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Introduction Cash is one of the most liquid assets. Its efficient management is crucial to solvency of the business. Cash is different from profits A business might be making good profits but might frequently suffer cash shortages. This can happen if the goods are sold on credit and receivables accumulate without realization. It can happen if huge advances are paid in anticipation of future supply. It can happen if profits generated instead of re-using in the business are taken out by way of large dividends. On the other hand a losing business might have lots of cash. This can arise with constant raising of funds by the business by borrowing. A business might default in payment to creditors and retain cash with it. Profits of a business arise from cash incomes and non cash incomes (sale on credit, discounts received etc.). Expenses would include cash expenses and non cash expenses (depreciation, expenses written off etc.). Outstanding expenses like unpaid salaries, rent etc. are deducted from income while there is no cash outgo thereof. These will have to added /subtracted to arrive at the cash generation. The term cash also includes cash in hand and bank balance. While profits reflect the earning capacity of a company, cash reflects its liquidity position. Need for cash There are three motives for any business to hold cash. - Transaction Motive A business enters into various transactions with other entities. The inflows from transaction and outflows from transaction might not always match. There is need to keep cash to cushion the imbalances. Precautionary motive
This is to meet unforeseen sudden requirements for expenses. Eg: An accident, employee strike, sudden demand etc. The business has to be prepared to face such situations.
ICFAI Business School-Chennai
50% ICFAI Business School-Chennai 73 . The actual sales during November ad December 2002 and forecast of sales for the first 6 months of 2003 are given below. For instance a firm might want to buy up material in advance in anticipation of future price rises. Cash in bank or other liquid or marketable investment. earns low return. Tools for cash management Cash Forecasting and Budget The time frame chosen for cash budgeting is normally one year. The cash budget can be illustrated with an example. Receivables from credit sales are expected to be collected as follows: After 1 month . Issues in Cash Management Cash provides liquidity to the business. It gives the comfort to meet unexpected expenditures. For better monitoring. Further to hold liquid cash. Actual Sales November 2002 December 2002 100000 100000 Forecast Sales January February March April May June 100000 100000 120000 120000 140000 140000 2. However cash and bank balances like other current assets if held in excess represents a wasted opportunity. A firm might want to undertake investments which might yield quick short term gains. 3. The cash in physical form is an idle asset and earns no return. The relevant details related to working of the company are given below: 1. funds would have to be raised which cost money. budgets are prepared quarterly and sometimes even monthly/fortnightly basis. It also satisfies creditors that their financial assets are good. As such excess cash results in opportunity loss. Cash sales and credit sales are expected to be 20% and 80% respectively.Akbar Industries wants to prepare a cash budget for period of 6 months starting from January 2003.Corporate Financial Management - Speculative motive Cash can also be used for speculation in anticipation of opportunities that do not arise in the normal course of the business. Eg:1. Thus cash should be held optimally to provide liquidity as well as profitability.50% After 1 month .
The expected purchases are forecast below. Manufacturing expenses expected to be 20000 Riyals per month. 2. Bad debt losses are unlikely.5*0. Cash sales = 20%. the realization will be = (0. Credit Sale for any month = 0. 9. Opening cash balance is 25000 Riyals.Corporate Financial Management 4. Therefore in January.50* credit sale of Nov 2002+ 0. Miscellaneous cash purchases of 2500 per month are planned from January through June. 74 ICFAI Business School-Chennai . General administrative and selling expenses are expected to be 10000 Riyals per month.8*100000) = 80000 Riyals. therefore January it is @20% of Sales = 0. In March sale of an old machine fetches 2000. 10. Payment for December purchases will be made in January. In the month of June 2003. 2000 Riyals are expected from sale of a machine and another 2000 Riyals by way of interest earned on security. and so on. Dividend payment of 20000 Riyals and tax payment of 18000 Riyals are scheduled in June 2003. 6.5* credit sale of December-2002) 3.8*100000+0. The management policy is to maintain a minimum cash balance of 18000 Riyals.20*100000=20000.80* Sales in that month 4.5*0. Statement of Cash Receipt forecasts January February Cash sales 20000 20000 Credit Sales 80000 80000 Sale of machine Interest received Total receipt 100000 100000 March 24000 80000 2000 106000 April 24000 88000 112000 May 28000 96000 124000 June 28000 104000 2000 134000 Notes: 1. 5. Similarly for February = 80000 Riyals 5. Credit sale of January-03 = (0. A machine worth 55000 Riyals is proposed to be purchased on cash in March2003. The payment for these purchases are made a month after the purchase. Wage payments are expected to be 16000 Riyals per month. 8. 11. Credit sales realization will be 50% in the following month of sales and balance 50% two months after sales. Period December 2002 Actual purchases 40000 Period January February March April May June Forecast purchases 40000 40000 45000 50000 55000 55000 7.
