MGT 325 Module 3 Cash Management Examples

The examples below illustrate how the firm manages its cash with regards to accounts receivable and inventory manageme

Working capital management, including current asset management, are covered extensively in Chapters 6 and 7 of your te Example One: Beth's Society Clothiers, Inc., has collection centers across the country to speed up collections. The company also makes payments from remote disbursement centers so the firm's checks will take longer to clear the bank. Collection time has been reduced by two and one-half days and disbursement time increased by one and one-half days because of these policies. Excess funds are being invested in short-term instruments yielding 6 percent per annum. Required: a. If the firm has $4 million per day in collections and $3 million per day in disbursements, how many dollars has the cash management system freed up? b. How much can the firm earn in dollars per year on short-term investments made possible by the freed-up cash? Solutions: a. If the firm has $4 million per day in collections and $3 million per day in disbursements, how many dollars has the cash management system freed up?
Assumptions:

Daily collections Reduction in collection time Daily disbursements Increase in disbursement time Interest rate Dollars freed up

$4,000,000 2.5 days $3,000,000 1.5 days 6% $14,500,000

b. How much can the firm earn in dollars per year on short-term investments made possible by the freed-up cash? Short-term investment earnings $870,000

Example Two: Route Canal Shipping Company has the following schedule for the aging of its accounts receivable:
AGE OF RECEIVABLES APRIL 30, 2010 (1) Month of Sales (2) Age of Account (3) Amounts (4) Percent of Amount Due

April March February January Total receivables

0-30 31-60 61-90 91-120

$105,000 60,000 90,000 45,000 $300,000

100%

a. Fill in column (4) for each month. b. If the firm had $1,440,000 in credit sales over the four-month period, compute the average collection period. Average daily sales should be based on a 120-day period. Assume the total receivables are still $300,000. but the amounts in each month would be different. c. If the firm likes to see its bills collected in 30 days, should it be satisfied with the average collection period? d. Disregarding your answer to part c and considering the aging schedule for accounts receivable, should the company be satisfied? e. What additional information does the aging schedule bring to the company that the average collection period may not show? Solutions: a. Fill in column (4) for each month. AGE OF RECEIVABLES APRIL 30, 2010 (2) (3) (4) Age of Percent of Account Amounts Amount Due 0-30 $105,000 35% 31-60 60,000 20% 61-90 90,000 30% 91-120 45,000 15% $300,000 100%

(1) Month of Sales April March February January Total receivables

Note: 65% of the accounts receivab

b. If the firm had $1,440,000 in credit sales over the four-month period, compute the average collection period. Average daily sales should be based on a 120-day period.

Daily sales Average collection period

12,000 25 days

c. If the firm likes to see its bills collected in 30 days, should it be satisfied with the average collection period? Yes, the average collection of 25 days determined in part a. is less than 30 days. d. Disregarding your answer to part c and considering the aging schedule for accounts receivable, should the company be satisfied?

No. The aging schedule provides additional insight that 65 percent of the accounts receivable are over 30 days old. e. What additional information does the aging schedule bring to the company that the average collection period may not show? It goes beyond showing how many days of credit sales accounts receivables represent, to indicate the distribution of accounts receivable between various time frames.

Example Three Wisconsin Snowmobile Corp. is considering a switch to level production. Cost efficiencies would occur under level production and aftertax costs would decline by $30,000, but inventory costs would increase by $250,000. Wisconsin Snowmobile would have to finance the extra inventory at a cost of 13.5 percent. a. Should the company go ahead and switch to level production? b. How low would interest rates need to fall before level production would be feasible? Solutions:
Assumptions:

Inventory increase Interest rate Cost savings

$250,000 13.50% $30,000

a. Should the company go ahead and switch to level production? Cost Savings Less: Increased costs Loss $30,000 -$33,750 (The increase in inventory times the interest rate) -$3,750

No. The company should not switch to level production. b. How low would interest rates need to fall before level production would be feasible? Interest rates would need to fall to: 12% or less for the switch to be feasible.

However, the decision is more complicated because it depends on expectations for interest rates. If the extra inventory were considered permanent current assets and was financed by locking in long-term interest rates below 12%, then it would make sense to switch. However, given that short-term rates are volatile; this decision can't be made on a dip in short-term interest rates below 12%.

eivable and inventory management.

ly in Chapters 6 and 7 of your textbook.

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