Corporate Finance

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Discuss the utility of cash budget as a tool of cash management. What are the steps involved in the construction of cash budget. Give an example. A cash budget is important for a variety of reasons. For one, it allows you to make management decisions regarding your cash position (or cash reserve). Without the type of monitoring imposed by the budgeting process, you may be unaware of the cash flow through your business. At the end of a year or a business cycle, a series of monthly cash budgets will show you just how much cash is coming into your company and the way it is being used. Seasonal fluctuations will be made clear.

Following are the utility of cash budget as a tool of cash management. 1. Helpful in Planning. Cash budget helps planning for the most efficient use of cash. It points out cash surplus, or deficiency at selected point of time and enables the management to arrange for the deficiency before time or to plan for investing the surplus money as profitable as possible without any threat to the liquidity. 2. Forecasting the Future needs. Cash budget forecasts the future needs of funds, its time and the amount well in advance. It, thus, helps planning for raising the funds through the most profitable sources at reasonable terms and costs. 3. Maintenance of Ample cash Balance. Cash is the basis of liquidity of the enterprise. Cash budget helps in maintaining the liquidity. It suggests adequate cash balance for expected requirements and a fair margin for the contingencies. 4. Controlling Cash Expenditure. Cash budget acts as a controlling device. The expenses of various departments in the firm can best be controlled so as not to exceed the budgeted limit. 5. Evaluation of Performance. Cash budget acts as a standard for evaluating the financial performance. 6. Testing the Influence of proposed Expansion Programme. Cash budget forecasts the inflows from a proposed expansion or investment programme and testify its impact on cash position. 7. Sound Dividend Policy. Cash budget plans for cash dividend to shareholders, consistent with the liquid position of the firm. It helps in following a sound consistent dividend policy. 8. Basis of Long-term Planning and Co-ordination. Cash budget helps in co-ordinating the various finance functions, such as sales, credit, investment, working capital etc. it is an important basis of long term financial planning and helpful in the study of long term financing with respect to probable amount, timing, forms of security and methods of repayment.

There are three main components necessary for creating a cash budget.  Time Period The first decision to make when preparing a cash budget is to decide the period of time for which your budget will apply. That is, are you preparing a budget for the next three months, six months, twelve months or some other period? In this Business Builder, we will be preparing a three-month budget. However, the instructions given are applicable to any time period you might select.  Cash Position The amount of cash you wish to keep on hand will depend on the nature of your business, the predictability of accounts receivable, and the probability of fast-happening opportunities (or unfortunate occurrences) that may require you to have a significant reserve of cash. You may want to consider your cash reserve in terms of a certain number of days’ sales. Your budgeting process will help you to determine if, at the end of the period, you have an adequate cash reserve.  Estimated Sales and Expenses The fundamental concept of a cash budget is estimating all future cash receipts and cash expenditures that will take place during the time period. The most important estimate you will make, however, is an estimate of sales. Once this is decided, the rest of the cash budget can fall into place.

Small Business Cash Budget For the three months ending March 31, 2013
January February March 15000.00 -13500.00 20000.00 20000.00 45000.00 0.00 80000.00 50000.00 10400.00 2000.00 10000.00 6000.00 25000.00 55000.00 0.00 66500.00 11000.00 10400.00 2000.00 0.00 8000.00 30000.00 70000.00 5000.00 125000.00 5000.00 10400.00 2000.00 0.00 6000.00

Beginning Cash Balance Expected Cash Receipts: Cash sales Collection of accounts receivable Other income Total Cash Expected Cash Payments: Raw materials (or inventory) Payroll Other direct expenses Advertising Selling expenses

Administrative expenses Plant and equipment expenditures Other payments Total Cash Expenses Ending Cash Balance

4500.00 10000.00 600.00 93500.00 -13500.00

4500.00 10000.00 600.00 46500.00 20000.00

4500.00 10000.00 600.00 38500.00 86500.00

*The ending cash balance becomes the beginning cash balance for the next period


What is meant by credit terms ?What are the expected effects of a) decrease in cash discount b) decrease in credit period. Credit terms are the conditions under which the company extends the credit given to the customer. This involves various aspects which are as follows:  Credit Period :

It is the time allowed by the company to the customers to pay their dues. At the end of this period the customer is supposed to pay for all goods and services which he has purchased. Duration of credit period depends on various factors such as: -In case of products having inelastic demand, the credit period may be small. -Nature of industry also affects credit period. -Credit period may also be affected by attitude of management. -Credit period may also depend on the amount of funds available and possible bad debts.

Credit Limit :

The maximum amount of money one is allowed to borrow. A bank or another financial services company may extend a credit line to a client, which is essentially approval for a loan or series of loans to be given on demand from the borrower. The borrower is under no obligation to actually take out a loan at any particular time. The maximum amount for which a particular borrower is approved is known as the credit limit. Banks and financial services company do not extend loans past the credit limit. For example, one may have a credit card with a credit limit of $2,000; if one attempts to put $2,100 on the card, the bank will decline payment. A good credit report and a regular history of loan payments may result in the credit limit being raised.

Discount Policy :

In this policy discounts are given to speed up the collection process by inducing the customers to pay the dues as early as possible.

Decrease in Cash Discount The cash discount has implication for the sales volume, average collection period/average investment in receivables, bad debt expenses and profit per unit. In taking a decision regarding the grant of cash discount, the management has to see what happens to these factors if it decreases in the discount rate. The changes in the discount rate would have both positive and negative effect. The implications of decrease cash discount are as follows: 1. The sale volume will decrease. The reduction of discount implies increase price.

2. Since the customer, to take advantage of the discount, would like to pay within the discount period, so if the discount is reduced the average collection period would be increase. So the increase in the collection period would lead to aincrease in the investment in receivables as also the cost. The increase in the average collection period would also cause aincrease in bad debt expenses. As a result, profit would decrease. 3. The discount would have positive effect on the profit. This is because the increase in the price would affect the profit margin per unit of sale.

Decrease in Credit Period

The second component of credit term id the credit period. The expected effect of an decrease in the credit period is as follows: 1. Decrease in credit period would decrease the sales volume of the organization and also affect negatively on profit. 2. Decrease in credit period would decrease the average collection period from the customer. It would affect positively on profit because of cash flow increase. 3. Bad debt expenses would decrease along with decrease in credit period and would increase the profit for the company.

3.Length of the operating cycle is the major determinant of working capital Explain. We can divide the operating cycle in two parts: 1. Production Cycle : The term production cycle refers to the time involved in the manufacturing goods. It covers the time span between the procurement of raw material and the completion of the manufacturing process leading to the production of finished goods. Funds have to be necessarily tied up during the process of manufacturing, necessitating embraced working capital. In other words, there is some time gap before raw materials become finished goods. To sustain such activities the need for the working capital is obvious. The longer the time span, the larger will be the tied-up funds and, therefore, the larger is the working capital needed and vice versa. Often, companies manufacturing heavy machinery and equipment minimize the investment in inventory or working capital by requiring advance payment from customer as work proceeds against orders. Thus, a part of the financial burden relating to the manufacturing cycle time is passed on to others. 2. Business Cycle : Business fluctuation lead to cyclical and seasonal changes which, in turn, cause a shift in the working capital position, particularly for temporary working capital requirements. During the uprising of business activity the need for the working capital is likely to grow to cover the lag between increased sales and receipt of cash as well as to finance purchase of additional material to cater the expansion of the level of activity. The downsizing phase of the business cycle has exactly an opposite effect on the level of working capital requirement.

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