Chapter 4, Problem 1DQ

What are the basic benefits and purposes of developing pro forma statements and a cash budget? (LO4-1)

Summary Introduction

To explain: The benefits of pro forma statements and cash budget.

Introduction:

Pro Forma Statements:

These are also known as projected financial statements and are an estimation of the financial position of a firm for a given period. These are useful in addressing 'what if' scenarios, determining future cash requirements, and submitting financial proposals.

Cash Budget:

It refers to the budget of expected cash receipts and cash payments. It helps in determining the expected cash surplus and deficit. The purpose of making a cash budget is to gauge the financing needs of a company and estimate its cash position.

Answer to Problem 1DQ

Pro forma statements assist in determining the anticipated inventory levels, receivables, and payables. Additionally, these also help in determining financing requirements. The benefits of cash budget include better credit terms with customers and adequate liquidity during peak seasons.

Explanation of Solution

The following are the benefits of pro forma statements.

i) Pro forma statements allow a firm to estimate its future financing requirements.

ii) These help in determining expected levels of inventory, receivables, and payables.

iii) The formulation of these statements enables a firm to anticipate its profit or loss that it might incur in the future.

The following are the benefits of a cash budget.

i) A cash budget allows a firm to establish credit terms for customers without causing a liquidity crunch.

ii) A cash budget helps a firm in avoiding liquidity issues during its peak business periods.