Net cash flow ending cash financing and excess cash

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Unformatted text preview: neral-format cash budget in Table 3.7. We have inputs for the first two entries, and we now continue calculating the firm’s cash needs. The firm’s net cash flow is found by subtracting the cash disbursements from cash receipts in each period. Then we add beginning cash to the firm’s net cash flow to determine the ending cash for each period. Finally, we subtract the desired minimum cash balance from ending cash to find the required total financing or the excess cash balance. If the ending cash is less than the minimum cash balance, financing is required. Such financing is typically viewed as short-term and is therefore represented by notes payable. If the ending cash is greater than the minimum cash balance, excess cash exists. Any excess cash is assumed to be invested in a liquid, short-term, interest-paying vehicle—that is, in marketable securities. Table 3.10 presents Coulson Industries’ cash budget, based on the data already developed. At the end of September, Coulson’s cash balance was $50,000, and its notes payable and marketable securities equaled $0.7 The company wishes to maintain, as a reserve for unexpected needs, a minimum cash balance of $25,000. TABLE 3.10 A Cash Budget for Coulson Industries ($000) Oct. Total cash receiptsa Less: Total cash disbursementsb Net cash flow Add: Beginning cash Ending cash Nov. Dec. $210 $320 $340 213 ($ 3) 50 $ 47 418 305 ($ 98) $ 35 47 ($ 51) ( 51) ($ 16) Less: Minimum cash balance 25 25 25 Required total financing (notes payable)c — $ 76 $ 41 $ 22 — — Excess cash balance (marketable securities)d aFrom Table 3.8. Table 3.9. cValues are placed in this line when the ending cash is less than the desired minimum cash balance. These amounts are typically financed short-term and therefore are represented by notes payable. dValues are placed in this line when the ending cash is greater than the desired minimum cash balance. These amounts are typically assumed to be invested short-term and therefore are represented by marketable securities. bFrom 7. If Coulson either had outstanding notes payable or held marketable securities at the end of September, its “beginning cash” value would be misleading. It could be either overstated or understated, depending on whether the firm had notes payable or marketable securities on its books at that time. For simplicity, the cash budget discussions and problems presented in this chapter assume that the firm’s notes payable and marketable securities equal $0 at the beginning of the period of concern. 116 PART 1 Introduction to Managerial Finance For Coulson Industries to maintain its required $25,000 ending cash balance, it will need total borrowing of $76,000 in November and $41,000 in December. In October the firm will have an excess cash balance of $22,000, which can be held in an interest-earning marketable security. The required total financing figures in the cash budget refer to how much will be owed at the end of the month; they do not represent the monthly changes in borrowing. The monthly changes in borrowing and in excess cash can be found by further analyzing the cash budget. In October the $50,000 beginning cash, which becomes $47,000 after the $3,000 net cash outflow, results in a $22,000 excess cash balance once the $25,000 minimum cash is deducted. In November the $76,000 of required total financing resulted from the $98,000 net cash outflow less the $22,000 of excess cash from October. The $41,000 of required total financing in December resulted from reducing November’s $76,000 of required total financing by the $35,000 of net cash inflow during December. Summarizing, the financial activities for each month would be as follows: October: November: Liquidate the $22,000 of marketable securities and borrow $76,000 (notes payable). December: Hint Not only is the cash budget a great tool to let management know when it has cash shortages or excesses, but it may be a document required by potential creditors. It communicates to them what the money is going to be used for, and how and when their loan will be repaid. Invest the $22,000 excess cash balance in marketable securities. Repay $35,000 of notes payable to leave $41,000 of outstanding required total financing. Evaluating the Cash Budget The cash budget indicates whether a cash shortage or surplus is expected in each of the months covered by the forecast. Each month’s figure is based on the internally imposed requirement of a minimum cash balance and represents the total balance at the end of the month. At the end of each of the 3 months, Coulson expects the following balances in cash, marketable securities, and notes payable: End-of-month balance ($000) Account Oct. Nov. Dec. Cash $25 $25 $25 22 0 0 0 76 41 Marketable securities Notes payable Hint Because of the uncertainty of the ending cash values, the financial manager will usually seek to borrow more than the maximum financing indicated in the cash budget. Note that the firm is assumed first to liquidate its marketable securities to meet deficits...
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