mgt325_m3_cashmanagement

MGT 325 Module 3 Cash Management Examples

The examples below illustrate how the firm manages its cash with regards to accounts receivable and inventory management.

Working capital management, including current asset management, are covered extensively in Chapters 6 and 7 of your textbook.

Beth's Society Clothiers, Inc., has collection centers across the country to speed up collections. The companyalso makes payments from remote disbursement centers so the firm's checks will take longer to clear the bank. Collection time has been reduced by two and one-half days and disbursement time increased by one and one-halfdays because of these policies. Excess funds are being invested in short-term instruments yielding 6 percent per annum.

Required:a. If the firm has $4 million per day in collections and $3 million per day in disbursements, how many dollars has the cash management system freed up?

b. How much can the firm earn in dollars per year on short-term investments made possible by the freed-up cash?

Solutions:a. If the firm has $4 million per day in collections and $3 million per day in disbursements, how many dollars has the cash management system freed up?

Assumptions:

Daily collections $4,000,000 Reduction in collection time 2.5 daysDaily disbursements $3,000,000 Increase in disbursement time 1.5 daysInterest rate 6%

Dollars freed up $14,500,000


Short-term investment earnings $870,000

Route Canal Shipping Company has the following schedule for the aging of its accounts receivable:

AGE OF RECEIVABLES

APRIL 30, 2010

(1) (2) (3) (4)

Age of Percent of

Example One:

Example Two:

Month of Sales Account Amounts Amount Due

April 0-30 $105,000

March 31-60 60,000

February 61-90 90,000

January 91-120 45,000

Total receivables $300,000 100%

a. Fill in column (4) for each month.

b. If the firm had $1,440,000 in credit sales over the four-month period, compute the average collection period.

Average daily sales should be based on a 120-day period. Assume the total receivables are still $300,000.

but the amounts in each month would be different.

c. If the firm likes to see its bills collected in 30 days, should it be satisfied with the average collection period?

d. Disregarding your answer to part c and considering the aging schedule for accounts receivable, should the

company be satisfied?

e. What additional information does the aging schedule bring to the company that the average collection period may not show?

Solutions:

a. Fill in column (4) for each month.

AGE OF RECEIVABLES

APRIL 30, 2010

(1) (2) (3) (4)

Age of Percent of

Month of Sales Account Amounts Amount Due

April 0-30 $105,000 35%March 31-60 60,000 20% Note: 65% of the accounts receivable are over 30 days old.February 61-90 90,000 30%January 91-120 45,000 15%

Total receivables $300,000 100%


Average daily sales should be based on a 120-day period.

Daily sales $ 12,000 Average collection period 25 days


Yes, the average collection of 25 days determined in part a. is less than 30 days.

d. Disregarding your answer to part c and considering the aging schedule for accounts receivable, should the company be satisfied?

No. The aging schedule provides additional insight that 65 percent of the accounts receivable are over 30 days old.

e. What additional information does the aging schedule bring to the company that the average collection period may not show?

It goes beyond showing how many days of credit sales accounts receivables represent, to indicate the distribution of accounts receivable between various time frames.

Example ThreeWisconsin Snowmobile Corp. is considering a switch to level production. Cost efficiencies would occur under level production and aftertax costs would decline by $30,000, but inventory costs would increase by $250,000. Wisconsin Snowmobile would have to finance the extra inventory at a cost of 13.5 percent.

a. Should the company go ahead and switch to level production?

b. How low would interest rates need to fall before level production would be feasible?

Solutions:

Assumptions:

Inventory increase $250,000 Interest rate 13.50%Cost savings $30,000

a. Should the company go ahead and switch to level production?

Cost Savings $30,000Less: Increased costs -$33,750 (The increase in inventory times the interest rate)Loss -$3,750

No. The company should not switch to level production.

b. How low would interest rates need to fall before level production would be feasible?

Interest rates would need to fall to: 12% or less for the switch to be feasible.

However, the decision is more complicated because it depends on expectations for interest rates. If the extra inventory were considered permanent current assets and was financed by locking in long-term interest rates below12%, then it would make sense to switch. However, given that short-term rates are volatile; this decision can't be

made on a dip in short-term interest rates below 12%.

The examples below illustrate how the firm manages its cash with regards to accounts receivable and inventory management.

Working capital management, including current asset management, are covered extensively in Chapters 6 and 7 of your textbook.

Beth's Society Clothiers, Inc., has collection centers across the country to speed up collections. The companyalso makes payments from remote disbursement centers so the firm's checks will take longer to clear the bank. Collection time has been reduced by two and one-half days and disbursement time increased by one and one-halfdays because of these policies. Excess funds are being invested in short-term instruments yielding 6 percent per

a. If the firm has $4 million per day in collections and $3 million per day in disbursements, how many dollars has


a. If the firm has $4 million per day in collections and $3 million per day in disbursements, how many dollars has



Average daily sales should be based on a 120-day period. Assume the total receivables are still $300,000.



e. What additional information does the aging schedule bring to the company that the average collection period

Note: 65% of the accounts receivable are over 30 days old.




No. The aging schedule provides additional insight that 65 percent of the accounts receivable are over 30 days old.

e. What additional information does the aging schedule bring to the company that the average collection period

It goes beyond showing how many days of credit sales accounts receivables represent, to indicate the

Wisconsin Snowmobile Corp. is considering a switch to level production. Cost efficiencies would occur under level production and aftertax costs would decline by $30,000, but inventory costs would increase by $250,000. Wisconsin Snowmobile would have to finance the extra inventory at a cost of 13.5 percent.

(The increase in inventory times the interest rate)

Note the formula used to calculate the 12%.Point to the cell containing the 12%.

However, the decision is more complicated because it depends on expectations for interest rates. If the extra inventory were considered permanent current assets and was financed by locking in long-term interest rates below12%, then it would make sense to switch. However, given that short-term rates are volatile; this decision can't be

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