SEXTAS JORNADAS NACIONALES DE SERVICIO SOCIAL
CONCLUSIONES DE LAS VIª JORNADAS NACIONALES DE SERVICIO SOCIAL
Transmission delay Postal delays of a day, maybe longer
Lodgement delay Delay in banking payments received, payee delaying presentation to bank of cash/cheques received
Clearance delay Time for bank to clear cheque, payment not available for use by recipient until clearance (2-3 days in UK)
There are several measures that could be taken to reduce the float.
(a) The payee should ensure that the lodgement delay is kept to a minimum. Cheques received should be presented to the bank on the day of receipt.
(b) The payee might, in some cases, arrange to collect cheques from the payer's premises. This would only be practicable, however, if the payer is local. The payment would have to be large to make the extra effort worthwhile.
(c) The payer might be asked to pay through his own branch of a bank. The payer can give his bank detailed payment instructions, and use the credit clearing system of the bank giro. The bank giro is a means of making credit transfers for customers of other banks and other branches. The payee may include a bank giro credit slip on the bottom of his invoice, to help with this method of payment.
(d) BACS (Bankers' Automated Clearing Services), a system which provides for the computerised transfer of funds between banks, could be used. BACS is available to corporate customers of banks for making payments.
(e) For regular payments standing orders or direct debits might be used.
(f) CHAPS (Clearing House Automated Payments System) is a computerised system for banks to make same-day clearances (that is, immediate payment) between each other. Each member bank of CHAPS can allow its own corporate customers to make immediate transfers of funds through CHAPS. However, there is a large minimum size for payments using CHAPS.
Ryan Coates owns a chain of seven clothes shops. Takings at each shop are remitted once a week on Thursday evening to the head office, and are then banked at the start of business on Friday morning. As business is expanding, Ryan Coates has hired an accountant to help him. The accountant gave him the following advice.
'Sales revenue at the seven shops totalled $1,950,000 last year, at a constant daily rate, but you were paying bank overdraft charges at a rate of 11%. You could have reduced your overdraft costs by banking the shop takings each day, except for Saturday's takings. Saturday takings could have been banked on Mondays.'
Comment on the significance of this statement, stating your assumptions. The shops are closed on Sundays.
(a) A bank overdraft rate of 11% a year is approximately 11/365 = 0.03% a day.
(b) Annual takings of $1,950,000 would be an average of $1,950,000/312 = $6,250 a day for the seven shops in total, on the assumption that they opened for a 52 week year of six days a week (312 days).
(c) Using the approximate overdraft cost of 0.03% a day, the cost of holding $6,250 for one day instead of banking it is 0.03% × $6,250 = $1.875.
(d) Banking all takings up to Thursday evening of each week on Friday morning involves an unnecessary delay in paying cash into the bank. The cost of this delay would be either:
(i) The opportunity cost of investment capital for the business, or (ii) The cost of avoidable bank overdraft charges
It is assumed here that the overdraft cost is higher and is therefore more appropriate to use. It is also assumed that, for interest purposes, funds are credited when banked.
Number of days delay incurred Takings on Could be banked on by Friday banking
Monday Tuesday 3
Tuesday Wednesday 2
Wednesday Thursday 1
Thursday Friday 0
Friday Saturday 6
Saturday Monday 4
16
In one week, the total number of days delay incurred by Friday banking is 16. At a cost of $1.875 a day, the weekly cost of Friday banking was $1.875 × 16 = $30.00, and the annual cost of Friday banking was $30.00 × 52 = $1,560.
Solution
Example: cash management
(e) Conclusion. The company could have saved about $1,560 a year in bank overdraft charges last year. If the overdraft rate remains at 11% and sales continue to increase, the saving from daily banking would be even higher next year.
Section summary
Reasons for a lengthy float include transmission delay, lodgement delay and clearance delay. There are several measures which can be taken to reduce the float.
