Cash Management 743

2. A company has a balance of `200 lakh in its books as well as in its bank account. The company issues
an outstation cheque for `45 lakh that will take 7 days to clear. The company’s book balance will reduce
immediately when the cheque is written. But its bank will not charge until 5 days. How much is the
payment float available to the company?
3. ABC Limited estimates its total cash requirement as `20 crore next year. The company’s opportunity cost
of funds is 16 per cent per annum. The company will have to incur `150 per transaction when it converts
its short-term securities to cash. Determine the optimum cash balance. How much is the total annual cost
of the demand for the optimum cash balance? How many deposits will have to be made during the year?
4. XYZ Company has a policy of maintaining a minimum cash balance of `50 lakh. The standard deviation
of the company’s daily cash flows is `20 lakh. The annual interest rate is 14 per cent. The transaction cost
of buying or selling securities is `150 per transaction. Determine XYZ’s upper control limit and the return
point as per the Miller-Orr model.
5. Nice Furniture Ltd is currently following a centralized collection system. Most of its customers are located
in the cities of Northern India. The remittances mailed by customers to the central location take three days
to reach. Before depositing the remittances in the bank, the firm looses two days in processing them. The
daily average collection of the firm is `12 lakh. The company is thinking of establishing a lock-box system.
It is expected that such a system will reduce mailing time by one day and processing time by one day. (i)
Find out the reduction in cash balances expected to result from the adoption of the lock-box system. (ii)
Determine the opportunity cost of the present centralized collection system if the interest rate is assumed
to be 15 per cent. (iii) Should the lock-box system be established if its annual cost is `24,500?
6. PKJ Limited has annual sales of `165 crore. The company has investment opportunities in the money
market to earn a return of 12 per cent per annum. If the company could reduce its float by 2 days, what
would be the company’s total return?

PROBLEMS

1. Kashiram & Co. is a manufacturer of children’s 30 per cent of the total sales.
garments. The sales vary seasonally, and are (c) Sales are collected after one month.
highest in the month of May. The management (d) Gross profit margin on sales is expected to
of the company wishes to prepare a cash budget be 25 per cent.
from the period January through June. The
(e) Payments for the purchases are made one
financial manager starts with the balance sheet of
month in advance.
1 January as shown in Table 30.5 and prepares a
cash budget. Table 30.6 gives the sales for seven (f) A minimum inventory of `60,000,000 at
months. cost is always maintained. The company
purchases sufficient inventory each month to
To prepare the cash budget, the following
take care of sales of the subsequent month.
additional information is given:
(g) Other monthly expenses are:
Table 30.5: Kashiram & Co’s
Balance Sheet, 1 January (` thousand)

