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Cash Management

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  1. Cash Management Chapter 11

  2. Cash Management • What Is the Difference Between Income and Cash Flow? • What Is Contained in a Cash Budget? • How Are Cash Receipts Forecasted? • How Do Short-Term and Long-Term Cash Budgeting Approaches Differ?

  3. Cash Management • What Are the Relevant Factors to Consider When Investing Working Capital Funds? • What Are Compensating Balances? • How Does a Lockbox System Speed up Cash Flow?

  4. Cash Management • Why Is Depreciation Expense Irrelevant in Cash Flow Considerations? • Why Are Investors Interested in Cash Flows? • How Are Non-Cash Current Assets Related to Cash Flows?

  5. Cash • Petty Cash Funds - Minor Purchases, Replenished Periodically by Amount Disbursed (Imprest Basis) • Cash on Hand - House Banks and Undeposited Receipts • Cash in Bank - Demand Deposits, Time Deposits, Certificates of Deposit

  6. Cash • Transaction Motive - The Maintenance of Minimum Cash Balances to Cover Checks Drawn • Compensating Balances - Amount Required to Remain on Deposit Without Interest to Cover Bank Services • Integrated Cash Management

  7. Is Net Income Different From Cash Flows? • Net Income - Summarizes Revenues and Expenses Accrual Accounting Non-Cash Revenue Non-Cash Expenses Ignores Transactions Related to LTD and Fixed Assets

  8. Is Net Income Different From Cash Flows? • Cash Flow - Analyzes Cash Account From Receipts and Disbursement Cash Account Only Cash Basis Accounting Includes All Cash Usages/Receipts

  9. Cash Budgeting • Most Information Is From the Operations Budget • Cash/Credit Split • Estimated Other Receipts • Estimated Other Disbursements • Receipt/Payment History

  10. Cash Budgeting • Cash Receipts and Disbursements Approach Up to Six Months Direct Sources/Uses of Cash Based on Operations Budget

  11. Cash Budgeting • Adjusted Net Income Approach Periods Longer Than Six Months Emphasizes External Sources Uses an Indirect Approach

  12. Other Cash Management • Float - Time Between the Addition or Subtraction to a Company’s Books and the Actual Addition or Subtraction (Disbursement Float and Collection Float)

  13. Other Cash Management • Lockbox System - Speeds the Flow of Cash Into the Bank’s Account. Payments of A/R Go Directly to the Bank. There Is a Breakeven Point for This. • Breakeven = Bank Charge Per Item Divided by the Daily Interest Rate Times the Change in Time

  14. Other Cash Management • Working Capital - Current Assets Less Current Liabilities • Trade Credit - Suppliers Don’t Charge Current Interest From Delivery to a Date.

  15. Effective Interest Rate Calculation • Annual Interest Paid on a Loan Divided by • Loan Amount Less Any Compensating Balance Requirement • Interest Paid = Principal X Rate X Time

  16. Effective Interest Rate Calculation • Example: $100,000 Loan at 8% Annual Interest With a $10,000 Compensating Balance Requirement • I = $100,000 X 8% X 1 Year = $8,000 • EIR = $8,000 / ($100,000 - $10,000) • EIR = 8.88%

  17. Purchase Discount • Effective Interest Rate - Compute to Determine If It Is Advantageous to Take It • Purchase Term Example - 2/10, N/30 2% Discount off the Invoice Price If Paid Within 10 Days, Otherwise the Balance Is Due Within 30 Days.

  18. Purchase Discount • Effective Interest Rate Equals Cash Discount Divided by the (Invoice Amount Less Cash Discount) Times Days in Year Divided by the Difference Between End of Discount Period and Final Due Date • If Money Can Be Borrowed at Less Than the EIR - Take the Discount

  19. Effective Interest Rate Calculation Purchase or Trade Credit • Example: terms are 2/10, N/30 Invoice for $1,000 ( (1,000 * .02) * ( (365 / (30-10) ) ( 1,000 - 20) ( 20 / 980 ) * ( 365 / 20) .0204081 * 18.25 = 37.24478%

  20. Lockbox Breakeven Calculation • B = breakeven; • C = charge per item; • I = daily interest rate; • T = change in time Formula B = C / (I * T)

  21. Lockbox Breakeven Example • Bank Charges $0.20 per item, Annual Interest is 12% and the lockbox speeds up processing by 2 days B = 0.20 / ( (.12/365) * 2 ) B = 0.20 / ( (0.0003287) * 2 ) B = 0.20 / (0.0006574) B = $304.23 per item