Learning Objectives

• Construct a cash budget and • Identify and describe the use

determine the timing and and value of conversion period
amount of any monthly cash ratios to the entrepreneur
needs
• Describe how short-term
projected statements of cash
flows relate to cash budgets
• Explain why short-term projected
statements of cash flow are
important to the entrepreneur
PDC Company initial Balance Sheet

Pamela, Dharma, and

Constance founded PDC
Company to distribute a
New-Age Paint. The
company has exclusive
distribution. It is
currently March 31.
PDC Company assumptions
• PDC is buying a used delivery truck on April 1 for $6,900 cash.
• PDC expects to pay miscellaneous cash expenses equal to 5 percent of the current sales and rent of
$4,600 per month.
• It records insurance expense at $460 per month, although it writes a check to the insurance company
for a year at a time. PDC plans to draw the prepaid insurance account balance down to zero before
cutting the next check to the insurance company.
• Depreciation expense is $1,150 per month, including the truck, and PDC anticipates a zero tax rate.
• Wages are paid twice a month with $5,750 per month fixed and 15 percent of sales (assumed to be
uniform throughout a month) as a variable commission. Wages are paid a half month after they are
earned. As an example, the expected and realized sales of $92,000 for March are responsible for the
$9,775 [(0.5 × $5,750) + (0.5 × 0.15 × $92,000)] currently in the accrued wages account.
PDC Company assumptions
• PDC’s inventory policy is to begin a month with sufficient inventory to cover 80 percent of the sales
for the month plus a $46,000 cushion. Previous inventory balances have conformed to the current
policy, and sales forecasts have been accurate.
• The cost of goods sold amounts to 70 percent of sales. For example, sales are forecasted to be
$115,000 in April. The corresponding desired inventory level (end of March and beginning of April) is
estimated as $64,400 ($115,000 × 0.8 × 0.7) + $46,000 = $110,400.
PDC Company assumptions
• PDC’s sales are 60 percent cash and 40 percent on accounts receivable collected in the following
month.
• PDC’s only available credit line is from a founder who agreed (in return for a piece of the equity) to
lend the company money at 1.5 percent interest per month for the next two years. The agreement
with this founder stipulates a $23,000 minimum cash balance in the venture’s checking account. PDC
borrows from, and repays, the founder only at the end of the month. Interest is therefore the
previous month’s ending balance multiplied by 0.015.
• Our goal is to project PDC’s cash balance at the end of each of the next four months and to create a
set of projected financial statements congruent to the projections.
Short-term Cash Planning Tools – Sales Schedule

Pamela, Dharma, and

Constance founded PDC
Company to distribute a
New-Age Paint. The
company has exclusive
distribution. It is
currently March 31.
Short-term Cash Planning Tools – Purchases Schedule

$110,400
Short-term Cash Planning Tools – Wages & Commissions
Schedule
Short-term Cash Planning
Tools - Cash Budget
Check with Projected Financials
As a check on
the cash budget,
you can get the
exact same cash
balance by
constructing a
full set of
financial
statements. See
Exhibits 6.3 – 6.5
in the textbook.
Check with Projected Financials
As a check on
the cash budget,
you can get the
exact same cash
balance by
constructing a
full set of
financial
statements. See
Exhibits 6.3 – 6.5
in the textbook.
Check with Projected Financials
As a check on
the cash budget,
you can get the
exact same cash
balance by
constructing a
full set of
financial
statements. See
Exhibits 6.3 – 6.5
in the textbook.
Operating Cycle
Conversion Period Ratios
Conversion Period Ratio:
indicates the average time it takes in days to convert certain current assets and
current liability accounts into cash
Operating Cycle:
time it takes to purchase, produce, and sell the venture’s products plus the time
needed to collect receivables if the sales are on credit
Cash Conversion Cycle:
sum of the inventory-to-sale conversion period and the sales-to-cash conversion
period less the purchase-to-payment conversion period
 Inventory-to-Sale Conversion Period
Measuring Conversion Times = Ave. Inventories
(CGS / 365)
2014 2015 2016 = (140,000 + 95,000)/2 = 117,500
380,000/365 1041
= 112.9 days

2015 2016
Measuring Conversion Times Sale-to-Cash Conversion Period:
= Ave Receivables
(Net Sales/365)
2014 2015 2016 = (105,000 + 75,000)/2
575,000/365
= 57.1 days

2015 2016
Measuring Conversion Times Purchase-to-Payment Conversion Period:
= Ave Payables + Ave Accrued Liabilities
(COGS / 365)
2014 2015 2016 = (84,000+57,000)/2 + (10,000+9,000)/2
380,000/365
= 76.8 days

2015 2016
 Cash Conversion Cycle
Measuring Conversion Times = Inventory-to-Sale Conversion Period
+ Sale-to-Cash Conversion Period
2014 2015 2016
– Purchase-to-Payment Conversion

= 112.9 days + 57.1 days – 76.8 days

= 93.2 days

2015 2016
MPC Conversion Period Performance

2015 2016