In June receipt of interest from investment amounts to 2000. which is to be liquidated in a year. In the normal course the proceeds should be used for buying raw material or meeting operational expenses.Corporate Financial Management 6. money is locked in for a long period. This is cash management in practice. The company for instance might have a policy of keeping a minimum balance of say 20000 and maximum of 40000. This would have ensured that the cash reconverts into cash after completion of one operating cycle. Statement of cash payment forecasts Purchases on credit Cash purchase Wages Manufacturing expenses General administrative and selling expenses Dividend payment Tax payment Purchase of machinery Total January 40000 2500 16000 20000 10000 February 40000 2500 16000 20000 10000 March 40000 2500 16000 20000 10000 April 45000 2500 16000 20000 10000 May 50000 2500 16000 20000 10000 June 55000 2500 16000 20000 10000 20000 18000 55000 88500 88500 143500 93500 98500 141500 Cash budget for the period January-June 2003 Total receipt Total payments Net cash flow Opening balance Closing balance January 100000 88500 11500 25000 36500 February 100000 88500 11500 36500 48000 March 106000 143500 -37500 48000 10500 April 112000 93500 18500 10500 29000 May 124000 98500 25500 29000 54500 June 134000 141500 -7500 54500 47000 From the above statement it is observed the cash balances of the company based on forecast of income and expenses varies from 10500 to 54500 over the period of six months. What happens when liabilities are short term and assets are long term? Eg: A company raises working capital finance from a bank. In such a situation. Returns from the fixed asset will arrive only after ICFAI Business School-Chennai 75 . However instead of meeting the requirement of current assets. In that case the company would have to arrange short term borrowing to meet the deficit (in relation to 20000) during March and invest surplus (in relation to 40000) in the months of February and June. let us assume that cash is used for buying fixed asset.
whereas cash availability to meet that would have reduced. Form of a cash report. Similar problems will confront a business that diverts cash in any other way. The following table illustrates the effect of diversion. Monitoring systems a. The debt from the bank will have to be repaid within one year. Cash Reports: Daily cash reports can be maintained for monitoring the receivables position. If finances are raised to compensate this diversion then there may not be an impact. Since lesser money is pumped into the operations. His might be a cumbersome affair. The two effects above (lower cash generation from operations) and cash locked in assets that will yield returns only over a long term will have an impact on the debt servicing capability for the business.Corporate Financial Management gestation period and a number of periods thereafter. Beginning of the year (Estimate) Cash inflow Loans Funds from operations Total Cash outflow Working capital Fixed assets Repayment Total outflow Cash surplus/defici t 100 100 100 0 100 0 Beginning of End of the End of the year the year year (Actual) (Actual) (Estimate) 100 100 60 40 100 0 120 120 70 70 100 100 20 100 100 (-) 30 From the above illustration it might be seen that instead of cash surplus of 20 Riyals the business ends up with a deficit of 30 Riyals. In such situations businesses default and face financial embarrassment. which is not productive. This has resulted due to diverting 40 Riyals at the beginning of the year into fixed assets. The financial liability will have to be settled within one year though. 76 ICFAI Business School-Chennai . Still the business will have to negotiate for further finances for its day-to-day operation. the scale of activity would reduce and this would lower the profits resulting in lesser cash generation.
A company. The difference between the payment float and collection float is called net float. There should be no slackness in promptly billing and mailing reminders for collection. once a company receives a cheque and deposits in the bank account. It is presented for payment and debit in the banks books of account occurs later. The last term “playing the float” needs to be explained a bit. 6. Similarly. In such a case it may issue cheque in excess of balances in its books. it credits its books of account with the cheque amount. 7. ICFAI Business School-Chennai 77 . 10. 3. 4. However it takes a while before the amount is actually credited in the bank’s account. This difference in timing is called payment float. Opening balance Receipts Cash Sales Collection on credit sales Loans received Other receipts Total Receipts Payment Cash purchases Payment to creditors Repayment of loans Other payments Total payment Net cash flow Closing balance ------------------------------------------------------(2+3+4+5) -----------------------------------------------------------------------(12-6) (1+13) ------------- -------------------------------- Factors for efficient cash management Prompt billing and mailing Collection of Cheque and Remittance of Cash Centralized purchases and payments to suppliers. 5. This is called playing the float. 12 13. 9. This arises due to the difference in balances as per books of the company (bank account with the company) and that of the bank with which it maintains the balances. 14. 2.Corporate Financial Management 1. Float arises on two counts. 8. Suitable arrangements should me made with bankers for transfer of sums to a central account once the balance exceeds a limit. which issues a cheque towards payment. Many concerns have also benefited by centralizing both collection and payment to have a tighter control over cash. immediately debits its books of account with the amount paid. Playing the float The first three above are self-explanatory. Collection of cheques and bills should be done without any delay. This difference in timing is called collection float. If the net float is positive the balance in the books of the company is less than that in books of the bank.
