DIMENSIONS OF CASH FLOW MANAGEMENT

Prof. N. C. Kar

Management of Cash
Cash includes hard currency, bank balances and marketable securities. Cash is the fastest moving asset of the firm.

Financial asset used for both operating & nonoperating purposes.

Earns nothing when held in its form.

Objectives of Cash Mgt.

To maintain a cash balance that provides sufficient liquidity to meet obligations. To avoid maintaining idle cash as it has an opportunity cost.

Motives for holding Cash.

Transactions Motive : Meeting day to day transactional needs. Precautionary Motive : Meeting Contigencies. Speculative Motive : To take advantage of the favorable market conditions. Compensating Balance : To get various bank services.

CASH BALANCE VS CASH FLOWS.

Cash Balance is a static concept : the resultant of cash

inflows and outflows.

Cash flow is the movement of cash into, within and out of the firm.

Management of cash basically refers to Planning,

Managing & Controlling Cash Flows.

TYPES OF CASH FLOWS.

Cash flows can be short cycle cash flows & long cycle cash flows. Short cycle cash flows takes a short route to return as against long route for long cycle cash flows. Cash flows can be classified as operating & nonoperating. Operating cash flows are inflows & outflows resulting from all operating transactions, i.e. sales, purchase of inputs. Office & administrative expeneces etc. Non-operating cash flows are classified into : Investment flows Financing flows Other flows

Investment flows : Capital expenditure and sale of various investment Financing flows : Issue of shares/debentures & repayment of loans, payment of dividend and interest Other flows : Un-common inflows and out-flows While operating cash flows show random fluctuations, nonoperating cash flows are fairly certain in timing and magnitude.

Cash Flow Vs Funds Flow.

Funds flow vs cash flow. Power and cash flow statement. Cash flow statement example.
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Short Term & Long Term Cash Flow Cycles.

Investment Equity Purchase Labour & Overheads

Cash
Loans Fixed Assets Sales Stock

W/C

The quantum of cash flow involved is much bigger than that of short term cash flow cycle. It covers normally fixed assets and long term liabilities.
* The

orbital time is much longer than that of short term cash flow. * It is less volatile.
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Funds Flow Vs Cash Flow.

Sales Less COGS EBIT Less INT PBT Less Tax PAT Depreciation (part of COGS) Fund From Operation 10,00,000 6,00,000 4,00,000 80,000 3,20,000 1,60,000 1,60,000 1,00,000 2,60,000

Assume 50 % Credit Sales not realized. All other cost incurred in cash terms excluding depreciation.
Continues . . . 8

Cash Sales Credit Realised Less Cash COGS Cash EBIT Less INT Cash PBT Less Tax Cash PAT

5,00,000 ---------5,00,000 0 80,000 - 80,000 1,60,000 -2,40,000

CASH FROM OPERATION CFO IS 24% OF SALE.

WHERE IS THE FUND IN THE FUNDS FLOW STATEMENT ?.

Continues . . .

CONCEPT OF FUNDS FLOW HAS LOST ITS SIGNIFICANCE.

ACCOUNTING STD BOARD HAS STRESSED ON CASH FLOW AS REPLACEMENT FOR FUNDS FLOW.
CASH FLOW STATEMENT IS THE MOST POWERFUL TOOL IN FINANCIAL EVALUATION. ACCOUNTING PROFIT IS MEANINGLESS EXCEPT FOR TAX PURPOSE. TAX AUTHORITIES ARE NOW LOOKING FOR CASH PROFIT WITH INTEREST.
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Cash Flow Statement (Significance) :

Integral to investment and credit decisions. Measures ability to generate cash or cash equivalents and to match the needs to utilize those cash flows. Ability to measure the amount and timing of cash flows. Compare the present value of future cash flows of different enterprises. Enhances the comparability of reporting of operating performances by eliminating the effects of using different accounting treatments for the same transactions. Future cash flow projections becomes easier.

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Power of Cash Flow Statement.