Amount Assets Amount Salary 9,600

Liabilities & Capital (` ’000) (` ’000) Rent 2,400
Depreciation 720
Current liabilities 3,000 Cash 84,480 Other 1% of sales
Other liabilities 10,800 Debtors 42,000
Share capital 317,280 Inventory 123,000 (h) A 16 per cent interest on borrowed funds is
Fixed assets 81,600 payable in the next month of every quarter,
Total funds 331,080 Total assets 331,080 on the outstanding balance. Borrowing is
possible each month in the multiples of
Table 30.6: Sales Estimates
`1,000,000.
(` thousand) (` thousand) 2. Kay Co. always prepares a cash budget for the
months of January, February and March. Estimated
December 60,000 April 228,000
sales for these months are `500,000, `600,000 and
January 84,000 May 288,000
`750,000 respectively. Actual sales for the month
February 156,000 June 108,000
of December were `520,000. About 80 per cent
March 132,000 July 108,000
of Kay Co.’s total sales are on cash basis and 20
(a) Sales for the month of December were per cent credit sales, collectible after one month.
`60,000,000. Kay Co. pays its creditors, which are usually
about 40 per cent of sales, one month after the
(b) Credit sales are 70 per cent and cash sales
sale month.
744 Financial Management
The forecasts of salary expenses for the coming (f) An advance tax of `15,000 will be paid in July.
three months are expected to be `280,000 per You are also required to determine whether or
month. Kay Co. is expected to spend about `80,000 not borrowing will be necessary during the period
in February and `190,000 in March on capital and if yes, when and for how much.
expenditures. A previously declared dividend of 4. X Co. has average credit sales of `1,500,000 per
`75,000 is to be paid in January and miscellaneous year. The working days per year are 300. If the
expenses are estimated to be `15,000 per month. company could reduce its bill processing time
The company also has `36,000 bills payable in by two days, what would be the annual savings,
February. assuming an interest rate of 18 per cent?
(a) Prepare a statement showing the sale receipts. 5. The Sirsa Company is a large wholesale distributor
(b) Assuming that the 1 January cash balance of consumer goods that sells mostly on credit.
is `500,000 and that the minimum cash Collections from a particular location average
balance requirement of the company is `200,000 per day. The total float averages 6 days
`500,000, prepare a cash budget for the next for customers in this location. The opportunity
three months. cost of funds is 15 per cent.
(c) Explain the reason for estimated cash shortage (a) The company has an offer from a bank to
that appears imminent. set up a lock-box system that will reduce
(d) Suppose that Kay Co. lends any surplus at 15 float by 4 days, but the company will have
per cent per year for one month and borrows to maintain a minimum balance of `400,000
for three months at 18 per cent year when with the bank. Should the offer be accepted?
there is a cash shortage. Make the necessary (b) The bank also offers an option of a fixed
changes in your cash budget prepared in (b) fee of `20,000 per year. What should the
to make it balance. Assume that interest is company do?
paid at the end of any borrowing or lending 6. A company has a central billing system. Its daily
period. collections on an average are `500,000. The total
3. Prepare a cash budget for the Kamp Manufacturing time for administering the collection is 6 days.
Company for three months of May, June and (a) If a firm’s required rate of return is 10 per
July. The company has a policy of maintaining a cent, what is the cost of the system to the
minimum cash balance of `30,000. The company’s firm?
cash balance as on 30 April is `30,000.
(b) If the management designs a lock-box system
Actual Sales (`) Estimated Sales (`) that reduces the lag by 3 days, what is the
reduction in cash balances?
January 75,500 May 105,000
7. Garima Detergents has discovered that it takes
February 75,000 June 120,000
about 10 days to collect the funds for use in the
March 90,000 July 150,000
company once the cheques are received from
April 90,000 August 150,000
the customers. The company’s annual turnover
is `9.70 crore. How much funds can be freed if
Consider the following additional information: the company could reduce the collection time
from 10 days to 8 days? If the freed funds could
(a) Cash sales are 60 per cent of the total sales.
be used to reduce bank borrowings which costs
The remaining sales are collected equally
18 per cent per annum, what would be the net
during the following two months.
savings to the company? Assume a 360-day year
(b) Cost of goods manufactured is 75 per cent and 35 per cent corporate tax rate.
of sales. 80 per cent of this cost is paid after
8. A company located in Ahmedabad wants to
one month and the balance is paid after two
transfer `15 lakh to its branch in Chennai. It
months of the cost incurrence.
will cost the company `10 to mail the draft by
(c) Fixed operating expenses are `15,000 per a registered post. It will take 10 days for money
month. Variable operating expenses are 10 to be finally transferred in Chennai. During these
per cent of sales each month. 10 days, the company is losing an opportunity
(d) Half yearly interest on 12%, `450,000 of earning 12 per cent p.a. Alternatively, the
debentures is paid during July. company can instantaneously transfer the money
(e) `60,000 are expected to be invested in fixed telegraphically that will cost the company
assets during June. `1,000. What should the company do?

CASE 30.1: BRIGHT PAINTS LIMITED

Bright Paints Limited, situated in Punjab, is a large mostly to small retailers in cities and towns of Northern
whole-seller of industrial paints. The company sells paints states. About 10 per cent of sales are made directly to