Assignment 2: Cash Management By July 28, 2015 - Solve The F

Assignment 2 Cash Managementbyjuly 28 2015solve The Following Proble

Norma’s Cat Food of Shell Knob ships cat food throughout the country. Norma has determined that through the establishment of local collection centers around the country, she can speed up the collection of payments by two and one-half days. Furthermore, the cash management department of her bank has indicated to her that she can defer her payments on her accounts by one-half day without affecting suppliers. The bank has a remote disbursement center in Iowa.

If the company has $5 million per day in collections and $3 million per day in disbursements, how many dollars will the cash management system free up? Justify your answers. If the company can earn 8 percent per annum on freed-up funds, how much will the income be? Justify your answers. If the annual cost of the new system is $800,000, should it be implemented? Explain why or why not.

Paper For Above instruction

The case of Norma’s Cat Food illustrates a strategic approach to cash management that can significantly improve the company's liquidity and operational efficiency. This analysis explores how the implementation of a new cash management system that reduces the cash conversion cycle can lead to financial benefits and whether such an investment is justified given the costs and potential income generated from freed-up funds.

Understanding the Cash Management System and Its Impact

Norma’s Company currently operates with daily collections of $5 million and daily disbursements of $3 million. By establishing local collection centers, Norma estimates that the collection period can be shortened by two and one-half days. Additionally, the bank indicates that disbursement payments can be deferred by half a day without straining supplier relationships, due to the presence of a remote disbursement center in Iowa.

Calculation of Cash Freed-Up

The primary benefit of improved cash management systems is the reduction in the cash conversion cycle, which directly correlates to the amount of cash that can be freed up. The cash conversion cycle in this context comprises the days of receivables outstanding minus the days of payables, adjusted for the improvements due to the new system.

Initially, the company's receivables are assumed to be collected in a standard number of days. The reduction in collection time by 2.5 days allows the company to hold less cash tied up in receivables. The daily collection amount mandated by Norma is $5 million, so the reduction in days translates to:

$5 million/day * 2.5 days = $12.5 million

This amount represents the cash that the company can theoretically free up through improved collection processes.

Similarly, deferring payments by 0.5 days effectively reduces the company's payables’ cycle. Since disbursements amount to $3 million daily, deferring payments by half a day results in:

$3 million/day * 0.5 days = $1.5 million

Adding these two impacts together, the total cash freed-up by the new system is:

$12.5 million + $1.5 million = $14 million

This sum represents the net amount of operational cash flow enhancements the company can realize due to the system.

Calculation of the Income from Freed-Up Funds

Norma’s Company can earn interest on the freed-up cash amounts at an annual rate of 8%. To determine the annual income generated by these freed-up funds, we multiply the total cash freed-up amount by the annual interest rate:

Income = $14 million * 8% = $1.12 million

This additional income stream provides tangible evidence of the financial benefits achieved through improved cash management practices, leveraging idle cash to generate returns.

Cost-Benefit Analysis: Implementation Decision

The annual cost of the new cash management system is projected to be $800,000. Comparing this cost to the additional income of $1.12 million, the implementation of the system appears financially advantageous, with a net benefit of:

$1.12 million - $800,000 = $320,000

Therefore, from a purely financial perspective, the system should be implemented because it results in a net gain. Beyond the monetary benefits, the system enhances operational efficiency, reduces reliance on external financing, and improves the company's liquidity position.

However, decision-makers should also consider qualitative factors such as implementation risks, potential disruptions, and long-term strategic goals. Nonetheless, given the quantifiable benefits, the new cash management system seems justifiable and beneficial for Norma’s Company.

Conclusion

In summary, the establishment of local collection centers and the use of remote disbursement centers can significantly improve the cash flow management of Norma’s Cat Food. The system potentially frees up approximately $14 million in cash, generating an annual income of around $1.12 million at an 8% return rate. Considering the annual cost of $800,000, the net benefit favors implementing the system, making it a financially sound decision that can enhance overall operational efficiency and liquidity management.

References

• Brigham, E. F., & Houston, J. F. (2019). Fundamentals of Financial Management. Cengage Learning.
• Ross, S. A., Westerfield, R. W., & Jaffe, J. (2018). Corporate Finance. McGraw-Hill Education.
• Graham, J. R., & Harvey, C. R. (2001). The Theory and Practice of Corporate Finance: Evidence from the Field. Journal of Financial Economics, 60(2-3), 187-243.
• Franklin, M., & Gerrard, N. (2014). Financial Management: Theory and Practice. Cengage Learning.
• Van Horne, J. C., & Wachowicz, J. M. (2008). Fundamentals of Financial Management. Pearson Education.
• Damodaran, A. (2015). Applied Corporate Finance. John Wiley & Sons.
• Moyer, R. C., McGuigan, J. R., & Kretovics, M. (2012). Contemporary Financial Management. Cengage Learning.
• Ross, S. A., & Allen, F. (2009). Corporate Finance. McGraw-Hill Education.
• Higgins, R. C. (2012). Analysis for Financial Management. McGraw-Hill/Irwin.
• Brealey, R. A., Myers, S. C., & Allen, F. (2017). Principles of Corporate Finance. McGraw-Hill Education.