18.1 Working capital management - Cash control

Question 1

Reasons for holding cash (readily available)

Answer 1

• Transactions motive - cash required to meet day to day expenses (eg. payroll, paying suppliers, etc)
• Precautionary motive - cash held to give a cushion against unplanned spending (buffer cash)
• Investment / speculative motive - cash kept available to take advantage of market investment opportunities

Question 2

Failure to carry sufficient cash levels can lead to

Answer 2

• Loss of settlement discounts
• Loss of supplier goodwill (they may refuse further credit, charge higher prices or downgrade order priority)
• Poor industrial relations (if wages are not paid on time industrial action may result - damaging production in short term and relationships and motivation in medium term)
• Potential liquidation - a court may be petitioned to wind up the entity if it consistently fails to pay bills

Question 3

The key principles of cash management are

Answer 3

• Collect debts as quickly as possible
• Pay suppliers as late as possible
• Bank cash takings promptly

Question 4

Cash balancing act

Answer 4

• Liquidity - Ability to pay bills as they fall due and take advantage of opportunities
• Profitability - Minimise the holding of cash which is an idle asset and better invested

Question 5

A cash forecast (cash budget) is an

Answer 5

estimate of cash receipts and payments for a future period under existing conditions

Question 6

Cash forecasts are used to

Answer 6

• assess and integrate operating budgets
• plan for cash shortages and surpluses
• compare with actual spending

Question 7

There are two different techniques that can be used to create a cash forecast

Answer 7

• A receipts and payments forecast
• A statement of financial position forecast

Question 8

Receipts and payments forecast

Answer 8

• based on predictions of sales and cost of sales
• the timings of cash flows will need to be considered to produce a reasonable forecast

Question 9

A statement of financial position forecast

Answer 9

• derived from predictions of future statements of financial positions
• predictions are made for all items except cash which is then calculated as the balancing figure

Question 10

Examples of factors to consider when interpreting a cash forecast include

Answer 10

• Is the balance at the end of the period acceptable / matching expectations?
• Does the cash balance become a deficit at any time in the period?
• Is there sufficient finance (eg. an overdraft) to cover any deficits?
• What are key causes of cash deficits?
• Can/should discretionary expenditure (ie. asset purchases) be made in another period in order to stabilise the pattern of cash flows
• Is there a plan for dealing with cash surpluses (reinvesting them elsewhere)?
• When is the best time to make discretionary expenditure?

Question 11

Spreadsheets are useful for cash forecasting because

Answer 11

• They save time in preparing forecasts - Once the basic model has been constructed it is relatively simple to insert figures and leave the model to produce completed forecast
• They are useful for what if analysis - When there is uncertainty in forecast, the assumptions can be changed and alternative forecasts produced (allows management to consider a range of possible outcomes)
• Cash flow forecasts can be consolidated - If the same spreadsheet model is used for each division or region, then it can automatically create a consolidated cash flow forecast for entity as a whole

Question 12

Possible decisions that could be made to deal with short term cash deficit forecast

Answer 12

• Additional short term borrowing
• Negotiating a higher overdraft limit with bank
• The sale of short term investments, if the entity has any
• Using different forms of financing to reduce cash flows in the short term, such as leasing instead of buying
• Changing the amount of discretionary cash flows, deferring expenditure or bringing forward revenues

Question 13

Examples of deferring forecasted expenditure and bring forward revenues:

Answer 13

• Reducing the dividends to shareholders
• Postponing non-essential capital expenditure
• Bringing forward the planned disposal of non current assets
• Reducing inventory levels perhaps incorporating just in time techniques
• Shortening the operating cycle by reducing time take to collect receivables (by offering discount)
• Shortening the operating cycle by delaying payment to payables