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7/30/2019 csh mgt nw mdfd

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DIMENSIONS OF CASH FLOWMANAGEMENT

Prof. N. C. Kar


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Management of Cash

2

Cash includes hard currency, bank balances and

marketable securities.

Cash is the fastest moving asset of the firm.

Financial asset used for both operating & non-operating purposes.

Earns nothing when held in its form.


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Objectives of Cash Mgt. To maintain a cash balance that provides sufficient

liquidity to meet obligations.

To avoid maintaining idle cash as it has an opportunitycost.

Transactions Motive : Meeting day to daytransactional needs.

Precautionary Motive : Meeting Contigencies.

Speculative Motive : To take advantage of thefavorable market conditions.

Compensating Balance : To get various bank services.

3

Motives for holding Cash.


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CASH BALANCE VS CASH FLOWS.

Cash Balance is a static concept : the resultant of cash

inflows and outflows.

Cash flow is the movement of cash into, within and out

of the firm.

Management of cash basically refers to Planning,Managing & Controlling Cash Flows.

4


5/74

TYPES OF CASH FLOWS.

Cash flows can be short cycle cash flows & long cycle

cash flows. Short cycle cash flows takes a short route to return as

against long route for long cycle cash flows.

Cash flows can be classified as operating & non-

operating. Operating cash flows are inflows & outflows resulting

from all operating transactions, i.e. sales, purchase ofinputs.

Office & administrative expeneces etc. Non-operating cash flows are classified into :

Investment flows

Financing flows

Other flows 5


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Cash Flow Vs Funds Flow.

6

Investment flows : Capital expenditure and sale of variousinvestment

Financing flows : Issue of shares/debentures &

repayment of loans, payment of dividendand interest

Other flows : Un-common inflows and out-flows

While operating cash flows show random fluctuations, non-operating cash flows are fairly certain in timing and

magnitude.

Funds flow vs cash flow.

Power and cash flow statement.

Cash flow statement example.


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Short Term & Long Term Cash Flow Cycles.

The quantum of cash flow involved is much bigger than thatof short term cash flow cycle.

It covers normally fixed assets and long term liabilities.

* The orbital time is much longer than that of short termcash flow.* It is less volatile.

7

Cash

Investment

Fixed Assets

Equity

Loans

Purchase

Sales

Labour&

Overheads

Stock

W/C


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Funds Flow Vs Cash Flow.Sales 10,00,000

Less COGS 6,00,000

EBIT 4,00,000

Less INT 80,000

PBT 3,20,000

Less Tax 1,60,000PAT 1,60,000

Depreciation (part of COGS) - 1,00,000

Fund From Operation 2,60,000

Assume 50 % Credit Sales not realized.

All other cost incurred in cash terms excludingdepreciation.

Continues . . . 8


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Cash Sales 5,00,000

Credit Realised - ----------

Less Cash COGS 5,00,000Cash EBIT 0

Less INT 80,000

Cash PBT - 80,000

Less Tax 1,60,000Cash PAT -2,40,000

CASH FROM OPERATION CFO IS 24% OF SALE.

WHERE IS THE FUND IN THE FUNDS FLOWSTATEMENT ?.

Continues . . . 9


10/7410

CONCEPT OF FUNDS FLOW HAS LOST ITSSIGNIFICANCE.

ACCOUNTING STD BOARD HAS STRESSED ON CASHFLOW AS REPLACEMENT FOR FUNDS FLOW.

CASH FLOW STATEMENT IS THE MOST POWERFULTOOL IN FINANCIAL EVALUATION.

ACCOUNTING PROFIT IS MEANINGLESS EXCEPT FOR

TAX PURPOSE.

TAX AUTHORITIES ARE NOW LOOKING FOR CASHPROFIT WITH INTEREST.


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Cash Flow Statement (Significance) :

11

Integral to investment and credit decisions.

Measures ability to generate cash or cash equivalentsand to match the needs to utilize those cash flows.

Ability to measure the amount and timing of cashflows.

Compare the present value of future cash flows ofdifferent enterprises.

Enhances the comparability of reporting of operatingperformances by eliminating the effects of using

different accounting treatments for the sametransactions.

Future cash flow projections becomes easier.


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Power of Cash Flow Statement.

12

INFLOWS OUTFLOWS

CASH FROMOPERATION

CFO

OPERATING

FINANCING

INVESTMENT

OTHER

OPERATING

FINANCING

INVESTMENT

OTHER

NCF

---------------------------------

OO

FO

IO

CFO > FO GROWTH FIRM

CFO = FO - STABLE

CFO < FO - DECLINING

CFO = 0 - SICK

CFO = -ve - ABSOLUTELY SICK


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Direct Method Cash Flow Statement.