RO 5000 is expected to be miscellaneous expenses per month. Bad debt losses are 5% of credit sales. Required: (i) Prepare a cash budget for the period from July to December. d. with the following information. b.000. c. The company might purchase machinery in October paying RO 540. 2.000 each. m. The cash balance on July 1. Present cash balance is RO 15000. Estimated purchase is RO 35000 per month on cash basis. The following information regarding Sohar Manufacturing LLC. (ii) If the company has a policy of maintaining a minimum balance of RO 100. g. l. Cash expenses are RO 14000 for each month.000 per month. Festive season is expected to result in additional sales of RO 150.000. Tax and dividend to be paid in the month of December are RO 35000 & RO 30000 respectively. is RO 5000. General. g.000 in November. Revenue is expected to be RO 90000. a. Rent per month is RO 4000 c. Payment to Directors is RO 6000 per month. Forty percent is paid in next month and purchase for December is RO 80000. Past two months sales have been RO 100. Credit to collection pattern is 1:1 after one month and two months respectively. e.000 what should be the amount of investment and when should it be done? 78 ICFAI Business School-Chennai . b.000 how much money would it require to borrow and when ? (iii) If the company has a policy of maintaining a maximum cash balance of RO 500. d. is available. Sales from July to December are expected to be RO 400. j. administrative and selling expenses are expected to be RO 5000 per month. a. RO 35. Purchases for January. f. A special market promotion program is proposed in September which is estimated to cost RO 350.000 is expected to be outflow towards purchase of a utility vehicle in the month of March. the proportion of cash and credit sales being 2:3. RO 92000 and RO 90000 in the three months. Interest on securities is expected to fetch RO 40000 in the month of August. k. h.Corporate Financial Management Practice Exercise 1. February and March are RO 60000 RO 65000 and RO 70000 respectively. e. f. Manufacturing expenses and wages are expected to be RO 20000 and RO 5000 respectively i. Prepare cash budget for Sacremento LLC.
The Accounts department ties up 4 days worth of remittance cheques. A company has total revenue of RO 60 million per year out of which 80% are credit sales. provided the company keeps a minimum deposit of RO 1 million with it. what is the minimum period for the firm to break even its investment expenditure? [ Answer : 113 days approximately] 6. this could be reduced by two days. The interest rates at present are 10% per annum. has an excess cash of RO 20 million which can be invested for a short term.000. The net positive float would be RO 9000] ICFAI Business School-Chennai 79 . what are the annual savings for the firm? [Answer : RO 28800] 5. Muscat Bulbs SAOC. issues cheques worth RO 15000 and also receives cheques worth RO 28000 daily.] 4. Find out on which date the steady state condition (constant difference between the company’s books and bank books) will be reached and calculate the net float? [Answer: From the end of day 5 . It has a collection arrangement with a bank wherein the bank branches will collect the money from company’s branches and transfer the same to company’s main account in Muscat. Its average collections per day amounts to RO 600. has 16 branches all over Sultanate of Oman. The collections occur at an even rate and the total working days of the firm in the year are 300.Corporate Financial Management 3. If the released funds could earn a rate of 9% p. For these transactions the firm incurs an expenditure of RO 50000. If instead of the minimum deposit. the new bank asks for an annual fee of RO 40000 should the firm accept its offer ? [Answer: (a) should not accept (b) yes it should accept. A different bank has offered to collect and credit the main account in 1 day.a. Assume that the opening credit balance of the company with the bank is RO 20000. If the securities invested have an annual yield of 8%. Gulf Cosmetics SAOG. Normally the cheques issued by the company takes 6 days to be cleared while the bank takes about 3 days for the cheques deposited by the company to be realized. It takes 5 days for the main account to be credited in this manner. If the internal delays are removed. Nizwa Paper Boards LLC. If the new bank does not charge any fee for the collection work should the firm accept its offer? b. a.
Corporate Financial Management 80 ICFAI Business School-Chennai .
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