Cash Management quiz

Cash inflows for March would consist of 50% of March credit sales ($90 × 50% = $45), plus 30% of February credit sales ($120 × 30% = $36), plus 20% of January
credit sales ($100 × 20% = $20), plus cash sales for March of $18. Consequently, total collections equal $119,000.

The annual benefit (loss) from using the bank’s proposed service is the excess (deficit) of interest earned on the early deposits over (under) the cost of the service. If the plan is adopted, the firm’s average cash balance will increase by $200,000 ($100,000 × 2 days).

Benefit (loss) = Interest earned – Cost

                             = ($200,000 × 6%) – ($500 × 12 months)

                             = $12,000 – $6,000

                             = $6,000

The annual benefit from using the lockbox system is the excess of interest earned on the early deposits over the cost of the service. If the plan is adopted, the firm’s average cash balance will increase by $2,000,000 ($20,000 average payment × 50 per day × 2 days).

The annual variable cost will be $9,125 ($.50 per payment × 50 per day × 365 days).

Benefit (loss) = Interest earned – Cost

                           = ($2,000,000 × 6%) – ($50,000 + $9,125)

                           = $120,000 – $59,125

                           = $60,875

Speeding up collections by 2 days will raise the firm’s average cash balance by $30,000. At 8% interest,

the benefit will be $2,400 annually [($15,000 × 2 days) × .08].

The additional annual income (loss) from using the bank’s proposed service is the excess (deficit) of interest earned on the early deposits over (under) the cost of the service. If the plan is adopted, the firm’s average cash balance will increase by $600,000 ($300,000 × 2 days).

Benefit (loss) = Interest earned – Cost

                             = ($600,000 × 11%) – ($3,000 × 12 months)

                             = $66,000 – $36,000

                             = $30,000

A company will hold cash and marketable securities to facilitate business transactions; cash is a medium of exchange. Cash and near-cash items are also held to meet future needs, to satisfy compensating balance requirements imposed by lenders, and to provide a precautionary balance for security purposes. Cash is usually not held in an attempt to earn maximum returns on investment because cash and marketable securities are not usually the highest paying investments.

John Maynard Keynes, founder of Keynesian economics, concluded that there were three major motives for holding cash: for transactional purposes as a medium of exchange, precautionary purposes, and speculative purposes (but only during deflationary periods) .

The three motives for holding cash are :

(1) as a medium of exchange (the transactions motive),

(2) to provide a reserve for contingencies (the precautionary motive), and

(3) to take advantage of unexpected opportunities (the speculative motive).

The difference between collections and payables is $5,000 daily. Five days’ worth amounts to $25,000 of float.

The firm can compare the costs of the two alternatives as follows:

Standard account= Variable cost + Fixed cost

                                   = [(80 checks × $.10) + $10] × 12 months

                                   = $18 × 12 months

                                   = $216 per year

Premium account = Variable cost + Fixed cost

                                     = [$0 + ($2,500 reqd. – $500 projected)] × 10%

                                     = $2,000 × 10%

                                     = $200 per year

Thus, the premium account should be selected because it is cheaper by $16 per year.

The three motives for holding cash are as a medium of exchange, as a precautionary measure, and for speculation. Reason #1 can be classified as a precautionary
measure, and Reason #2 can be classified as holding cash for speculation.

The additional annual income generated by Bank 4’s lockbox service can be calculated as follows:

Benefit (loss) = Interest earned – Cost

                             = ($300,000 × 2 days × 6%) – ($1,000 × 12 months)

                             = $36,000 – $12,000

                             = $24,000

Compensating balances are either (1) an absolute minimum balance or (2) a minimum average balance that bank customers must keep at the bank. These are
generally required by the bank to compensate for the cost of services rendered. Maintaining compensating balances will not accelerate a company’s cash inflows
because less cash will be available even though the amount of cash coming in remains unchanged.

The float period is the time between when a check is written and when it clears the payor’s checking account. Check float results in an interest-free loan to the payor because of the delay between payment by check and its deduction from the bank account. If checks written require 1 more day to clear than checks received, the net float equals 1 day’s receipts. The company will have free use of the money for 1 day. In this case, the amount is $10,000.

The additional annual income (loss) from using the bank’s proposed service is the excess (deficit) of interest earned on the early deposits over (under) the cost of the service. If the plan is adopted, the firm’s average cash balance will increase by $600,000 ($200,000 × 3 days).

Benefit (loss) = Interest earned – Cost

                           = ($600,000 × 12%) – ($4,000 × 12 months)

                           = $72,000 – $48,000

                           = $24,000 

The most direct way of preparing a cash budget requires incorporation of sales projections and credit terms, collection percentages, estimated purchases and payment terms, and other cash receipts and disbursements.

In other words, preparation of the cash budget requires consideration of both inflows and outflows.

Various methods of accelerating cash collections include decentralized collection outposts (normally one in each Federal Reserve District), electronic funds transfers, centralized banking for all company branches to avoid having to maintain minimum balances in several locations, and lockbox systems. A compensating balance is a minimum average or absolute amount that must be maintained in a bank account. Hence, it is not a means of accelerating cash collections. This requirement means that less cash is available to the depositor.

A draft is a three-party instrument in which one person (the drawer) orders a second person (the drawee) to pay money to a third person (the payee). A check is the most common form of draft. It is an instrument payable on demand in which the drawee is a bank. Consequently, a draft can be used to delay the outflow of cash. A draft can be dated on the due date of an invoice and will not be processed by the drawee until that date, thereby eliminating the necessity of writing a check earlier than the due date or using an EFT. Thus, the outflow is delayed until the check clears the drawee bank.

The annual benefit (loss) from using the lockbox system is the excess (deficit) of interest earned on the early deposits over (under) the cost of the service. If the plan is adopted, average cash balance will increase by $750,000 [$90,000,000 × (3 days ÷ 360 days)].

Benefit (loss) = Interest earned – Cost

                            = ($750,000 × 8%) – $80,000

                           = $60,000 – $80,000

                           = $(20,000)

Cash disbursements for the month of April are calculated as follows:

April purchases:  $140,000× 40% = $ 56,000

March purchases:  $160,000× 30% = 48,000

February purchases:  $160,000× 30% = 48,000

April payroll:  $300,000× 10% = 30,000

April op. expenses:  $260,000× 20% = 52,000

Interest = 20,000

Total April disbursements = $254,000