Proper management of cash budget is an important practice in business management that enables an organization to efficiently utilize cash inflows and control the cash outflows. It is in this regard that this is study looks at the various issues that affect Alpine Wear’s cash budget.
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Seasonal Variations and Target Balance
When cash requirements are higher, the target balance increases due to the expected increase in cash flow. This strategy can be recommended for a company like Alpine Inc due to the fact that short term budgeting is characterized by a lot of variations. The strategy would enable the company to overcome unexpected changes in expenditure due to procurement of raw materials, the variable cost of production, and other overheads.
The strategy will enable the company to overcome any cash shortages. However, in case the company has compensating balance requirements, the strategy should not be recommended since the balance can cater for any emergency.
When the volume of sales declines, it is important to add the variable target balance to the cash flow in the budget. On the other hand, when the sales increase, the value of the variable target balance is deducted from the total value of sales.
Other Types of Inflows
In addition to receipts, other categories of inflows that could occur in the budget include savings in labor cost, debt collection, savings in cost of production, and interest received from cash surplus. A 7% interest on bank loan should be reflected under the payment section of the cash budget.
The interest rate is like expenditure in the budget. On the other hand, a 5% interest received from surplus cash should be reflected under the income section of the budget. The interest rate is an inflow into the company.
The best investment policy that will provide liquidity and safety to the company is investing in treasury bills. Due to the size of the company’s capital base, investing in treasury bills will provide a great opportunity to increase liquidity since the bills mature within a short period of time. Investing in treasury bills will enable the company to get high returns. They also have low risks as compared to other policies such as insurance bonds.
Apart from treasury bills, other types of securities that exist in the market include commercial paper and certificate of deposit. A commercial paper is a type of a promissory note that is given to investors who in turn pay the given amount after getting their proceeds from the investment. A commercial paper may mature within one day or 12 months. Commercial papers also create high liquidity and attract low risk.
Certificate of deposit is another investment policy that can be used by an organization to invest its funds. Unlike, treasury bills and commercial papers that take a short period of time to mature, certificates of deposits mature after very many months or even years.
However, they have a higher interest than commercial papers and treasury bills. An investor who has ventured into certificates of deposits earns a fixed interest and is able to recover the invested capital.
For a company whose balances are projected to be in the millions, the best investment policy would be certificate of deposit. The policy will enable the company to earn more interest due to the size of the invested capital. However, the investment policy would be affected by fluctuations in cash surpluses and deposits.
For instance, if the surpluses keep on fluctuating, the investment policy for the company would be treasury bills since they have a short maturity period. Investing in a long term investment policy in situations where the cash surpluses are unstable may lead to liquidity problems.
The Impact of Monthly Net Cash Flows
Actual Sales and Forecasted Sales
In a situation where the actual sales are less than the forecasted sales by 20%, the company is likely to experience problems with both inflows and the outflows in the cash budget. The company will experience difficulties in paying its expenses such as labor cost, overheads, taxes, and purchases.
Alpine is likely to experience great problems in meeting its expenditure since the payments for the aforementioned expenses are according to the value of the expected sales. If the problem persists without immediate intervention measures, the company may be sued by the suppliers for late payments of purchases or workers may strike due to low wages.
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It would be a great mistake for the company to have $ 400,000 as the line of credit while the actual cash requirement is $ 600,000.
In such a situation where the actual line of credit is greater than the forecasted amount, the organization is likely to experience problems in managing its expenses and funding its operations. If the problem is not properly solved, the organization may experience cash management issues such insolvency and bankruptcy.
Actual Sales and Forecasted Sales Level
In a situation where the company’s actual sales are 50 % of the forecasted sales level, the company will still experience problems in managing its expenses. Since all the expenses of the company are based on the expected sales, the company will experience a deficit in its budget and will be forced to search for alternative sources of funds to be able to pay them.
The situation may interrupt the operations of the company since it will not be able to pay for labor, purchase of raw materials, and other expenses such as taxes. The situation may lead to a decline of cash inflows in the cash budget. Moreover, the company will also be prone to losses should the problem persist without immediate intervention.
Change in Payment Patterns
Should the customers change their payment pattern from 25-65-10 to 20-30-50; the company will still experience some problems in meeting its expenses. Alpine pays a bigger percentage of the expenses in the second month that is why the older payment pattern of 65% of sales enabled the company to meet most of the expenses.
For instance, the company pays 70% of labor, purchases, and other variable expenses within the second month. 50% in cash payment will lead to a decline in cash inflow which may interfere with the cash budget. The change in payment pattern will also result in more credit problems to the company since it will have to waste a lot of time in debt collection.
A 15% change in cash collection may also lead to instances of bad debts, which may in turn affect the company’s cash flows. Due to the changes in payment pattern, the company would have to change its credit line in order to meet its expenses without any difficulties.
The company may therefore consider going for a larger credit line that will cover all the expenses as it waits for the customers to pay. In this case, the credit line may be bigger than $ 600,000. The amount would enable the company to cover all the outflows.
Based on the above analysis, the company therefore needs a bigger credit line in order to manage all cash outflows before it can receive the collections. The size of the credit line that the company should seek from the bank should enable the business to overcome all the expected fluctuations between the actual and the forecasted sales.
Moreover, the credit line should enable the company to meet all the delays that emanate from late payments. The company had used a credit line of $ 400,000 in the past but it did not meet all the expenses. Therefore, a bigger figure in the range of $ 600,000 to $ 700,000 would enable the company to manage all the expenses.
To establish the company’s line of credit, it is important to estimate the value of the company’s sales, the debt collection policy, the credit worthiness of the customers, the rate of inventory conversion, and the credit collection period.
It is also important to determine the company’s debt situation before estimating the value of the credit line. If the company has other debts, the amount of credit line will be lowered in order to reduce instances such as loan default. The company’s repayment period for raw materials and other purchases will also provide valuable information to be used in estimating the size of the credit line.