INFLOWS
CFO OPERATING OUTFLOWS OPERATING OO FO IO

CASH FROM OPERATION

FINANCING
INVESTMENT

FINANCING INVESTMENT OTHER

CFO CFO CFO CFO CFO > = < = = FO FO FO 0 -ve -

OTHER NCF --------------------------------GROWTH FIRM STABLE DECLINING SICK ABSOLUTELY SICK

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Direct Method Cash Flow Statement.

Cash flows from operating activities Cash receipts from customers Cash paid to suppliers and employees Cash generated from operations Income tax paid Cash flow before extraordinary item Proceeds from earthquake disaster settlement
(Rs. 000) 1996

Net cash from operating activities

30,150 (27,600) 2,550 (860) 1,690 180

1,870

Cash flows from investing activities Purchase of fixed assets Proceeds from sale of equipment Interest received Dividend received

Net cash from investing activities

(350) 20 200 160

30
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Continues . . .

Net cash from investing activities

Cash flows from financing activities Proceeds from issuance of share capital Proceeds from long term borrowings Repayments of long term borrowings Interest paid Dividend paid
250 250 (180) (270) 1,200

30

Net cash used in financing activities

1,150
750 160

Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period

Cash and cash equivalents at end of the period

910

Continues . . .

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Cash flow parameters for performance analysis.

The format of CF statement as per AS3 is more suitable for external users than for managers. A manager can easily prepare the statement from cash book on weekly and monthly basis. In order to plan outflows, cash flow can be divided into Priority out cash flows (Int + Loan + Tax) Discretionary cash flows Objective of the manager should be to meet priority out cash flows from operating inflows. Balance available should be used for discretionary outflows in conjunction with other inflows. Following ratios can be used for analysis & control :
Cash flow sufficiency ratio Cash flow efficiency ratio Priority obligation ratio CFO / Priority Outflows Adequancy measure for priority outflows
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Sufficiency and Efficiency Ratios.

(Sufficiency)

Ratio

Formula
Cash from operations dividends paid + asset purchases + long term debt paid

Indication
Ability to generate cash to cover growth requirements. A value >1 deemed satisfactory cover Adequacy measure for contractual payments

Cash flow adequacy

Long term debt payment Longterm debt payments Cash from operations Dividend payout ReInvestment Dividends Cash from operations Asset purchases Cash from operations Total Debt Cash from operations

Payout ratio measure for discretionary distributions Outlay ratio measure for discretionary investments Coverage used as payback how many years, at current flows, will it take to retire debt
Continues . . . 16

Debt Converage

Sufficiency and Efficiency Ratios (Continued).

(Efficiency)

Ratio

Formula

Indication

Depreciationamortisation impact Depreciation + amortisation Cash from operations Priority obligation ratio Cash flow to sales

Ratio of non-cash items to cashfrom operations

CFO Priority outflows Ratio of sales dollar realised as cash from operations Measures cash generating productivity of continuing operations Measure return on assets (on cash generation basis)
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Cash from operations sales Cash from operations Income from continuing operations Cash from operations Total Assets

Operations Index

Cash flow return On assets

Cash Flow Planning & Control:

Forecasting of cash flows. Monitoring and accelerating inflows. Controlling outflows. Managing the balance. Review and follow up action.

Forecasting of Cash Flows:

Long period vs short period forecasts. Forecasting methods and skills. Details of forecasting variables.
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Cash Budget: The Primary Cash Management Tool

Purpose: Uses forecasts of cash inflows, outflows, and ending cash balances to predict loan needs and funds available for temporary investment.

Timing: Daily, weekly, or monthly, depending upon budgets purpose. Monthly for annual planning, daily for actual cash management.

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DATA REQUIRED FOR CASH BUDGET

1. Sales forecast. 2. Information on collections delay. 3. Forecast of purchases and payment terms. 4. Forecast of cash expenses: wages, taxes, utilities, and so on. 5. Initial cash on hand. 6. Target cash balance.
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SKIs Cash Budget for January and February

Net Cash Inflows January February Collections $67,651.95 $62,755.40 Purchases 44,603.75 36,472.65 Wages 6,690.56 5,470.90 Rent 2,500.00 2,500.00 Total payments $53,794.31 $44,443.55 Net CF $13,857.64 $18,311.85

Cash Budget (Continued)

January

February

Cash at start if no borrowing $ 3,000.00 $16,857.64 Net CF 13,857.64 18,311.85 Cumulative cash $16,857.64 $35,169.49 Less: target cash 1,500.00 1,500.00 Surplus $15,357.64 $33,669.49

Should depreciation be explicitly included in the cash budget?