Trading profits and cash flows are different. A company can make losses but still have a net cash income from trading. A company can also make profits but have a net cash deficit on its trading operations.
Cash flow forecasts provide an early warning of liquidity problems and funding needs. Banks often expect business customers to provide a cash forecast as a condition of lending.
Cash budgets and forecasts can be used for control reporting.
Cash budgets are prepared by taking operational budgets and converting them into forecasts as to when receipts and payments occur. The forecast should indicate the highest and lowest cash balance in a period as well as the balance at the end.
Cleared funds are used for short-term planning. They take clearance delays into account.
A cash flow forecast can be prepared by projecting the movement in the statement of financial position or income statement.
Cash shortages can be eased by postponing capital expenditure, selling assets, taking longer to pay suppliers and pressing customers for earlier payment (leading and lagging).
Reasons for a lengthy float include transmission delay, lodgement delay and clearance delay. There are several measures which can be taken to reduce the float.
Chapter Roundup
1 Operational cash flows of a business could be improved directly by:
• Reducing/Increasing receivables
• Reducing/Increasing inventories
• Reducing/Increasing the credit period for the company's trade payables Delete the word that does not apply.
2 Explain what a rolling forecast is in not more than 20 words.
3 The 'float' is the time between (A) ……… and (B) ……… . (Fill in the blanks)
4 List the twelve main steps involved in preparing a cash budget.
5 Heavy Metal is preparing its cash flow forecast for the next quarter. Which of the following items should be excluded from the calculations?
A The receipt of a bank loan that has been raised for the purpose of investment in a new rolling mill B Depreciation of the new rolling mill
C A tax payment that is due to be made, but which relates to profits earned in a previous accounting period
D Disposal proceeds from the sale of the old rolling mill
6 What are the main uses of forecasts based on the statement of financial position?
7 The cash flow forecast prepared by Heavy Metal suggests that the overdraft limit will be exceeded during the second month of the forecast period due to the timing of the asset purchase. However, by the end of the quarter the overdraft should be back to a level similar to that at the start of the period. Which of the following courses of action would you recommend to overcome this problem?
A Acquire the asset using a finance lease rather than by outright purchase B Seek help from a venture capital company
C Make a rights issue to raise the additional funds
D Negotiate with the bank for a short-term loan to cover the deficit 8 Possible reasons for a lengthy float are:
(A) ………..………….. delay (B) ……….…... delay (C) ………..….. delay
9 Hallas is a small manufacturing business that uses a large number of suppliers, many of which are located outside the UK. The accountant has suggested that Hallas could improve its cash position by sending payments out using surface mail rather than airmail as at present. If Hallas did this, which of the following would it be taking advantage of?
A Lodgement delay B Clearance delay C Transmission delay D Collection delay
Quick Quiz
1 Cash flows could be improved by:
• Decreasing receivables
• Decreasing inventories
• Increasing the credit period for the company's trade payables 2 A forecast that is continually updated
3 (A) Initiation of a payment
(B) When cleared funds become available in the recipient's bank account 4 Step
1 Set up a proforma cash budget
2 Establish budgeted sales month by month
3 Establish the length of credit period taken by customers
4 Determine when budgeted sales revenue will be received as cash 5 Establish when opening receivables will pay
6 Establish when any other cash income will be received
7 Establish production quantities and material usage quantities each month
8 Establish material inventory changes and quantity and cost of month-by-month materials purchases
9 Establish length of credit period taken from suppliers and calculate when cash payments to suppliers will be made
10 Establish when amount due to opening payables will be paid 11 Establish when any other cash payments will be made
12 Show clearly on the bottom of the budget opening position, net cash flow and closing position 5 B This is a non-cash item and should therefore be excluded.
6 • As longer-term estimates, to assess the scale of funding requirements or cash surpluses the company expects over time
• To act as a check on the realism of cash flow-based forecasts
7 D Since the cash flow problems appear to be temporary in nature, it is appropriate to use a short-term solution. Additional long-short-term capital should not be required.
