Chapter 16 Solution To Ch 16 P18 Build A Model Data Coll

1841110chapter 16 Solution To Ch16 P18 Build A Modelinput Datacoll

Build a comprehensive monthly cash budget for a company, considering sales, collections, payments, expenses, and financing needs over a specified period, factoring in seasonal variations, payment terms, and potential late payments. The goal is to determine the cash surplus or requirement to maintain a target cash balance, the monthly borrowing needs, and how changes in sales or collection patterns impact financing requirements. Additionally, analyze how seasonality affects financial ratios, perform sensitivity analyses regarding late payments and sales drops, and evaluate trade credit costs. Use given financial assumptions and historical data to accurately model cash flows, asset turnover, and profitability measures, providing insights into liquidity management and working capital policies.

Paper For Above instruction

Introduction

Effective cash management is a fundamental aspect of financial planning for any business, ensuring liquidity sufficiency while optimizing the use of resources. The task here involves constructing a detailed monthly cash budget for a company operating over a specific six-month forecast period. This process requires analyzing various cash inflows and outflows, understanding the impact of seasonal sales fluctuations, payment terms, and potential late payments or sales declines. Additionally, the analysis extends to evaluating the implications of seasonal operations on financial ratios and performing sensitivity analyses to assess the impact of delays in collections and sales variations. The comprehensive approach enables the management to determine the month's borrowing requirements and maintain a desired cash reserve.

Constructing the Cash Budget

The first step in creating an accurate cash budget involves understanding the sales and collection patterns. The company’s sales estimates vary month by month, with collections during the month of sale, the first month after sale, and the second month after sale. For instance, in the forecast, sales for July are projected at $360,000, with collection patterns indicating 10% collected during the month, 75% in the following month, and 15% two months later. These percentages translate into actual cash inflows, which are summed to derive total collections each month.

Payments for purchases, labor, raw materials, administrative salaries, lease payments, taxes, and miscellaneous expenses are then deducted from the inflows to determine net cash flows. Taking into account beginning cash balances of $132,000, the present cash position influences subsequent borrowings or surplus cash accumulation. The target cash balance is specified at $90,000; thus, if the forecasted ending cash is below target, the company must borrow; if above, surplus cash can be used or invested.

The model considers all known expenses and planned expenditures, including significant payments such as a new studio in October. Sensitivity to changes in sales, collection rates, and timing of payments are crucial, especially when considering the possible impact of late customer payments or seasonal fluctuations on cash flows.

Borrowing Requirements and Maintaining Liquidity

The analysis reveals that the company's maximum borrowing need—calculated from the "surplus or deficit" at each month—is critical for maintaining operational liquidity. For instance, if the cumulative net cash flows indicate an anticipated shortfall below the target balance, the company must borrow accordingly. By evaluating the "Surplus cash or loan needed" line, management can determine its monthly financing requirements to maintain a stable cash cushion.

Furthermore, the budget illustrates the importance of timing payments and collections, which affects cash flow smoothness. It is evident that inflows, if received late or bunched, can cause cash shortages even if the overall projected sales are adequate.

Impact of Seasonality and Payment Terms

Seasonality significantly influences liquidity ratios such as the current ratio and debt ratio. During peak months with high sales, current assets rise, potentially improving the current ratio but possibly overstating liquidity if receivables are not collected timely. Conversely, during low sales months, ratios may decline, indicating tighter liquidity.

The effect of payment terms, such as the 2/10 net 40 arrangement, alters the timing of cash inflows and outflows. Early discounts incentivize prompt payments, but firms must balance the cost of discounts against improved cash flow timing. Similarly, late payments or delayed collections increase the need for borrowing, raising the importance of accurate modeling.

Sensitivity Analyses of Collection Delays and Sales Declines

Alterations in customer payment behavior or sales volume impact the maximum loan requirements. For example, if customers begin paying 15 days late instead of promptly, the cash inflow is delayed, necessitating higher short-term borrowing to cover ongoing expenses. Similarly, a decrease in sales reduces cash inflows, forcing reliance on existing cash or increased borrowing.

Adjusting the sales forecast by a percentage adjustment factor allows simulation of worst-case scenarios, illustrating the company's exposure to credit risk and seasonal fluctuations. Sensitivity analyses help quantify the potential increase in loan requirements, informing better risk management and contingency planning.

Trade Credit Costs and Financing

The analysis of trade credit terms, such as 2/10 net 40, provides insight into the effective cost of supplier credit. Calculations involve determining the nominal and effective annual interest costs of delaying payment past the discount period and the financial implications of extending payable periods. For instance, delaying payment beyond the discount window may equate to financing at high implicit interest rates, emphasizing the importance of optimizing payables without violating contractual terms.

Understanding these costs assists in evaluating whether utilizing trade credit is a cost-effective financing strategy against other sources, such as short-term loans.

Conclusion

Building an accurate cash budget involves integrating detailed sales, collection, and payment forecasts, considering seasonal variability, payment terms, and customer payment behaviors. Sensitivity analyses highlight the company's vulnerability to late payments and sales fluctuations, underscoring the importance of maintaining sufficient liquidity and balancing trade credit costs. Such comprehensive financial modeling enables effective working capital management, mitigating potential liquidity shortfalls, and optimizing the company's financial stability amid seasonal and market uncertainties.

References

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