Continues . . . 13

(Rs. 000)1996Cash flows from operating activities

Cash receipts from customers 30,150Cash paid to suppliers and employees (27,600)

Cash generated from operations 2,550

Income tax paid (860)

Cash flow before extraordinary item 1,690

Proceeds from earthquake disaster settlement 180

Net cash from operating activities 1,870

Cash flows from investing activities

Purchase of fixed assets (350)

Proceeds from sale of equipment 20Interest received 200

Dividend received 160

Net cash from investing activities 30


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Continues . . . 14

Net cash from investing activities 30

Cash flows from financing activities

Proceeds from issuance of share capital 250

Proceeds from long term borrowings 250Repayments of long term borrowings (180)

Interest paid (270)

Dividend paid 1,200

Net cash used in financing activities 1,150

Net increase in cash and cash equivalents 750

Cash and cash equivalents at beginning of period 160

Cash and cash equivalents at end of the period 910


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Cash flow parameters for performance analysis.

15

The format of CF statement as per AS3 is more suitable forexternal users than for managers.

A manager can easily prepare the statement from cash book onweekly and monthly basis.

In order to plan outflows, cash flow can be divided into

Priority out cash flows (Int + Loan + Tax)

Discretionary cash flows

Objective of the manager should be to meet priority out cashflows from operating inflows.

Balance available should be used for discretionary outflows inconjunction with other inflows.

Following ratios can be used for analysis & control : Cash flow sufficiency ratio Cash flow efficiency ratio

Priority obligation ratio

Adequancy measure for priority outflows

CFO / Priority Outflows


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Sufficiency and Efficiency Ratios.

Continues . . . 16

Ratio(Sufficiency)

Formula Indication

Cash flow adequacy Cash from operations Ability to generate cash todividends paid + asset cover growth requirements. Apurchases + long term value >1 deemed satisfactorydebt paid cover

Long term debt payment Longterm debt payments Adequacy measure forCash from operations contractual payments

Dividend payout Dividends Payout ratio measure forCash from operations discretionary distributions

ReInvestment Asset purchases Outlay ratio measure forCash from operations discretionary investments

Debt Converage Total Debt Coverage used as payback howCash from operations many years, at current flows, will

it take to retire debt


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Sufficiency and Efficiency Ratios (Continued).

17

Ratio(Efficiency)

Formula Indication

Cash flow to sales Cash from operations Ratio of sales dollar realisedsales as cash from operations

Operations Index Cash from operations Measures cash generating

Income from continuing productivity of continuingoperations operations

Cash flow return Cash from operations Measure return on assetsOn assets Total Assets (on cash generation basis)

Priority obligation ratio CFOPriority outflows

Depreciation-amortisation impact Depreciation + amortisation Ratio of non-cash items toCash from operations cashfrom operations


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Cash Flow Planning & Control:

18

Forecasting of cash flows.

Monitoring and accelerating inflows. Controlling outflows.

Managing the balance.

Review and follow up action.

Forecasting of Cash Flows:

Long period vs short period forecasts. Forecasting methods and skills.

Details of forecasting variables.


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Cash Budget: The Primary CashManagement Tool

Purpose: Uses forecasts of cashinflows, outflows, and ending cashbalances to predict loan needs andfunds available for temporaryinvestment.

Timing: Daily, weekly, or monthly,depending upon budgets purpose.Monthly for annual planning, daily for

actual cash management. 19


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DATA REQUIRED FOR CASHBUDGET

20

1. Sales forecast.

2. Information on collections delay.

3. Forecast of purchases and paymentterms.

4. Forecast of cash expenses: wages,

taxes, utilities, and so on.5. Initial cash on hand.

6. Target cash balance.


21/74

SKIs Cash Budget forJanuary and February

Net Cash InflowsJanuary February

Collections $67,651.95 $62,755.40Purchases 44,603.75 36,472.65

Wages 6,690.56 5,470.90

Rent 2,500.00 2,500.00Total payments $53,794.31 $44,443.55

Net CF $13,857.64 $18,311.85


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Cash Budget (Continued)

January February

Cash at start ifno borrowing $ 3,000.00 $16,857.64

Net CF 13,857.64 18,311.85

Cumulative cash $16,857.64 $35,169.49Less: target cash 1,500.00 1,500.00

Surplus $15,357.64 $33,669.49


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Should depreciation be explicitlyincluded in the cash budget?

