Cash Flow Cycle and Cash Budgets

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Cash Flow Cycle and Cash Budgets

• Lakehead Shad Valley

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Importance of Cash Flow

• Planning to have cash available to pay bills of
  the business as they become due is a critical
  aspect of business survivalit is a management
  skill.
• Understanding the cash flow cycle of a firm can
  help you manage those elements that are critical
  to ensuring you can pay your bills.
• Cash flow forecasting through a cash budget
  provides important information to you and to your
  potential funding partners about your operating
  financial needs and most particularly, the timing
  and magnitude of any projected cash deficits or
  surpluses.

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Sources and Uses of Cash

• The foregoing diagram of the cash flow cycle is
  very helpful to you when trying to identify
  changes in balance sheet amounts from one balance
  sheet date to another.
• For example, if inventories risethe only way
  that can happen is for the cash account to
  decreaseso a rise in inventories is a USE of
  cash.
• If you borrow more money (ie. sell bonds or
  negotiate a loan) that will increase the amount
  in the cash account..that is a SOURCE of cash.
• Be sure to be able visualize that diagramit will
  help you in identifying sources and uses of
  funds.

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• Operating Cycle

• Operating cycle is the time period between the
  acquisition of inventory and when cash is
  collected from receivables.

Finance Industry
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• Cash Cycle

• Cash cycle is the time between cash disbursement
  and cash collection.

Finance Industry
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Cash Flow CycleStart
Cash Account Balance 0
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Cash Flow CycleInitial Equity Investment
Balance Sheet Cash 1m Common Stock 1
m ___________________________________ T.
Assets 1m T. Claims 1m
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Cash Flow CyclePurchase of 500,000 Fixed Assets
Balance Sheet Cash 0.5 F. Assets 0.5 Common
Stock 1 m ___________________________________ T.
Assets 1m T. Claims 1m
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Cash Flow CycleBuy 300,000 of inventory on
credit
Balance Sheet Cash 0.5 A/P 0.3 Inventory 0.3 F.
Assets 0.5 Common Stock 1 m ____________________
_______________ T. Assets 1.3m T. Claims 1.3m
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Cash Flow CycleFurther Work-in-process plus
finished goods
Balance Sheet Cash 0.5 A/P 0.4 Inventory 0.8 Ac
cruals 0.3 F. Assets 0.4 Common Stock 1
m ___________________________________ T.
Assets 1.7m T. Claims 1.7m
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Cash Flow CyclePayment of initial A/P and
Accruals
Balance Sheet Cash 0.1 A/P 0.1 Inventory 0.8 Ac
cruals 0.2 F. Assets 0.4 Common Stock 1
m ___________________________________ T.
Assets 1.3m T. Claims 1.3m
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Cash Flow CycleGoods sold on A/R for a profit
Balance Sheet Cash 0.1 A/P 0.1 A/R 0.5 Inventor
y 0.4 Accruals 0.2 F. Assets 0.4 Common Stock 1
m R/E 0.1 ___________________________________ T.
Assets 1.4m T. Claims 1.4m
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Cash Flow CycleCollection on A/R
Balance Sheet Cash 0.6 A/P 0.1 A/R 0.0 Inventor
y 0.4 Accruals 0.2 F. Assets 0.4 Common Stock 1
m R/E 0.1 ___________________________________ T.
Assets 1.4m T. Claims 1.4m
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Cash Conversion Cycle

• Cash Conversion Cycle Inventory conversion
  period
• Receivables conversion period -
• Payables deferral period
• Management of the cash cycle can make an
  important difference in the amount of financing
  required, assets employed to generate a given
  level of sales...and therefore, can affect ROA
  and ROE.

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Cash Flow Time Line
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Cash Budgeting
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The Cash Budget

• Cash budgets are most often prepared on a monthly
  basis.
• Most funding partners expect to see three years
  of projects. Some may require as many as seven
  years.
• If your business expects to encounter any
  seasonality in the sales cycle, you will find
  some interesting effects that may dramatically
  affect the amount of start-up financing that you
  require.
• If there is seasonality effects, you will have to
  carefully manage your cash flows, inventories and
  accounts receivable to remain solvent.

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Cash Budgets

• allow us to forecast the cash flows of a firm
  over time (between balance sheet dates).
• identifies the timing and magnitude of expected
  cash surpluses and deficits - thereby providing
  the manager with the opportunity to prepare, in
  advance, to finance expected deficits, or to
  invest surpluses.
• may be used as the basis for pro forma financial
  statements.

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General Form - Cash Budget
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Assumptions of Cash Budgets

• that cash inflows and outflows occur evenly
  throughout the month.
• this is rarely the case
• disbursements often are predictable
• wages/salaries due on 15th and 30th
• payments to suppliers on 15th or 30th, etc.
• cash receipts depend on how we manage accounts
  receivable....depending on how we do this they
  may largely occur between the 20th and 30th of
  the month...
• what is the impact of the foregoing?
• how can we overcome this?

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General Form - Cash Budget
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General Form - Cash Budget
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Cash Balance
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The Cash Budget

• The purpose of the cash budget is to forecast the
  timing and magnitude of expected cash deficits
  and surpluses so that, before the fact, you (the
  manager) can arrange appropriate financing or
  plan an appropriate investment strategy.