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Managing Cash

Managing Cash. Chapter 18. May 5, 2010. Learning Objectives. Factors that affect a firm’s minimum cash balance, so they can operate comfortably. Factors that affect a firm’s maximum cash balance, so they don’t have more than necessary. Preparation of a cash budget.

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Managing Cash

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  1. Managing Cash Chapter 18 May 5, 2010

  2. Learning Objectives • Factors that affect a firm’s minimum cash balance, so they can operate comfortably. • Factors that affect a firm’s maximum cash balance, so they don’t have more than necessary. • Preparation of a cash budget. • Managing cash inflows and outflows to maximize cash balance.

  3. How much cash should a firm keep on hand? • Managers must keep enough cash to make payments when needed, i.e., wages, accounts payable, etc. (Minimum balance) • But since cash sitting in a checking account does not earn much, managers should invest excess cash and keep just the amount of cash that is necessary to make payments. (Maximum balance) • Risk/Return trade off. Risk = not enough cash; Return = too much cash, lower earnings

  4. Factors that affect the size of the cash balance • How quickly and cheaply a firm can raise cash when needed, i.e., from operations (McDonalds) or available line of credit. • How accurately managers can predict current cash requirements. • How much precautionary cash the managers need to set aside for emergencies or contingencies

  5. Other factors affecting cash balance • Availability of (short-term) investment opportunities - Liquidity • e.g. money market funds, CDs, commercial paper, etc • Expected return on alternative investment opportunities (opportunity cost) • If high expected return, firms are quick to invest excess cash in capital projects • Why do many firms today have high cash balances?

  6. Forecasting Cash Needs - Cash Budget • Used to determine monthly needs and surpluses for cash during the budgeted period • Examines timing of cash inflows and outflows i.e. when checks are written (outflows) and when deposits are made (inflows). • Payments to suppliers are typically made some time after shipment is received. • Receipts from credit customers are received some time after sale is recorded. (Draw time chart.)

  7. Steps in the Cash Budget • Forecast of monthly cash Collections and other cash inflows • Forecast of purchase Payments and other cash outflows • Summarize the effect on net monthly cash flows and determine borrowing needs or surpluses.

  8. Cash Budget – Problem information Rocky Mountain Climbing, Inc. (RMC) has the following information: Previous Sales: November 2002 130,000 December 2002 125,000 Forecast sales for: January 2003 120,000 February 2003 260,000 March 2003 140,000 April 2003 140,000 Collections : 30% of customers pay cash 50% pay in month after sale 20% pay 2 months after sale

  9. Cash Budget – Problem information Other information for RMC Cash Budget: Purchases of inventory are 75% of sales and are made 2 months before sale and are paid for 1 month after delivery Other expenses $14,000 per month Taxes $10,000 due in March Beginning Cash Balance(12- 31-01) = $28,000 Minimum balance required = $25,000 (ST borrowing rate = 6% annually)

  10. Cash Budget – Forecasting Collections and other inflows • In each month RMC will collect cash from sales that have occurred in that month and in the preceding two months. • In January, sales are $120,000 • Collections: • 30% x $120,000 (January sales) = 36,000 • 50% x $125,000 (December sales) = 62,500 • 20% x $130,000 (November sales) = 26,000 • Total cash collected in January =$124,500

  11. Cash Budget RMC, Inc. Nov Dec Jan Feb Mar Sales 130,000 125,000 120,000 260,000 140,000 Collections: Month of Sale (30%) 36,000 78,000 42,000 Month after sale (50%) 62,500 60,000 130,000 2nd Month after sale (20%) 26,000 25,000 24,000 Total Collections 124,500 163,000 196,000 Cash Budget - Collections Calculate collections for other months.