No.

Depreciation is a noncash charge. Only cash payments and receipts appear on cash budget. However, depreciation does affect taxes, which do appear in the cash budget.

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What are some other potential cash inflows besides collections?

Proceeds

from fixed asset

sales. Proceeds from stock and bond sales. Interest earned. Court settlements.
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How can interest earned or paid on short-term securities or loans be incorporated in the cash budget?
Interest

earned: Add line in the collections section. Interest paid: Add line in the payments section. Note: Interest on any other debt would need to be incorporated as well.
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How could bad debts be worked into the cash budget? Collections would be reduced by the amount of bad debt losses. For example, if the firm had 3% bad debt losses, collections would total only 97% of sales. Lower collections would lead to lower surpluses and higher borrowing requirements.

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SKIs forecasted cash budget indicates that the companys cash holdings will exceed the targeted cash balance every month, except for October and November.
Cash budget indicates the company probably is holding too much cash. SKI could improve its EVA by either investing its excess cash in more productive assets or by paying it out to the firms shareholders.

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What reasons might SKI have for maintaining a relatively high amount of cash?
If sales turn out to be considerably less than expected, SKI could face a cash shortfall. A company may choose to hold large amounts of cash if it does not have much faith in its sales forecast, or if it is very conservative. The cash may be there, in part, to fund a planned fixed asset acquisition.

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Speeding Up Cash Receipts

Collections
Expedite preparing and mailing the invoice Accelerate the mailing of payments from customers Reduce the time during which payments received by the firm remain uncollected

Collection Float

Mail Float

Processing Float Deposit Float

Availability Float

of the check by the customer and the availability of cash to the receiving firm.

Collection Float: total time between the mailing

Mail Float

Customer mails check

Firm receives check

Mail Float: time the check is in the mail.

Processing Float

Firm receives check

Firm deposits check

Processing Float: time it takes a company

to process the check internally.

Availability Float

Firm deposits check

Firms bank account credited

Availability Float: time consumed in clearing

the check through the banking system.

Deposit Float

Processing Float

Availability Float

received by the firm remains uncollected funds.

Deposit Float: time during which the check

Managing Float
Payers

attempt to create delays in the check clearing process. Recipients attempt to remove delays in the check clearing process.
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Float. Float is associated with both collection & disbursement of funds. Float is the time delay between mail of a cheque by the customer and its realisation. Can be of the types :
Collection float (-ve float) Disbursement float (+ve float)

Float is also the difference between book balance and bank balance. Book balance > bank balance -ve float. Book balance < bank balance +ve float. Collection float + disbursement float is called Net float. Objective of the manager should be to generate +ve net float.

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FLOAT Billing float A/c Credits Clearing float Sales Billing Customer mails cheque Mail Float

Company deposits cheque

Comp processes

Company receives cheque

Processing Float

For accelerating inflows, collection float has to be reduced by following Methods : Lock box system Concentration banking Post dated cheques Electronic fund transfer

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Lockbox Systems
Traditional Lockbox A post office box maintained by a firms bank that is used as a receiving point for customer remittances.
Electronic Lockbox A collection service provided by a firms bank that receives electronic payments and accompanying remittance data and communicates this information to the company in a specified format.

Lockbox Process*
Customers are instructed to mail their remittances to the lockbox location. Bank picks up remittances several times daily from the lockbox. Bank deposits remittances in the customers account and provides a deposit slip with a list of payments. Company receives the list and any additional mailed items.

* Based on the traditional lockbox system

Lockbox System
Advantage
Receive remittances sooner which reduces processing float. Disadvantage Cost of creating and maintaining a lockbox system. Generally, not advantageous for small remittances.

Concentration Banking
Cash Concentration
The movement of cash from lockbox or field banks into the firms central cash pool in a concentration bank. Compensating Balance Demand deposits maintained by a firm to compensate a bank for services provided, credit lines, or loans.

