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Managing Cash

Managing Cash. Chapter 18. Dec 3, 2012. How much cash should a firm keep on hand?. Managers must keep enough cash to make payments when needed. (Minimum balance)

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Managing Cash

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  1. Managing Cash Chapter 18 Dec 3, 2012

  2. How much cash should a firm keep on hand? • Managers must keep enough cash to make payments when needed. (Minimum balance) • But since cash is a non-earning asset, managers should invest excess cash and keep just the amount of cash that is necessary. (Maximum balance) • Risk/Return trade off. Risk = not enough cash; Return = too much cash, lower earnings

  3. Forecasting Cash Needs - Cash Budget • Used to determine monthly needs and surpluses for cash during the planning period • Examines timing of cash inflows and outflows i.e. when checks are written and when deposits are made. • 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 line)

  4. Steps in the Cash Budget • Forecast of monthly collections and other cash inflows • Forecast of purchases and other cash outflows • Summarize the effect on net monthly cash flows and determine borrowing needs or surpluses.

  5. Cash Budget - Example Rocky Mountain Climbing, Inc. (RMC) has the following information: Previous Sales: November 2010 130,000 December 2010 125,000 Forecast sales for: January 2011 120,000 February 2011 260,000 March 2011 140,000 April 2011 140,000 Collections : 30% of customers pay cash 50% pay in month after sale 20% pay 2 months after sale

  6. Cash Budget - Example 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 Cash Balance (Dec. 31, 2010) = $28,000 Minimum balance required by bank = $25,000 (ST borrowing rate = 6% annually)

  7. Cash Budget - Collections • 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 in January: • 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

  8. Collection of January Sales Nov Dec Jan Feb Mar Sales 130,000 125,000 120,000 260,000 140,000 60,000 36,000 120,000 x .30 120,000 x .50 Cash Budget - Collections Sales made in January will not be fully collected until March. 24,000 120,000 x .20

  9. 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 First Month (50%) 62,500 60,000 130,000 2nd Month (20%) 26,000 25,000 24,000 Total Collections 124,500 163,000 196,000 Cash Budget - Collections Calculate collections for other months.

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

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

  12. Payments for January Purchases Nov Dec Jan Feb Mar Sales 130,000 125,000 120,000 260,000 140,000 Cash Budget - Purchases/Payments 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

  13. Cash Budget RMC, Inc. Nov Dec Jan Feb Mar Apr Sales 130,000 125,000 120,000 260,000 140,000 140,000 Purchases 195,000 105,000 105,000 Payments 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.

  14. 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

  15. Cash Budget RMC, Inc. Jan Feb Mar Cash Collections 124,500 163,000 196,000 Material Payments 195,000 105,000 105,000 Other Payments: Other Monthly Expenses 14,000 14,000 14,000 Tax Payments 0 0 10,000 Remaining Cash Outflows

  16. Remaining Cash Outflows • Purchases of capital equipment • Repayment of long term borrowings • Payment of interest on borrowings • Repurchase of company stock

  17. Cash Budget RMC, Inc. Jan Feb Mar Cash Collections 124,500 163,000 196,000 Material Payments 195,000 105,000 105,000 Other Payments: Rent 2,000 2,000 2,000 Other Monthly Expenses 12,000 12,000 12,000 Tax Payments 0 0 10,000 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 Cash available/(deficit) Needed (ST Borrowing) ST Loan Repayment ST 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 Cash available / (deficit) (56,500) Needed / ST Borrow ST Loan Repayment ST Interest Cost Ending Cash Balance Cumulative Borrowing

  20. 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 Cash available /(deficit) (56,500) Needed /ST Borrow ST Loan Repayment ST Interest Cost Ending Cash Balance 25,000 Cumulative Borrowing Target Ending Balance

  21. 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 Cash available / (deficit) (56,500) Needed (ST Borrowing) 81,500 ST Loan Repayment 0 ST Interest Cost 0 Ending Cash Balance 25,000 Cumulative Borrowing

  22. Cash Budget RMC, Inc. Jan Feb Mar Analysis of Borrowing Needs Net Monthly Change (84,500) 44,000 67,000 Beginning Cash Balance 28,000 Cash available / (deficit) (56,500) Needed (Borrowing) 81,500 Loan Repayment 0 Interest Cost 0 Ending Cash Balance 25,000 Cumulative Borrowing (memo) 81,500

  23. 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 Cash available / (deficit) (56,500) 69,000 Needed (Borrowing) 81,500 Loan Repayment 0 Interest Cost 0 Ending Cash Balance 25,000 Cumulative Borrowing 81,500

  24. 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 Cash available / (deficit) (56,500) 69,000 Needed (ST Borrowing) 81,500 0 ST Loan Repayment 0 ST Interest Cost 0 408 Ending Cash Balance 25,000 25,000 Cumulative Borrowing 81,500

  25. 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 Cash available / (deficit) (56,500) 69,000 Needed (ST Borrowing) 81,500 0 ST Loan Repayment 0 43,592 ST Interest Cost 0 408 Ending Cash Balance 25,000 25,000 Cumulative Borrowing 81,500

  26. 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 Cash available / (deficit) (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

  27. 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 Cash available / (deficit) (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

  28. 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 Cash available / (deficit) (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

  29. 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 Cash available / (deficit) (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

  30. 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 Cash available / (deficit) (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

  31. 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. In March RMC has a 28,902 surplus ($53,902 - $25,000). It would probably invest in marketable securities at this point in time. See table 18-7 for complete example of cash budget

  32. 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 16 • 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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