8 (A) Transmission delay (B) Lodgement delay (C) Clearance delay
9 C Transmission delay
Answers to Quick Quiz
2.1 Profits and cash flow
Operational Profit cash flow
$ $
Sales 200,000 200,000
Opening receivables (∴ received in year) 15,000
Closing receivables (outstanding at year end) (24,000)
Cash in 191,000
Cost of sales 170,000 170,000
Closing inventory (bought, but not used, in year) 21,000
Opening inventory (used, but not bought, in year) (12,000)
Purchases in year 179,000
Opening payables (∴ paid in year) 11,000
Closing payables (outstanding at year end) (14,000)
Cash out 176,000
Profit/operational cash flow 30,000 15,000
2.2 Profits compared with cash flow
The principal reasons why profit will not equal cash flow are as follows.
(a) The 'matching concept' means that costs and revenues do not equal payments and receipts. Revenue is recognised in the income statement when goods are sold, and any revenue not received is recorded as a receivable. Similarly, costs are incurred when a resource is acquired or subsequently used, not when it happens to be paid for.
(b) Some items appearing in the income statement do not affect cash flow. For example, depreciation is a 'non-cash' deduction in arriving at profit.
(c) Similarly, items may affect cash flow but not profit. Capital expenditure decisions (apart from depreciation) and inventory level adjustments are prime examples.
2.3 Cash forecast
The opening cash balance at 1 October will consist of Tom's initial $15,000 less the $8,000 expended on non-current assets purchased in September, ie the opening balance is $7,000. Cash receipts from credit customers arise two months after the relevant sales.
Payments to suppliers are a little more tricky. We are told that cost of sales is 100/150 × sales. Thus for October cost of sales is 100/150 × $3,000 = $2,000. These goods will be purchased in October but not paid for until November. Similar calculations can be made for later months. The initial inventory of $5,000 is purchased in September and consequently paid for in October.
The forecast budget can now be constructed.
Answers to Questions
CASH FORECAST FOR THE SIX MONTHS ENDING 31 MARCH 20X7
(b) The overdraft arrangements are quite inadequate to service the cash needs of the business over the six-month period. If the figures are realistic then action should be taken now to avoid difficulties in the near future. The following are possible courses of action.
(i) Activities could be curtailed.
(ii) Other sources of cash could be explored, for example a long-term loan to finance the capital expenditure and a factoring arrangement to provide cash due from receivables more quickly.
(iii) Efforts to increase the speed of debt collection could be made.
(iv) Payments to suppliers could be delayed.
(v) The dividend payments could be postponed (the figures indicate that this is a small company, possibly owner-managed).
(vi) Staff might be persuaded to work at a lower rate in return for, say, an annual bonus or a profit-sharing agreement.
(vii) Extra staff might be taken on to reduce the amount of overtime paid.
(viii) The inventory holding policy should be reviewed. It may be possible to meet demand from current production and minimise cash tied up in inventories.
2.5 Types of forecast
Kim O'Hara would be best served by a cleared funds forecast, Creighton by a cash book based forecast.
Number Level Marks Time
Q2 Examination 15 27 mins
Now try the question from the Exam Question Bank
53
3
topic list learning outcomes syllabus references ability required
1 Budgeting for borrowings E2(a) E2(ii) comprehension
2 Overdrafts E2(a) E2(ii) comprehension
3 Loans E2(a) E2(ii) comprehension
4 Trade payables as a source of finance E2(a) E2(i) comprehension
5 Export finance E2(c) E2(vi) comprehension
6 Cash surpluses E2(b) E2(iii) comprehension
7 Cash investments: bank and building society accounts
E2(b) E2(iv) comprehension
8 Marketable securities: prices and interest rates E2(b) E2(v) comprehension
9 Other types of investment E2(b) E2(iv) comprehension
10 Risk and exposure E2(b) E2(iv) comprehension