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CASE 23: GETTING OUR ACT TOGETHER

CASE 23: GETTING OUR ACT TOGETHER. Case Discussion. Objectives. Analyze a firm’s cash position. Prepare a detailed cash budget with minimum cash balance. Understand the importance of short-term financial planning. Background Information.

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CASE 23: GETTING OUR ACT TOGETHER

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  1. CASE 23:GETTING OUR ACT TOGETHER Case Discussion

  2. Objectives • Analyze a firm’s cash position. • Prepare a detailed cash budget with minimum cash balance. • Understand the importance of short-term financial planning.

  3. Background Information • Best Electronics has had a number of overdrafts recently. • Mark Wahl, the owner, has been cautioned by his banker that if it continues, interest rates will go up. • Mark knows he had better do something soon. • Asks Joe Ferguson, his MBA intern to help.

  4. Question 1 • Even though sales have been increasing, why is Best Electronics in such a cash flow crunch?

  5. Answer 1 • Best Electronics’ cash inflows and outflows are not well balanced. Its sales are seasonal as well, with the highest sales occurring in the last quarter of the year. • The firm’s payments for purchases are made in 30 days while the receipts (especially from wholesale orders) take between 30-60 days to come in, on average. • The firm does not have a minimum cash balance policy and therefore in lean cash flow months its cash balance declines considerably.

  6. Question 2 • What does the firm need to do as soon as possible?

  7. Answer 2 • The firm needs to prepare a detailed cash budget showing the monthly cash collections and disbursements and the resulting surpluses and shortfalls. • This will help it to determine how much of a line of credit it needs to set up so as to avoid having to be faced with overdraft notices from its bank.

  8. Question 3 • Prepare the collections worksheet. • Which month has the greatest amount of cash inflows?

  9. Answer 3 Cash Budget (click here) The greatest amount of cash inflows occurs in December ($808,350).

  10. Question 4 • Prepare the disbursements worksheet. • Which months seem to be hit by the highest amount of cash outflows? Why? • Can this trend be changed?

  11. Answer 4 • Spreadsheet solution (click here) June, September, October, November, and December are hit by relatively high cash outflows. This is because of higher payments for purchases resulting from higher forecasted sales during the last quarter of the year. Changing the ordering and payment schedules during the year can change this trend.

  12. Question 5 • How should the depreciation expense be treated in the cash budget?

  13. Answer 5 • Depreciation is not a cash outflow and should be ignored in the cash budget

  14. Question 6 • Which months seem to be particularly vulnerable to cash deficits? • Which months have the greatest surpluses?

  15. Answer 6 • March, April, May, June, September, and December seem to be particularly vulnerable to cash deficits. • January and February have the greatest surpluses.

  16. Question 7 • If the cash balance outstanding is -$2,000, help Joe develop a cash budget for Best Electronics for the next twelve months. • How can Mark use the cash budget to minimize cash shortages and plan for the future?

  17. Answer 7 • Spreadsheet solution (click here) The budget shows that September and December are going to particularly vulnerable months for the firm as far as cash shortages are concerned. The maximum shortfall seems to be around $45,000. Mark can use the cash budget to determine how much of the surplus cash should be invested and how much should be kept as a minimum reserve to prevent shortfalls.

  18. Question 8 • Given that the monthly sales figures have been fluctuating so much what should Joe do while preparing the cash budget? • Can he take the sales figures provided by the finance department at face value? • If so why? If not why? What other options does he have?

  19. Answer 8 • Joe should prepare various versions of the cash budget using alternative sales scenarios. For example, Best, Base, and Worst case scenarios can be analyzed by varying the sales figures. • The finance department’s sales figures should not be taken at face value. They are probably too conservative. • As stated earlier, alternative scenario analyses should be performed.

  20. Question 9 • How can a minimum cash balance be built in? • How much of a minimum cash balance seems warranted? • What can the company do with the excess cash that is generated in some months?

  21. Answer 9 • By taking a look at the forecasted cash flows and providing enough of a reserve to cover the largest forecasted shortfall one can build in a minimum cash balance. The largest shortfall seems to be $45,100 (in December). • So a minimum cash balance of about $50,000 seems to be warranted. • If this cash balance is allocated at the start of the budget, it will help minimize the risk of future cash shortfalls. Excess cash can be invested in money market securities.

  22. Question 10 • Rework the budget by using your suggested minimum cash balance and assume that short-term loans carry an interest rate of 8% per year.

  23. Answer 10 • Spreadsheet solution (click here)

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