No. Depreciation is anoncash charge. Only

cash payments andreceipts appear on cash

budget.However, depreciationdoes affect taxes, which do

appear in the cash budget. 23


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What are some other potential cashinflows besides collections?

Proceeds from fixed asset

sales.Proceeds from stock and

bond sales. Interest earned.Court settlements.

24


25/74

How can interest earned or paid onshort-term securities or loans be

incorporated in the cash budget?

Interest earned: Add line in the

collections section. Interest paid: Add line in the

payments section.

Note: Interest on any other debtwould need to be incorporated aswell.

25


26/74

How could bad debts be worked into the

cash budget? Collections would be reduced by the

amount of bad debt losses.

For example, if the firm had 3% baddebt losses, collections would totalonly 97% of sales.

Lower collections would lead to lower

surpluses and higher borrowingrequirements.

26


27/74

SKIs forecasted cash budget

indicates that the companys cashholdings will exceed the targetedcash balance every month, except forOctober and November.

Cash budget indicates the companyprobably is holding too much cash.

SKI could improve its EVA by eitherinvesting its excess cash in moreproductive assets or by paying it out tothe firms shareholders.

27


28/74

What reasons might SKI have for

maintaining a relativelyhigh amount of cash?

If sales turn out to be considerably less than

expected, SKI could face a cash shortfall.A company may choose to hold large

amounts of cash if it does not have muchfaith in its sales forecast, or if it is very

conservative. The cash may be there, in part, to fund a

planned fixed asset acquisition.

28


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Speeding Up CashReceipts

Expedite preparing and mailing the invoiceAccelerate the mailing of payments from

customers

Reduce the time during which paymentsreceived by the firm remain uncollected

Collections


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Collection Float

Collection Float: total time between the mailingof the check by the customer and the availability

of cash to the receiving firm.

ProcessingFloat

AvailabilityFloat

MailFloat

Deposit Float


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Mail Float

Mail Float: time the check is in the mail.

Customermails check

Firmreceives check


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Processing Float

Processing Float: time it takes a companyto process the check internally.

Firmdeposits check

Firmreceives check


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Availability Float

Availability Float: time consumed in clearingthe check through the banking system.

Firmdeposits check

Firms bankaccount credited


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Deposit Float

Deposit Float: time during which the checkreceived by the firm remains uncollected funds.

Processing Float Availability Float


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Managing Float

Payers attempt to createdelays in the check clearing

process.Recipients attempt to

remove delays in the checkclearing process.

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Float


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Float.

36

Float is associated with both collection & disbursement offunds.

Float is the time delay between mail of a cheque bythe customer and its realisation.

Can be of the types : Collection float (-ve float)

Disbursement float (+ve float)

Float is also the difference between book balance andbank balance.

Book balance > bank balance -ve float.

Book balance < bank balance

+ve float. Collection float + disbursement float is called Netfloat.

Objective of the manager should be to

generate +ve net float.

FLOAT


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37

FLOAT

A/c Credits Sales Billing

Customer mails cheque

Company receives cheque

Company deposits cheque

Comp processes

Billing float

MailFloat

Clearingfloat

ProcessingFloat

For accelerating inflows, collection float has to be reduced by followingMethods :

Lock box system Concentration banking Post dated cheques Electronic fund transfer


38/74

Lockbox Systems

Traditional LockboxA post office box maintained by a firmsbank that is used as a receiving point for

customer remittances.

Electronic Lockbox

A collection service provided by a firmsbank that receives electronic payments andaccompanying remittance data and

communicates this information to the

company in a specified format.


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Lockbox Process*

Customers are instructed to mailtheirremittances to the lockbox location.

Bank picks up remittances several times dailyfrom the lockbox.

Bank deposits remittances in the customersaccount and provides a deposit slip with a list of

payments. Company receives the list and any additional

mailed items.

* Based on the traditional lockbox system


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Lockbox System

Disadvantage

Cost of creating and maintaining alockbox system. Generally, not

advantageous for small remittances.

Advantage

Receive remittances sooner which

reduces processing float.


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Concentration Banking

Compensating Balance

Demand deposits maintained by a firm tocompensate a bank for services provided,

credit lines, or loans.

Cash Concentration

The movement of cash from lockbox or

field banks into the firms central cashpool in a concentration bank.


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Concentration Banking

Improves control over inflows andoutflows of corporate cash.

