Short Term Financial Needs
Added on 2022-08-26
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Case 1: Cash Management
Answer to Question 1:
The requirement for short term financing as computed in the attached excel reflects no definite
pattern and changed over months. This can be because of many reasons including general trend
of growth in the economy, seasonal variation in the business, and uncertainty associated with any
business in general. In order to manage a smooth fund flow, the company has to tide over the
short term financial needs as reflected by the projected cash deficit in the cash budget. Further, if
today we input the data for the estimated sales over next 13 months in the attached sheet, we will
witness that the company has surplus funds and need no additional funding. Short term funds are
raised to tide over short term deficits and thus company should have a flexible approach towards
raising funds and the policy should not be stringent or rigid.
Answer to Question 2:
The depreciation expense for a company is a non-cash expense, which does not involve any cash
flow (neither cash inflow nor cash outflow). The depreciation expenses are allowable expense
that reduces the value of assets of the company and do not involve any cash payment. Since cash
budgets include only transactions that affect cash position of the company, depreciation is not
included in the cash budget of the company.
Answer to Question 3:
If the company changes the minimum cash reserve policy from current $20,000 to $0 or $5,000
the company will run into cash shortage. in months of August, the company has a deficit and this
minimum cash reserve will not cover the shortage. This will affect the revenue of the company
negatively. Further, the cost of borrowing in emergency will rise and lead to higher interest costs.
In case of reserves for $50,000, the company would be in a better position to manage the
shortages in most of the months in next 13 projected months. At $5,00,000 the company would
suffer from loss of opportunity costs as they will have excess cash and in absence of such reserve
policy they could have used the cash for some other growth opportunities or investment leading
to generation of cash.
The company should not have a fixed cash reserve policy and adopt a compromise approach
where it plans for next 6 months and depending on the projection fixes minimum cash reserve
policy.
Answer to Question 4:
The EAR = (1 + 0.03) ^ 1/6 -1 = 0.494% per month.
Based on the above EAR at 6% interest from the bank, the company should invest with the bank
as they will receive 0.494% per month on the surplus that they maintain based on projections of
13 months. (as attached in excel)
1
Answer to Question 1:
The requirement for short term financing as computed in the attached excel reflects no definite
pattern and changed over months. This can be because of many reasons including general trend
of growth in the economy, seasonal variation in the business, and uncertainty associated with any
business in general. In order to manage a smooth fund flow, the company has to tide over the
short term financial needs as reflected by the projected cash deficit in the cash budget. Further, if
today we input the data for the estimated sales over next 13 months in the attached sheet, we will
witness that the company has surplus funds and need no additional funding. Short term funds are
raised to tide over short term deficits and thus company should have a flexible approach towards
raising funds and the policy should not be stringent or rigid.
Answer to Question 2:
The depreciation expense for a company is a non-cash expense, which does not involve any cash
flow (neither cash inflow nor cash outflow). The depreciation expenses are allowable expense
that reduces the value of assets of the company and do not involve any cash payment. Since cash
budgets include only transactions that affect cash position of the company, depreciation is not
included in the cash budget of the company.
Answer to Question 3:
If the company changes the minimum cash reserve policy from current $20,000 to $0 or $5,000
the company will run into cash shortage. in months of August, the company has a deficit and this
minimum cash reserve will not cover the shortage. This will affect the revenue of the company
negatively. Further, the cost of borrowing in emergency will rise and lead to higher interest costs.
In case of reserves for $50,000, the company would be in a better position to manage the
shortages in most of the months in next 13 projected months. At $5,00,000 the company would
suffer from loss of opportunity costs as they will have excess cash and in absence of such reserve
policy they could have used the cash for some other growth opportunities or investment leading
to generation of cash.
The company should not have a fixed cash reserve policy and adopt a compromise approach
where it plans for next 6 months and depending on the projection fixes minimum cash reserve
policy.
Answer to Question 4:
The EAR = (1 + 0.03) ^ 1/6 -1 = 0.494% per month.
Based on the above EAR at 6% interest from the bank, the company should invest with the bank
as they will receive 0.494% per month on the surplus that they maintain based on projections of
13 months. (as attached in excel)
1
Answer to Question 5:
The starting point for any budget is the estimation of sales over the next few periods, which is
provided by the sales department of a company. The department tries and manage the demand
and supply aspect of the product and set an estimated price for the offering against which they
predict some level of unit sales. The fact is that this estimation of price is dependent on various
assumptions, which are uncertain and may be inaccurate.