  12. Other Cash Inflows • Sale of assets • Borrowing • Stock issues • Interest on investments • Liquidation of short term investments • All other cash receipts

  13. Payments for January Purchases Nov Dec Jan Feb Mar Sales 130,000 125,000 120,000 260,000 140,000 Cash Budget - Purchases/Payments and other cash outflows Purchases are made 2 months prior to sale and are paid for 1 month later. 90,000 90,000 75% of January Sales Purchased in November, Paid for in December

  14. Cash Budget RMC, Inc. Nov Dec Jan Feb Mar Apr Sales 130,000 125,000 120,000 260,000 140,000 140,000 Purchases 90,000 195,000 105,000 105,000 Payments 90,000 195,000 105,000 105,000 Cash Budget - Purchases/Payments Calculate payments for all months. Note that in order to do a cash budget, you will need forecasts of sales for April.

  15. Cash Budget RMC, Inc. Jan Feb Mar Cash Collections 124,500 163,000 196,000 Material Payments 195,000 105,000 105,000 Summary of Previous Calculations

  16. Cash Budget RMC, Inc. Jan Feb Mar Cash Collections 124,500 163,000 196,000 Material Payments 195,000 105,000 105,000 All Other Payments: Other Expenses (wages, rent, etc.) 14,000 14,000 14,000 Tax Payments (quarterly) 0 0 10,000 Equip purchases 0 0 0 Remaining Cash Outflows

  17. Cash Budget RMC, Inc. Jan Feb Mar Cash Collections124,500 163,000 196,000 Less Payments: Material Payments 195,000 105,000 105,000 Other Payments: Rent 2,000 2,000 2,000 Other Expenses 12,000 12,000 12,000 Tax Payments 0010,000 Total Payments209,000119,000129,000 Net Monthly Change (84,500) 44,000 67,000

  18. Cash Budget RMC, Inc. Jan Feb Mar Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,000 Ending Cash (B4 Borrow) (56,500) Needed (Borrowing)? Loan Repayment Interest Cost Ending Cash Balance Cumulative Borrowing

  19. Cash Budget RMC, Inc. Jan Feb Mar Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,000 Ending Cash (No Borrow) (56,500) Needed (Borrowing)? Loan Repayment Interest Cost Ending Cash Balance 25,000 Cumulative Borrowing Minimum Ending Balance

  20. Cash Budget RMC, Inc. Jan Feb Mar Borrowing Required to cover Minimum Balance and Deficit 56,500 + 25,000 Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,000 Ending Cash (No Borrow) (56,500) Needed (Borrowing) 81,500 Loan Repayment 0 Interest Cost 0 Ending Cash Balance 25,000 Cumulative Borrowing

  21. Cash Budget RMC, Inc. Jan Feb Mar Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,000 Ending Cash (No Borrow) (56,500) Needed (Borrowing) 81,500 Loan Repayment 0 Interest Cost 0 Ending Cash Balance 25,000 Cumulative Borrowing Balance 81,500

  22. Cash Budget RMC, Inc. Jan Feb Mar Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,00025,000 Ending Cash (No Borrow) (56,500) 69,000 Needed (Borrowing) 81,500 Loan Repayment 0 Interest Cost 0 Ending Cash Balance 25,000 Cumulative Borrowing 81,500

  23. Cash Budget RMC, Inc. Jan Feb Mar Interest Incurred on Prior Month Borrowing 81,500 x .005 Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,000 25,000 Ending Cash (No Borrow) (56,500) 69,000 Needed (Borrowing) 81,500 0 Loan Repayment 0 Interest Cost 0 408 Ending Cash Balance 25,000 25,000 Cumulative Borrowing 81,500

  24. Cash Budget RMC, Inc. Jan Feb Mar Amount that can be repaid from monthly surplus 69,000 - 408 - 25,000 Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,000 25,000 Ending Cash (No Borrow) (56,500) 69,000 Needed (Borrowing) 81,500 0 Loan Repayment 0 43,592 Interest Cost 0 408 Ending Cash Balance 25,000 25,000 Cumulative Borrowing 81,500

