Cash Conversion Cycle and Cash Budget

Cash Conversion Cycle and Cash Budget

• 1.
  Working Capital Management
• 2.
  How can weeffectively managed Working Capital? 16-4. Cash Conversion Cycle 16-5. Cash Budget
• 3.
  16-5. The CashConversion Cycle  The length of time funds are tied up in working capital, or the length of time between paying for working capital and collecting cash from the sale of the working capital.
• 4.
  Components of CCC 1.Inventory Conversion Period 2. Average collection Period 3. Payables Deferral Period
• 5.
  Inventory Conversion Period The average time required to convert raw materials into finished goods and then to sell them. Average Collection Period  The average length of time required to convert the firm’s receivables into cash, that is, to collect cash following a sale.
• 6.
  Payables Deferral Period The average length of time between the purchase of materials and labor and the payment of cash for them.
• 7.
  Sample Problem:  OnDay 1, GFI buys merchandise and expects to sell the goods and thus convert to Accounts Receivable in 60 days. It should take another 60 days to collect the receivables, making a total of 120 days between receiving merchandise and collecting cash. However, GFI is able to defer its own payments for only 40 days to it’s suppliers.
• 8.
  CCC Basic Formula InventoryConversion Period Average collection Period Payables Deferral Period 60 DAYS 60 (40) 80 DAYSCCC ( ADD ) ( LESS )
• 9.
   Inventory Conversion Period Average collection Period  Payables Deferral Period Inventory Cost of Goods sold/365 Receivables Sales per/365 Payables Cost of Goods sold/365
• 10.
  16-5. The CashBudget  A table that shows cash receipts, disbursements and balances over some period.  A primary forecasting tool of the firm’s cash flows.  Cash budgets can be of any length, daily, quarterly or monthly.
• 11.
  Steps of CashBudget: 1. Begin with a sales forecast for each month and a projection of when actual collections will occur. 2. Followed by forecast payments for purchases and forecasted payments for materials, labor, leases, new equipment, taxes and other expenses.
• 12.
  Steps of CashBudget: 3. Then subtract forecasted collections from forecasted payments in order to have net cash gain or loss for each month. 4. The gain or loss is added or subtracted from the beginning cash balance, and the result is the amount of cash the firm would have on hand at the end of the month if it neither borrowed nor invested
• 13.
  XYZ Co. (forthe last half of 2013) • Collections during the month • Collections during the 1st month after sale (prior month’s sale) • Collections during the 2nd month after sale (Sales 2 months ago) • Percent Bad Debts • Discount on first month of collections • Purchases(% of next month’s sales) • Lease payments • Construction cost for new plant (Oct) • Target Cash Balance 20% 70% 10% 0% 70% $15 $100 $10 2%
• 14.
  May June JulyAug. Sept. Oct. Nov. Dec. Sales(gross) $200 $250 $300 $400 $500 $350 $250 $200 Collections During the month of sale: 0.2(Sales)(.98) 59 78 98 69 49 39 During the prior month's sales: 0.7 175 210 280 350 245 175 Sales two months ago: 0.1 20 25 30 40 50 35 Total Collections 254 313 408 459 344 249 Purchases: 70% of next month's sales 210 280 350 245 175 140 Estimated Disbursements: Last month Purchases of Materials 210 280 350 245 175 140 Wages and Salaries 30 40 50 40 30 30 Lease payments 15 15 15 15 15 15 Other expenses 10 15 20 15 10 10 Taxes 30 20 Payment for Plant Construction 100 Total Payments 265 350 465 415 230 215
• 15.
  Net Cash flows: NetCash flows for month: (Collections-Payments) -11 -37 -57 44 114 34 Cumulative NCF: (prior month cum. NCF plus this month NCF) -11 -48 -105 -61 53 87 Cash Surplus for loan requirement Target Cash Balance 10 10 10 10 10 10 Surplus Cash for Loan Needed: (Cum. NCF minus Target cash Balance) -21 -58 -115 -71 43 77 Maximum Required Loan $-115 Maximum Available Investment $77