budget must capture the whole machine-purchase outflow now, exactly when the cheque clears.
The minimum cash balance and the financing section
Now the cash budget earns its keep. No sensible business wants to run its bank account down to zero, because cash flows arrive lumpy and unpredictable, and a balance of zero is a balance one late customer away from a bounced cheque. So a company sets a minimum cash balance — a cushion, a floor it refuses to drop below, say 10,000. The cash budget is then read not against zero but against that floor: in any month where the projected ending balance would fall *below* the minimum, the company knows in advance it must borrow, and roughly how much.
This adds a final financing section to the budget. Walk a tiny example. A company begins June with 12,000 of cash. It expects 90,000 of receipts and 100,000 of disbursements that month, so its ending balance before any financing would be 12,000 + 90,000 − 100,000 = 2,000. That is positive — the company is still solvent on paper — but it sits below the 10,000 minimum. The cash budget therefore signals: borrow at least 8,000 in June to restore the floor. In a later month flush with collections, the budget shows a surplus well above the minimum, and the financing section flips to *repaying* that loan with interest. The same tool that warns of drought also schedules the repayment when the rains come.
Notice the timing advantage this buys. A company that learns in February that it will be short of cash in June has four months to arrange a line of credit calmly, negotiate good terms, perhaps chase slow receivables harder or delay a discretionary purchase. A company that discovers the same shortfall in June, when the cheque bounces, is begging a bank for emergency money from a position of weakness. The cash budget does not create cash out of nothing — it cannot. What it creates is *foresight*, and foresight is the difference between managing liquidity and being managed by it.
Where the cash budget sits in the master plan
Step back and see how the pieces lock together. The cash budget is fed *by* almost every other budget — the sales budget tells it what to collect, the purchases and production budgets tell it what to pay, the capital plan tells it about big asset outflows. In turn, the cash budget feeds the budgeted balance sheet: its ending cash becomes the cash line, its leftover uncollected sales become the receivables line, its unpaid purchases become the payables line, and any borrowing becomes a loan liability. The cash budget is the hub where the master plan's many streams converge into the single question that keeps owners awake: will there be enough money in the bank, each month, to keep the doors open?
One honest caveat to carry forward. A cash budget is a *forecast*, only as good as the assumptions beneath it — the collection pattern, the payment pattern, the sales forecast it all rests on. If customers slow their payments, or a big sale falls through, the real cash position will drift from the plan. That is not a flaw to be embarrassed by; it is why companies revise the cash budget continuously, rolling it forward each month with fresh numbers, and why the minimum-balance cushion exists in the first place. The budget's value is not in being exactly right but in being approximately right *early* — early enough to do something about what it warns you of.