One of the many ways to reduce or minimize the uncertainty is use of sensitivity analysis by
which they can identify one or more variables that affect their estimation vastly and are of key
importance. This would enable to focus on that variable more and arrive at better projections.
2
The starting point for any budget is the estimation of sales over the next few periods, which is
provided by the sales department of a company. The department tries and manage the demand
and supply aspect of the product and set an estimated price for the offering against which they
predict some level of unit sales. The fact is that this estimation of price is dependent on various
assumptions, which are uncertain and may be inaccurate.
One of the many ways to reduce or minimize the uncertainty is use of sensitivity analysis by
which they can identify one or more variables that affect their estimation vastly and are of key
importance. This would enable to focus on that variable more and arrive at better projections.
2
Case 2: Credit Policy Management Case
Answer to Question 1:
The three components of a credit policy for any company are:
Terms of Sale - This includes the credit length and the discounts for early payments
Credit Extension – This includes offering credit to worthy customers after careful analysis of the
customer’s portfolio and goodwill
Collection Policy – This includes the follow up mechanism on credit extended.
Even though, the company satisfies all these 3 aspects of a credit policy, the policy is inefficient
in the sense that the credit policy mentions only the days in which the customers should pay but
do not mention any cash discount that it extends in case the customer is paying early or before
the stipulated time.
Answer to Question 2:
Alternative 1: 2/20 net 30 – Here, the company is extending 10 days credit. Considering the rate
per 10 days of .02∕.98 = 2.040%, there are 365∕10 = 36.5 such periods in a year, so the effective
annual rate is computed as:
EAR = (1.0204) ^36.5 − 1 = 109%; APR = .02040 × 36.5 = 74.46%
Alternative 1: 2/25 net 45 - Here, the company is extending 20 days credit. Considering the rate
per 20 days of .02∕.98 = 2.040%, there are 365∕20 = 18.25 such periods in a year, so the effective
annual rate is computed as:
EAR = (1.0204) ^18.25 − 1 = 44.56%; APR = .02040 × 18.25 = 37.24%
Buyer’s Point of View – Borrowing rate of 15%
Based on the above APR’s, both the alternatives are extremely expensive for them and thus they
wont benefit from early payments. The APR’s at which they should be able to accept the offers
are: APR = .15 x 36.5 = 5.48%; APR = .15 x 18.25 = 2.74%
Answer to Question 3:
Ageing Schedule for Current Policy
Average sales per day = Sales / Number of days per year = $500,000/365 = $1370
Thus, Amount outstanding for accounts, which are paid in 50 days
= Probability of payment in 50 days x Average sales per day x 50 days
= 0.85 x $1370 x 50 = $58,225
Further, Amount outstanding for accounts that are10 days late
= Probability of payment in 60 days x Average sales per day x 60 days
= 0.15 x $1370 x 60
= $12,330
3
Answer to Question 1:
The three components of a credit policy for any company are:
Terms of Sale - This includes the credit length and the discounts for early payments
Credit Extension – This includes offering credit to worthy customers after careful analysis of the
customer’s portfolio and goodwill
Collection Policy – This includes the follow up mechanism on credit extended.
Even though, the company satisfies all these 3 aspects of a credit policy, the policy is inefficient
in the sense that the credit policy mentions only the days in which the customers should pay but
do not mention any cash discount that it extends in case the customer is paying early or before
the stipulated time.
