Forecasting Net Cash Flows In Financial Management ✓ Solved

Forecasting net cash flows in financial management

Topic C - You can readily understand why forecasting net cash flows is a necessary skill in financial management. So, how do we forecast cash collections from customers? Sales Revenues are as follows: November $50,000 actual, December $75,000 actual, January $20,000 actual, February $15,000 Forecast. If the credit manager tells us cash is collected from credit sales as follows: 25% is collected in the month of sale, 50% from the prior month's sales, 20% from two months ago, and 3% from three months ago.

(a) Is it okay that the total collected is only 98% of sales? How do you explain this?

(b) How much cash will be collected in February?

Wrap-up questions include: (a) How is a single payment different from an annuity? (b) What are some of the ways that time value of money concepts are used in the finance profession? (c) What is the difference between discounting and compounding? Which term applies to future value calculations? Which one applies to present values?

Paper For Above Instructions

Forecasting cash flows is fundamental to effective financial management, allowing companies to predict their liquidity position and manage resources efficiently. Understanding how cash is collected from customers is a critical aspect of this forecasting process. In this paper, we will explore the methods used to forecast cash collections, addressing specific questions posed in the assignment.

Forecasting Cash Collections

Based on the sales data provided, the total revenue for November, December, and January was $50,000, $75,000, and $20,000, respectively. The forecast for February is $15,000.

The cash collection percentages indicate how much of past credit sales will be collected in the following months. The breakdown is as follows: 25% of current month sales, 50% of prior month sales, 20% of two months ago's sales, and 3% of sales three months prior. Using this information, we can forecast how much cash will be collected in February.

Understanding Cash Collection Percentages

The total collections for February can be calculated by analyzing the previous months' sales. Here is the calculation:

• From January ($20,000): 25% = $5,000
• From December ($75,000): 50% = $37,500
• From November ($50,000): 20% = $10,000
• From October (Since it’s not specified, assume $0): 3% = $0

Therefore, the total cash collected for February would be:

$5,000 + $37,500 + $10,000 + $0 = $52,500

This indicates a solid cash inflow relative to the forecasted sales for February of $15,000, demonstrating efficient cash collection processes.

Is It Okay That Collections Are Only 98% of Sales?

The question of whether it is acceptable that total collected is only 98% of sales is an important one. In financial management, it is relatively common that not all sales convert into cash collections due to various factors such as customer defaults, payment delays, or discrepancies in accounting. A 98% collection rate is quite good and can be attributed to several factors:

• Cash flow management practices are efficient.
• Effective credit policies and customer screening.
• Poor economic conditions affecting customer payments.

Thus, while a total collected percentage lower than sales may raise some concerns, a 98% collection rate is generally acceptable in practice, signaling that the business is effectively managing credit risk.

Wrap-Up Questions

In addition to the cash flow aspects, let's address the wrap-up questions provided:

1. Single Payments vs. Annuities

A single payment refers to a one-time cash flow, whereas an annuity consists of multiple payments made at regular intervals. For example, a loan with fixed monthly payments is classified as an annuity, while a bond paying back principal on a set date is a single payment.

2. Time Value of Money Concepts

Time value of money (TVM) is a crucial concept in finance that underscores the principle that a dollar today is worth more than a dollar in the future due to its potential earning capacity. Finance professionals use TVM principles to evaluate investment opportunities, determine loan payments, and make strategic financial decisions.

3. Difference Between Discounting and Compounding

Discounting and compounding are two sides of the same coin in financial calculations. Discounting refers to calculating the present value of future cash flows, applicable to present value calculations. Compounding, on the other hand, involves determining the future value of cash flows based on interest earned, relevant to future value calculations.

Conclusion

In conclusion, forecasting cash collections is an essential skill for financial management, allowing companies to maintain liquidity and effectively manage their financial resources. Understanding the timing of cash flows, the differences between payment structures, and the foundational concepts of time value of money reinforces the importance of strategic financial planning.

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