Assignment 2: Cash Management - Solve The Following Problem

Assignment 2 Cash Managementsolve The Following Problem Normas Cat

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

In the realm of corporate finance, cash management plays a pivotal role in optimizing liquidity and enhancing profitability. Effective cash management systems aim to accelerate cash inflows and delay outflows strategically, thereby freeing up funds that can be invested or used to reduce external borrowing costs. The case of Norma’s Cat Food exemplifies how technological advancements and process improvements can significantly impact cash flow efficiency and overall financial health.

To analyze the scenario at hand, it is essential to understand the primary financial metrics involved. Norma’s company has daily collections amounting to $5 million and daily disbursements of $3 million. By establishing local collection centers, Norma can expedite collections by two and a half days, while the deferred payments facilitated by the bank’s remote disbursement center allow her to delay disbursements by half a day without affecting suppliers. These adjustments lead to substantial cash flow savings, which can be precisely quantified.

Calculation of Funds Freed Up

The core concept here revolves around the reduction in the 'cash conversion cycle'—the time span between cash outflows and cash inflows. Normally, the cash conversion cycle includes the days taken to convert inventory and receivables into cash minus the days payable outstanding. In Norma’s case, by accelerating collections and deferring payments, the company effectively shortens its operating cycle.

Accelerated collections: Norma can speed up collections by 2.5 days. Given daily collections of $5 million, the additional cash flow captured per day is $5 million. Therefore, the funds freed up due to faster collections are:

• $5 million/day × 2.5 days = $12.5 million

Deferred disbursements: By delaying payments by half a day, with daily disbursements of $3 million, the company can hold onto cash longer by:

• $3 million/day × 0.5 days = $1.5 million

Adding these, the total cash flow that the management system frees up is:

$12.5 million + $1.5 million = $14 million

This indicates that the new cash management system effectively increases the company's available cash by approximately $14 million, assuming the incremental cash flows are continuous and the system implementation functions as intended.

Income From Freed-Up Funds

With the company's ability to earn an 8% annual return on the freed-up funds, the additional income can be calculated based on the amount of liquidity freed up over the year. Since the funds are recovered quickly (within roughly a day or so), the annual interest earnings approximate to applying the annual rate to the average balance of these funds.

The annual income generated from the freed-up $14 million can be estimated as:

Interest Income = Freed-up funds × Annual interest rate = $14 million × 8% = $1.12 million

This income signifies the additional earnings the company can realize by investing its idle cash strategically, which contributes positively to its profitability.

Cost-Benefit Analysis and Implementation Decision

Despite the apparent benefits, one must weigh these gains against the costs associated with implementing the new system. The annual cost of the system is projected at $800,000. Comparing this investment to the estimated interest income of $1.12 million results in a net gain of:

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

Given this analysis, the implementation of the new cash management system appears financially advantageous, as it yields a positive net benefit of approximately $320,000 annually. The decision to proceed should also consider qualitative factors, such as the system's reliability, risk management, and strategic alignment with the company's long-term goals. Nevertheless, based purely on the financial metrics, the project’s benefits surpass its costs.

Conclusion

Enhanced cash management through operational improvements and technological systems offers substantial financial benefits. In Norma’s case, the system can free up approximately $14 million in cash over the year, generating an estimated interest income of $1.12 million at an 8% return rate. When considering the $800,000 annual system cost, the project yields a net benefit of $320,000, making it a financially sound decision. This illustrates how strategic investments in cash flow management can significantly impact a company's liquidity position and profitability, ultimately supporting sustainable growth and competitive advantage in the marketplace.

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