HFT 3431 Chapter 11 Cash Management What Is the Difference Between Income and Cash Flow?What Is the Difference Between Income and Cash Flow? What Is.

HFT 3431HFT 3431

Chapter 11Chapter 11

Cash ManagementCash Management

Cash ManagementCash Management

• What Is the Difference Between What Is the Difference Between Income and Cash Flow?Income and Cash Flow?

• What Is Contained in a Cash Budget?What Is Contained in a Cash Budget?

• How Are Cash Receipts Forecasted?How Are Cash Receipts Forecasted?

• How Do Short-Term and Long-Term How Do Short-Term and Long-Term Cash Budgeting Approaches Differ?Cash Budgeting Approaches Differ?

Cash ManagementCash Management

• What Are the Relevant Factors to What Are the Relevant Factors to Consider When Investing Working Consider When Investing Working Capital Funds?Capital Funds?

• What Are Compensating Balances?What Are Compensating Balances?

• How Does a Lockbox System Speed How Does a Lockbox System Speed up Cash Flow?up Cash Flow?

Cash ManagementCash Management

• Why Is Depreciation Expense Why Is Depreciation Expense Irrelevant in Cash Flow Irrelevant in Cash Flow Considerations?Considerations?

• Why Are Investors Interested in Cash Why Are Investors Interested in Cash Flows?Flows?

• How Are Non-Cash Current Assets How Are Non-Cash Current Assets Related to Cash Flows?Related to Cash Flows?

CashCash

• Petty Cash Funds - Minor Purchases, Petty Cash Funds - Minor Purchases, Replenished Periodically by Amount Replenished Periodically by Amount Disbursed (Imprest Basis)Disbursed (Imprest Basis)

• Cash on Hand - House Banks and Cash on Hand - House Banks and Undeposited ReceiptsUndeposited Receipts

• Cash in Bank - Demand Deposits, Cash in Bank - Demand Deposits, Time Deposits, Certificates of Time Deposits, Certificates of DepositDeposit

CashCash

• Transaction Motive - The Transaction Motive - The Maintenance of Minimum Cash Maintenance of Minimum Cash Balances to Cover Checks DrawnBalances to Cover Checks Drawn

• Compensating Balances - Amount Compensating Balances - Amount Required to Remain on Deposit Required to Remain on Deposit Without Interest to Cover Bank Without Interest to Cover Bank ServicesServices

• Integrated Cash ManagementIntegrated Cash Management

Is Net Income Different Is Net Income Different From Cash Flows?From Cash Flows?

• Net Income - Summarizes Revenues Net Income - Summarizes Revenues and Expensesand Expenses

Accrual AccountingAccrual Accounting

Non-Cash RevenueNon-Cash Revenue

Non-Cash ExpensesNon-Cash Expenses

Ignores Transactions Related to LTD Ignores Transactions Related to LTD and Fixed Assetsand Fixed Assets

Is Net Income Different Is Net Income Different From Cash Flows?From Cash Flows?

• Cash Flow - Analyzes Cash Account Cash Flow - Analyzes Cash Account From Receipts and DisbursementFrom Receipts and Disbursement

Cash Account OnlyCash Account Only

Cash Basis AccountingCash Basis Accounting

Includes All Cash Usages/ReceiptsIncludes All Cash Usages/Receipts

Cash BudgetingCash Budgeting

• Most Information Is From the Most Information Is From the Operations BudgetOperations Budget

• Cash/Credit SplitCash/Credit Split

• Estimated Other ReceiptsEstimated Other Receipts

• Estimated Other DisbursementsEstimated Other Disbursements

• Receipt/Payment HistoryReceipt/Payment History

Cash BudgetingCash Budgeting

• Cash Receipts and Disbursements Cash Receipts and Disbursements ApproachApproach

Up to Six MonthsUp to Six Months

Direct Sources/Uses of CashDirect Sources/Uses of Cash

Based on Operations BudgetBased on Operations Budget

Cash BudgetingCash Budgeting

• Adjusted Net Income ApproachAdjusted Net Income Approach

Periods Longer Than Six MonthsPeriods Longer Than Six Months

Emphasizes External SourcesEmphasizes External Sources

Uses an Indirect ApproachUses an Indirect Approach

Other Cash ManagementOther Cash Management

• FloatFloat - Time Between the Addition or - Time Between the Addition or Subtraction to a Company’s Books Subtraction to a Company’s Books and the Actual Addition or and the Actual Addition or Subtraction (Disbursement Float and Subtraction (Disbursement Float and Collection Float)Collection Float)

Other Cash ManagementOther Cash Management

• Lockbox System Lockbox System - Speeds the Flow - Speeds the Flow of Cash Into the Bank’s Account. of Cash Into the Bank’s Account. Payments of A/R Go Directly to the Payments of A/R Go Directly to the Bank. There Is a Breakeven Point for Bank. There Is a Breakeven Point for This.This.