Concentration Banking
Moving cash balances to a central location:
Improves control over inflows and outflows of corporate cash. Reduces idle cash balances to a minimum. Allows for more effective investments by pooling excess cash balances.

Playing the Float

Net Float -- The dollar difference between the balance shown in a firms (or individuals) checkbook balance and the balance on the banks books.
You write a check today, which is subtracted from your calculation of the account balance. The check has not cleared, which creates float. You can potentially earn interest on money that you have spent.

EXTENSIONS OF FLOAT MANAGEMENT

Understand the impact of payment and receipt mechanism or cash flow time line. Float refers to delay in value transfer from the time a cheque is written until it is finally charged to the account

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Exmpl : A cheque receipt per day Rs. 60 lakhs. Practice is to deposit cheques twice a week, Wednesday and Friday
Received Mon Tue Wed Thur Reported Wed Wed Wed Fri Float 2 X 60 = 120 1x 60= 60 ---1x60= 60

Fri
Sat

Fri
Wed

---3x60= 180 420 lakh

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Continuing float 420 lacs float days per week

Opportunity cost = 18% p.a

0.18 Loss due to float per week 420 x 365 0.20712 lakhs Rs.20712 /

Loss per annum = 20, 712 x 52 = Rs. 10,75

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LOCK BOX SERVICES :

Lock box system involves both a fixed and a variable cost Fixed cost : Account maintenance fee,Transfer fee of the balance Variable cost : lock box processing charge Total Cost = N [ F x D x i] + VC] + FC

N = no of remittances processed F = Avg. face value of remittances D = No of days it takes to clear the cheque I = Daily Opportunity cost of fund VC = variable cost for each remittance FC = Fixed cost charged by the processor
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Ex:Variable N F D i VC FC

Processor A 1000 1500 6 0.10/365 0.45 225

Processor B 1000 1500 5 - lower 0.10/365 0.50 275

Higher

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0.10 TC(A) 1000(1500 X 6X 45) 225 3140 365

.10 TC(B) 1000(1500 X 5X 45) 275 2830 365

Even if charges are higher lower processing time

generates savings.
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Assume there are 100 cheques of face value of Rs 15 per cheque. Total amount is same.
TC(A) = 47,685 TC(B)= 52,325 With increased no of cheques and lower face value Bank A provides lower total cost. Float savings is less significant when the value of the cheque is small.
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Controlling Disbursements.

Making payment only when it is due and availing cash discount. Stretching payables beyond the due date when there is no discount without impairing the credit standing. Paying through a centralized system. Increasing the disbursement float without affecting image.

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S-l-o-w-i-n-g D-o-w-n Cash Payouts

Playing the Float

Control of Disbursements Zero Balance Account (ZBA) Remote and Controlled Disbursing

Control of Disbursements
Firms should be able to: 1. shift funds quickly to banks from which disbursements are made. 2. generate daily detailed information on balances, receipts, and disbursements. Solution:

Centralize payables into a single (smaller number of) account(s). This provides better control of the disbursement process.

Methods of Managing Disbursements

Zero Balance Account (ZBA):
A corporate checking account in which a zero balance is maintained. The account requires a master (parent) account from which funds are drawn to cover negative balances or to which excess balances are sent.

Eliminates the need to accurately estimate each disbursement account.

Only need to forecast overall cash needs.

Remote and Controlled Disbursing

Remote Disbursement -- A system in which the
firm directs checks to be drawn on a bank that is geographically remote from its customer so as to maximize check-clearing time. This maximizes disbursement float.
Example: A Vermont business pays a Maine supplier with a check drawn on a bank in Montana. This may stress supplier relations, and raises ethical issues.

FORMS OF INVESTMENT.

Invest in current account. Increase reserve drawing power under cash credit arrangement. Invest in marketable securities like treasury bills, commercial papers etc. Invest in inter-corporate reports. Invest in M M Mutual fund.
Safety Liquidity Yield Maturity
Primary considerations Secondary considerations

Criteria of Investment :

Continues . . .

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Investment in Marketable Securities

Marketable Securities are shown on the balance sheet as:
1. Cash equivalents if maturities are less than three (3) months at the time of acquisition. 2. Short-term investments if remaining maturities are less than one (1) year.