Answer to Question 2:
Alternative 1: 2/20 net 30 – Here, the company is extending 10 days credit. Considering the rate
per 10 days of .02∕.98 = 2.040%, there are 365∕10 = 36.5 such periods in a year, so the effective
annual rate is computed as:
EAR = (1.0204) ^36.5 − 1 = 109%; APR = .02040 × 36.5 = 74.46%
Alternative 1: 2/25 net 45 - Here, the company is extending 20 days credit. Considering the rate
per 20 days of .02∕.98 = 2.040%, there are 365∕20 = 18.25 such periods in a year, so the effective
annual rate is computed as:
EAR = (1.0204) ^18.25 − 1 = 44.56%; APR = .02040 × 18.25 = 37.24%
Buyer’s Point of View – Borrowing rate of 15%
Based on the above APR’s, both the alternatives are extremely expensive for them and thus they
wont benefit from early payments. The APR’s at which they should be able to accept the offers
are: APR = .15 x 36.5 = 5.48%; APR = .15 x 18.25 = 2.74%
Answer to Question 3:
Ageing Schedule for Current Policy
Average sales per day = Sales / Number of days per year = $500,000/365 = $1370
Thus, Amount outstanding for accounts, which are paid in 50 days
= Probability of payment in 50 days x Average sales per day x 50 days
= 0.85 x $1370 x 50 = $58,225
Further, Amount outstanding for accounts that are10 days late
= Probability of payment in 60 days x Average sales per day x 60 days
= 0.15 x $1370 x 60
= $12,330
3
Age Amount
Outstanding
Percentageof
Accounts
Receivable
0 to 50 days $58,225 83%
51 to 60 days $12,330 17%
Total $70,555 100%
Ageing Schedule for Alternative 1:
Average sales per day = Sales / Number of days per year = $475,000/365 = $1301
Thus, Amount outstanding for accounts, which are paid in 20 days
= Probability of payment in 20 days x Average sales per day x 20 days x (1 – 0.02)
= 0.5 x $1301 x 20 x 0.98 = $12,750
Further, Amount outstanding for accounts, which are paid in 30 days
= Probability of payment in 30 days x Average sales per day x 30 days
= 0.4 x $1301 x 30 = $15,612
Amount outstanding for accounts that are paid 30 days late
= 0.1 x $1301 x 60 = $7,806
Age AmountOutstanding
Percentageof
Accounts
Receivable
0 to 20 days $12,750 35.25%
21 to 30 days $15,612 43.17%
31 to 60 days $7,806 21.58%
Total $36,168 100%
Ageing Schedule for Alternative 2:
Average sales per day = Sales / Number of days per year = $500,000/365 = $1370
Thus, Amount outstanding for accounts, which are paid in 15 days
= Probability of payment in 15 days x Average sales per day x 15 days x (1 – 0.02)
= 0.6 x $1370 x 25 x 0.98 = $20,139
Further, Amount outstanding for accounts, which are paid in 30 days
= Probability of payment in 30 days x Average sales per day x 30 days
= 0.35 x $1370 x 45 = $21,758
Amount outstanding for accounts that are paid 15 days late
= 0.05 x $1370 x 60 = $4,110
Age Amount
Outstanding
Percentageof
Accounts
Receivable
0 to 25 days $20,139 43.95%
26 to 45 days $21,578 47.09%
46 to 60 days $4,110 8.97%
Total $45,827 100%
4
Outstanding
Percentageof
Accounts
Receivable
0 to 50 days $58,225 83%
51 to 60 days $12,330 17%
Total $70,555 100%
Ageing Schedule for Alternative 1:
Average sales per day = Sales / Number of days per year = $475,000/365 = $1301
Thus, Amount outstanding for accounts, which are paid in 20 days
= Probability of payment in 20 days x Average sales per day x 20 days x (1 – 0.02)
= 0.5 x $1301 x 20 x 0.98 = $12,750
Further, Amount outstanding for accounts, which are paid in 30 days
= Probability of payment in 30 days x Average sales per day x 30 days
= 0.4 x $1301 x 30 = $15,612
Amount outstanding for accounts that are paid 30 days late
= 0.1 x $1301 x 60 = $7,806
Age AmountOutstanding
Percentageof
Accounts
Receivable
0 to 20 days $12,750 35.25%
21 to 30 days $15,612 43.17%
31 to 60 days $7,806 21.58%
Total $36,168 100%
Ageing Schedule for Alternative 2:
Average sales per day = Sales / Number of days per year = $500,000/365 = $1370
Thus, Amount outstanding for accounts, which are paid in 15 days
= Probability of payment in 15 days x Average sales per day x 15 days x (1 – 0.02)
= 0.6 x $1370 x 25 x 0.98 = $20,139
Further, Amount outstanding for accounts, which are paid in 30 days
= Probability of payment in 30 days x Average sales per day x 30 days
= 0.35 x $1370 x 45 = $21,758
Amount outstanding for accounts that are paid 15 days late
= 0.05 x $1370 x 60 = $4,110
Age Amount
Outstanding
Percentageof
Accounts
Receivable
0 to 25 days $20,139 43.95%
26 to 45 days $21,578 47.09%
46 to 60 days $4,110 8.97%
Total $45,827 100%
4
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