• Breakeven = Bank Charge Per Item Breakeven = Bank Charge Per Item Divided by the Daily Interest Rate Divided by the Daily Interest Rate Times the Change in TimeTimes the Change in Time

Other Cash ManagementOther Cash Management

• Working Capital Working Capital - Current Assets - Current Assets Less Current LiabilitiesLess Current Liabilities

• Trade Credit Trade Credit - Suppliers Don’t - Suppliers Don’t Charge Current Interest From Charge Current Interest From Delivery to a Date.Delivery to a Date.

Effective Interest Rate Effective Interest Rate CalculationCalculation

• Annual Interest Paid on a Loan Divided byAnnual Interest Paid on a Loan Divided by• Loan Amount Less Any Compensating Loan Amount Less Any Compensating

Balance RequirementBalance Requirement

• Interest Paid = Principal X Rate X TimeInterest Paid = Principal X Rate X Time

Effective Interest Rate Effective Interest Rate CalculationCalculation

• Example: $100,000 Loan at 8% Example: $100,000 Loan at 8% Annual Interest With a $10,000 Annual Interest With a $10,000 Compensating Balance RequirementCompensating Balance Requirement

• I = $100,000 X 8% X 1 Year = $8,000I = $100,000 X 8% X 1 Year = $8,000

• EIR = $8,000 / ($100,000 - $10,000)EIR = $8,000 / ($100,000 - $10,000)

• EIR = 8.88%EIR = 8.88%

Purchase DiscountPurchase Discount• Effective Interest Rate Effective Interest Rate - Compute to - Compute to

Determine If It Is Advantageous to Determine If It Is Advantageous to Take ItTake It

• Purchase Term Example - 2/10, N/30Purchase Term Example - 2/10, N/30

2% Discount off the Invoice Price If 2% Discount off the Invoice Price If Paid Within 10 Days, Otherwise the Paid Within 10 Days, Otherwise the Balance Is Due Within 30 Days. Balance Is Due Within 30 Days.

Purchase DiscountPurchase Discount

• Effective Interest Rate Equals Cash Effective Interest Rate Equals Cash Discount Divided by the (Invoice Discount Divided by the (Invoice Amount Less Cash Discount) Times Amount Less Cash Discount) Times Days in Year Divided by the Days in Year Divided by the Difference Between End of Discount Difference Between End of Discount Period and Final Due DatePeriod and Final Due Date

• If Money Can Be Borrowed at Less If Money Can Be Borrowed at Less Than the EIR - Take the DiscountThan the EIR - Take the Discount

Effective Interest Rate Calculation Purchase or Trade Credit

• Example: terms are 2/10, N/30 Invoice for $1,000

( (1,000 * .02) * ( (365 / (30-10) )

( 1,000 - 20)

( 20 / 980 ) * ( 365 / 20)

.0204081 * 18.25 = 37.24478%

Lockbox Breakeven Calculation

• B = breakeven; B = breakeven;

• C = charge per item; C = charge per item;

• I = I = dailydaily interest rate; interest rate;

• T = change in timeT = change in time

Formula B = C / (I * T)Formula B = C / (I * T)

Lockbox Breakeven Example

• Bank Charges $0.20 per item, Annual Bank Charges $0.20 per item, Annual Interest is 12% and the lockbox Interest is 12% and the lockbox speeds up processing by 2 daysspeeds up processing by 2 days

B = 0.20 / ( (.12/365) * 2 )B = 0.20 / ( (.12/365) * 2 )

B = 0.20 / ( (0.0003287) * 2 )B = 0.20 / ( (0.0003287) * 2 )

B = 0.20 / (0.0006574)B = 0.20 / (0.0006574)

B = $304.23 per itemB = $304.23 per item