The Marketable Securities Portfolio

F$
C$

Ready Cash Segment (R$)

R$

Optimal balance of marketable securities held to take care of probable deficiencies in the firms cash account.

The Marketable Securities Portfolio

F$
C$

Controllable Cash Segment (C$)

R$

Marketable securities held for meeting controllable (knowable) outflows, such as taxes and dividends.

The Marketable Securities Portfolio

F$
C$

Free Cash Segment (F$)

R$

Free marketable securities (that is, available for as yet unassigned purposes).

Variables in Marketable Securities Selection

Safety
Refers to the likelihood of getting back the same number of dollars you originally invested (principal). Marketability (or Liquidity) The ability to sell a significant volume of securities in a short period of time in the secondary market without significant price concession.

Variables in Marketable Securities Selection

Interest Rate (or Yield) Risk The variability in the market price of a security caused by changes in interest rates.
Maturity Refers to the remaining life of the security.

Common Money Market Instruments

Money Market Instruments
All government securities and short-term corporate obligations. (Broadly defined)

Treasury Bills (T-bills): Short-term, noninterest bearing obligations of the U.S. Treasury issued at a discount and redeemed at maturity for full face value. Minimum $1,000 amount and $1,000 increments thereafter.

T-Bills and Bond Equivalent Yield (BEY) Method:

BEY = [ (FA PP) / (PP) ] *[ 365 / DM ]
FA: face amount of security PP: purchase price of security DM: days to maturity of security
A $1,000, 13-week T-bill is purchased for $990 what is its BEY?

BEY = [ (1000 990) / (990) ] *[ 365 / 91 ] BEY = 4.05%

T-Bills and Equivalent Annual Yield (EAY) Method:

EAY = (1 + [ BEY / (365 / DM) ] )365/DM - 1
BEY: bond equivalent yield from the previous slide DM: days to maturity of security

Calculate the EAY of the $1,000, 13-week T-bill purchased for $990 described on the previous slide?

EAY = (1 + [.0405/(365 / 91)])365/91 - 1 EAY = 4.11%

Common Money Market Instruments

Treasury Notes: Medium-term (2-10 years original maturity) obligations of the U.S. Treasury.
Treasury Bonds: Long-term (more than 10 years original maturity) obligations of the U.S. Treasury.

Common Money Market Instruments

Repurchase Agreements (RPs; repos): Agreements to buy securities (usually Treasury bills) and resell them at a higher price at a later date. Bankers Acceptances (BAs): Short-term promissory trade notes for which a bank (by having accepted them) promises to pay the holder the face amount at maturity.

Common Money Market Instruments

Commercial Paper: Short-term, unsecured promissory notes, generally issued by large corporations (unsecured IOUs). The largest dollar-volume instrument. Federal Agency Securities: Debt securities issued by federal agencies and governmentsponsored enterprises (GSEs). Examples: FFCB, FNMA, and FHLMC.

Selecting Securities for the Portfolio Segments

F$
C$

Ready Cash Segment (R$)

R$

Safety and ability to convert to cash is most important. Select U.S. Treasuries for this segment.

Selecting Securities for the Portfolio Segments

F$
C$

Controllable Cash Segment (C$)

R$

Marketability less important. Possibly match time needs.

May select CDs, repos, BAs, euros for this segment.

Selecting Securities for the Portfolio Segments

F$
C$

Free Cash Segment (F$)

R$

Base choice on yield subject

to risk-return trade-offs. Any money market instrument may be selected for this segment.

STEPS IN CASH CRISIS:

Utilize Sell

unused credit limit

marketable securities spacing of repayment schedule of term

Negotiate

liabilities
Negotiate

for enhancement of short term credit

facilities with bank

Defer

payment of suppliers bill slacks in cash out flows

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Advance Sell

assets

Ways to Minimize Cash Holdings

Use lockboxes. Insist on wire transfers from customers. Synchronize inflows and outflows.

Use a remote disbursement account.

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REVIEW AND FOLLOW UP ACTIONS

Identify slacks in the system Take remedial measures

Introduce improvements in the system.

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