Lecture 32
Cash Budget Overview
Definition: A cash budget is a financial plan that outlines expected cash inflows and outflows over a specific period.
Purpose: Helps to ensure the organization has enough cash to meet its obligations by projecting cash balance.
Components of the Cash Budget
Cash Inflows
Sources: Primarily generated from operations such as sales and collections.
Focus: It's important to remember that cash inflows in the cash budget are always projected, meaning they are estimations of future cash collections.
Cash Outflows
Nature: Include payments for expenses, inventory purchases, liabilities, etc.
Impact: Cash outflows must be accurately projected to understand the cash balance.
Expected Cash Balance Calculation
Cash balance is calculated as:
Cash Inflows - Cash Outflows.
Key Characteristics of the Cash Budget
Forward-Looking: The cash budget is not historical; it is a forecast of future cash flows.
Estimation: It incorporates estimates, making it crucial for flexibility as not everything will unfold as planned.
Current Liabilities
Definition: Liabilities that must be settled within one year.
Examples: Accounts payable and notes payable.
Accounts Payable
Cost Consideration: Often presents no cost if discounts for early payment are utilized; otherwise, there’s an opportunity cost (implicit cost).
Implicit Cost: The cost incurred if a discount for early payment is available but not taken.
Notes Payable
Interest: A primary cost associated with notes payable, incurred over the life of the note.
Types:
Standard Notes: Interest is paid at the end.
Discounted Notes: Interest is deducted upfront, meaning the borrower receives less cash initially but pays back the full amount later.
Compensating Balance: An additional cost where a borrower must maintain a minimum balance in their bank account to secure the note. It does not act as collateral but raises the effective cost of borrowing.
Effective Interest Rate
Definition: The actual rate of interest paid by the borrower due to factors like compensating balances and discounting.
Stated Rate vs. Effective Rate: The stated rate does not reflect the actual cost if conditions such as compensating balances or upfront discounts are applied.
Impact of Corporate Actions on Cash
Categories: Transactions may cause cash to increase, decrease, or remain unchanged.
For instance:
Borrowing cash to pay dividends: No change (increase cash, decrease cash).
Paying interest: Decrease cash.
Selling on credit: No change in cash.
Operating Cycle and Cash Conversion Cycle
Operating Cycle
Definition: The duration between purchasing inventory and collecting cash from sales.
Components:
Days to sell inventory.
Days to collect cash from accounts receivable.
Cash Conversion Cycle
Definition: The total period required to turn inventory and accounts receivable into cash.
Calculation:
Cash Conversion Cycle = Operating Cycle - Days Deferred.
Days Deferred: The amount of time a business has before it is obligated to pay its accounts payable.
Calculating Components
Days to Sell: 365 / Inventory Turnover.
Days to Collect: 365 / Receivables Turnover.
Days Deferred: 365 / Payables Turnover.
Problem Assessment in Cash Management
of factors impacting cash and operating cycles:
Increase in receivables: Increases operating cycle.
Faster inventory turnover: Decreases operating cycle.
Accelerating payments to suppliers: Does not change operating cycle but may affect cash conversion.
Summary and Importance
Understanding the cash budget alongside current liabilities is essential for effective cash management and ensuring that an organization can meet its financial obligations adequately.