Reduces idle cash balances to a

minimum. Allows for more effective investments by

pooling excess cash balances.

Moving cash balances toa central location:


43/74

Playing the Float

You write a check today, which is subtracted from

yourcalculation of the account balance. The checkhas not cleared, which creates float. You can

potentially earn interest on money that you havespent.

Net Float -- The dollar difference betweenthe balance shown in a firms (or

individuals) checkbook balance and thebalance on the banks books.

EXTENSIONS OF FLOAT


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EXTENSIONS OF FLOATMANAGEMENT

44

Understand the impact of payment andreceipt mechanism or cash flow time line.

Float refers to delay in value transferfrom the time a cheque is written until it is

finally charged to the account


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45

Exmpl :A cheque receipt per day Rs. 60 lakhs.Practice is to deposit cheques twice a week, Wednesdayand Friday

Received Reported Float

Mon Wed 2 X 60 = 120

Tue Wed 1x 60= 60

Wed Wed ----Thur Fri 1x60= 60Fri Fri ----

Sat Wed 3x60= 180

420 lakh


46/74

46

Continuing float 420 lacs float days per week

Opportunity cost = 18% p.a

/20712.20712.0

365

0.18x420per weekfloattodueLoss

Rslakhs

Loss per annum = 20, 712 x 52 = Rs. 10,75

LOCK BOX SERVICES


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LOCK BOX SERVICES : Lock box system involves both a fixed and a variable cost

Fixed cost : Account maintenance fee,Transfer fee of thebalance

Variable cost : lock box processing charge

Total Cost = N [ F x D x i] + VC] + FC

N = no of remittances processed

F = Avg. face value of remittances

D = No of days it takes to clear the cheque

I = Daily Opportunity cost of fund

VC = variable cost for each remittance

FC = Fixed cost charged by the processor47


48/74

48

Variable Processor A Processor BN 1000 1000F 1500 1500D 6 5 - loweri 0.10/365 0.10/365

VC

FC

0.45

225

0.50

275Higher

Ex:


49/74

49

3140225)45365

0.106XX15001000(TC(A)

2830275)45365

.105XX15001000(TC(B)

Even if charges are higher lower processing time

generates savings.


50/74

Assume there are 100 cheques of facevalue of Rs 15 per cheque.

Total amount is same.

TC(A) = 47,685

TC(B)= 52,325

With increased no of cheques and lowerface value Bank A provides lower total cost.

Float savings is less significant when thevalue of the cheque is small.

50

Controlling Disbursements


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Controlling Disbursements.

51

Making payment only when it is due and

availing cash discount. Stretching payables beyond the due date

when there is no discount without

impairing the credit standing. Paying through a centralized system.

Increasing the disbursement float

without affecting image.

S l i D


52/74

S-l-o-w-i-n-g D-o-w-nCash Payouts

Playing the Float

Control of Disbursements

Zero Balance Account (ZBA)

Remote and Controlled Disbursing


53/74

Control of Disbursements

Solution:Centralize payables into a single (smaller

number of) account(s). This provides better

control of the disbursement process.

Firms should be able to:

1. shift funds quickly to banks from which

disbursements are made.2. generate daily detailed information onbalances, receipts, and disbursements.

M th d f M i


54/74

Methods of ManagingDisbursements

Eliminates the need to accuratelyestimate each disbursement account.

Only need to forecast overallcash needs.

Zero Balance Account (ZBA):A corporate checking account in which a zerobalance is maintained. The account requires amaster (parent) account from which funds aredrawn to cover negative balances or to which

excess balances are sent.

R t d C t ll d


55/74

Remote and ControlledDisbursing

Example: A Vermont business pays a Maine supplierwith a check drawn on a bank in Montana.

This maystress supplier relations, and raises ethicalissues.

Remote Disbursement -- A system in which thefirm directs checks to be drawn on a bank that isgeographically remote from its customer so as to

maximize check-clearing time.This maximizes disbursement float.

FORMS OF INVESTMENT


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FORMS OF INVESTMENT.

Continues . . . 56

Invest in current account.

Increase reserve drawing power under cash creditarrangement.

Invest in marketable securities like treasury bills,commercial papers etc.

Invest in inter-corporate reports. Invest in M M Mutual fund.

Criteria of Investment :

Safety Liquidity

Yield

Maturity

Primary considerations

Secondary considerations

Investment in


57/74

Investment inMarketable Securities

Marketable Securities are shown on thebalance sheet as:

1. Cash equivalents if maturities are lessthan three (3) months at the time ofacquisition.

2. Short-term investments if remainingmaturities are less than one (1) year.

The Marketable


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The MarketableSecurities Portfolio

Ready CashSegment (R$)

Optimal balance ofmarketable securitiesheld to take care of

probable deficienciesin the firms cash

account.