  25. Cash Budget RMC, Inc. Jan Feb Mar New Loan Balance 81,500 - 43,592 Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,000 25,000 Ending Cash (No Borrow) (56,500) 69,000 Needed (Borrowing) 81,500 0 Loan Repayment 0 43,592 Interest Cost 0 408 Ending Cash Balance 25,000 25,000 Cumulative Borrowing 81,500 37,908

  26. Cash Budget RMC, Inc. Jan Feb Mar Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,000 25,000 25,000 Ending Cash (No Borrow) (56,500) 69,000 92,000 Needed (Borrowing) 81,500 0 Loan Repayment 0 43,592 Interest Cost 0 408 Ending Cash Balance 25,000 25,000 Cumulative Borrowing 81,500 37,908

  27. Cash Budget RMC, Inc. Jan Feb Mar Interest Incurred on Prior Month Borrowing 37,908 x .005 Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,000 25,000 25,000 Ending Cash (No Borrow) (56,500) 69,000 92,000 Needed (Borrowing) 81,500 0 0 Loan Repayment 0 43,592 Interest Cost 0 408 Ending Cash Balance 25,000 25,000 Cumulative Borrowing 81,500 37,908 190

  28. Cash Budget RMC, Inc. Jan Feb Mar Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,000 25,000 25,000 Ending Cash (No Borrow) (56,500) 69,000 92,000 Needed (Borrowing) 81,500 0 0 Loan Repayment 0 43,592 Interest Cost 0 408 190 Ending Cash Balance 25,000 25,000 Cumulative Borrowing 81,500 37,908 37,908 Repay Outstanding Loan Balance

  29. Cash Budget RMC, Inc. Jan Feb Mar Ending Cash Balance $28,902 Surplus Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,000 25,000 25,000 Ending Cash (No Borrow) (56,500) 69,000 92,000 Needed (Borrowing) 81,500 0 0 Loan Repayment 0 43,592 37,908 Interest Cost 0 408 190 Ending Cash Balance 25,000 25,000 Cumulative Borrowing 81,500 37,908 0 53,902

  30. Cash Budget RMC, Inc. Jan Feb Mar Analysis of Borrowing Needs Ending Cash Balance 25,000 25,000 53,902 Cumulative Borrowing 81,500 37,908 0 RMC needs to raise $81,500 in short-term debt in January, would probably take out a short-term bank loan or line of credit. In March RMC has a $28,902 surplus. It would probably invest in marketable securities at this point in time. See table 18-7 for complete example of cash budget

  31. Managing Cash Inflows and Outflows • Generally managers try to increase the amount of cash flowing into a business during any given time period. • They also try to slow down cash outflows. • Collect early and pay later (but not too late!).

  32. Managing Cash Flows • Can increase cash inflows (or speed them up) by: • Increasing cash sales • Increasing credit card sales • Getting bills out on time • Satisfying customer requirements (main reason why people don’t pay) • Improving credit sales collections

  33. Managing Cash Flows • Can decrease cash outflows (or slow them down) by: • Cutting costs (spending less, down-size) • Defer discretionary expenditures • Taking full advantage of time allowed to pay obligations i.e. net 30

  34. Managing Cash Flows • Can speed up inflows by: • Tightening up credit policy, i.e., shorter pay cycle, tougher credit checks, etc. • Obtaining computerized fund transfers from customers (direct pay) • Using centralized bank to consolidate all funds (draw chart) • Using a lockbox system

  35. Managing Cash Flows • Can slow down cash outflows by • Delaying the payment of bills (60 days vs 30) • Using remote disbursement banks

  36. Homework 18-13 – Using data from 18-6 and 18–10, provide the following: • Jan Feb Mar …. Dec • Monthly collections (18-6) 129 128 134 • Monthly disbursements (18-10) 108 112 126 • Net surplus (deficit) 21 • Add: Begin. Bal. 20 41 • Bal. B4 borrowing 41 • Needed Borrowing • Loan Repayment • Interest (1% per month) • Ending Cash Balance 41 • Cumulative Borrowing • (Minimum Bal 25)

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