R$F$

C$

The Marketable


59/74

Controllable CashSegment (C$)

Marketable securitiesheld for meeting

controllable (knowable)

outflows, such as taxesand dividends.


R$F$

C$

The Marketable


60/74

Free Cash Segment(F$)

Free marketable

securities (that is,available for as yet

unassigned purposes).


R$F$

C$

Variables in Marketable


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Variables in MarketableSecurities Selection

Marketability (or Liquidity)The ability to sell a significant volume ofsecurities in a short period of time in the

secondary market without significant priceconcession.

SafetyRefers to the likelihood of getting back the

same number of dollars you originallyinvested (principal).

Variables in Marketable


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Variables in MarketableSecurities Selection

MaturityRefers to the remaining life of the security.

Interest Rate (or Yield) Risk

The variability in the market price of

a security caused by changes ininterest rates.

Common Money Market


63/74

Common Money MarketInstruments

Treasury Bills (T-bills): Short-term, non-interest bearing obligations of the U.S.

Treasury issued at a discount andredeemed at maturity for full face value.Minimum $1,000 amount and $1,000increments thereafter.

Money Market InstrumentsAll government securities and short-term

corporate obligations. (Broadly defined)

T Bills and Bond Equivalent


64/74

T-Bills and Bond EquivalentYield (BEY) Method:

BEY = [ (1000990) / (990) ] *[ 365 / 91 ]

BEY = 4.05%

BEY = [ (FAPP) / (PP) ] *[ 365 / DM ] FA: face amount of security

PP: purchase price of security

DM: days to maturity of security

A $1,000, 13-week T-bill is purchased for $990 what is its BEY?

T Bills and Equivalent


65/74

T-Bills and EquivalentAnnual Yield (EAY) Method:

EAY = (1 + [.0405/(365 / 91)])365/91

- 1EAY = 4.11%

EAY = (1 + [ BEY / (365 / DM) ] )365/DM - 1 BEY: bond equivalent yield from the previous slide

DM: days to maturity of security

Calculate the EAY of the $1,000, 13-week T-bill purchasedfor $990 described on the previous slide?

Common Money Market


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Treasury Bonds: Long-term (more than

10 years original maturity) obligations ofthe U.S. Treasury.

Treasury Notes: Medium-term(2-10 years original maturity)

obligations of the U.S. Treasury.

Common Money Market


67/74


Bankers Acceptances (BAs): Short-termpromissory trade notes for which a bank

(by having accepted them) promises topay the holder the face amount atmaturity.

Repurchase Agreements (RPs; repos):Agreements to buy securities (usuallyTreasury bills) and resell them at ahigher price at a later date.

Common Money Market


68/74


Federal Agency Securities: Debt securitiesissued by federal agencies and government-

sponsored enterprises (GSEs). Examples:FFCB, FNMA, and FHLMC.

Commercial Paper:Short-term, unsecuredpromissory notes, generally issued by largecorporations (unsecured IOUs). The

largest dollar-volume instrument.

Selecting Securities for


69/74

Selecting Securities forthe Portfolio Segments

Ready CashSegment (R$)

Safety and ability toconvert to cash is most

important.

Select U.S. Treasuriesfor this segment.

R$F$

C$



70/74

Controllable CashSegment (C$)

Marketability lessimportant. Possiblymatch time needs.

May select CDs, repos,BAs, euros for this

segment.

R$F$

C$




71/74

Free Cash Segment(F$)

Base choice on yieldsubject

to risk-return trade-offs.

Any money market

instrumentmay beselected for this se ment.

R$F$

C$


STEPS IN CASH CRISIS:


72/74

STEPS IN CASH CRISIS:

Utilize unused credit limit

Sell marketable securities

Negotiate spacing of repayment schedule of term

liabilities

Negotiate for enhancement of short term credit

facilities with bank

Defer payment of suppliers bill

Advance slacks in cash out flows

Sell assets

72


73/74

Ways to Minimize Cash Holdings

Use lockboxes.

Insist on wire transfers from

customers.

Synchronize inflows and outflows.

Use a remote disbursement account.

73


74/74

REVIEW AND FOLLOW UP ACTIONS

Identify slacks in the system

Take remedial measures

Introduce improvements in thesystem.

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