Short-Term Borrowing and Investing

Short-Term Borrowing and Investing

A cash budget helps a firm plan its short-term cash flows. During periods when cash outflows exceed oper- ating inflows, firms borrow against their lines of credit at banks or issue short-term commercial paper. This consists of promissory notes that are sold to other firms, insurance companies, banks, and pension funds. When cash inflows exceed outflows, firms deposit money in their bank accounts or purchase commercial paper or other marketable securities.

Case Study: Keystone Department Store Sales last year at the Keystone Department Store were $600,000 in November and $950,000 in December.

Forecast sales for the first six months of the current year are as follows: January

$600,000 Twenty percent (20%) of all sales are cash sales, 50 percent of all sales are paid for the following month,

and the remainder of all sales are paid for two months after the sale. The cost of goods that Keystone buys from wholesalers for resale at its store is 70 percent of the selling price. Keystone pays cash for 10 percent of the goods it purchases for retailing, it pays for 40 percent of its purchases the following month, and it pays for the remainder two months after purchase.

Wages and salaries depend on the level of sales. Keystone maintains a base cadre of managers, supervisors, and clerks for which it pays $60,000 each month, including benefits. This cadre is the minimum needed to operate the store efficiently during January, which is the month of lowest sales. For other months, when there are more customers than in January, Keystone hires part-time clerks to augment its workforce. The amount it pays for part-time clerks during months other than January is 20 percent of the amount by which the monthly sales exceed the January sales. For example, the cost of part-time clerks in February is $15,000 (calculated as

20 percent of the difference between $375,000 and $300,000). Other monthly operating expenses are constant at the following amounts:

Monthly฀mortgage฀payment

Interest฀on฀long-term฀loans

Keystone expects to pay taxes of $6,000 in January and $7,000 in April. It also expects to pay quarterly dividends of $20,000 to its shareholders in January and April. Keystone ended the past year with a cash balance of $20,000 and with short-term (30-day) borrowing of $65,000. Keystone’s chief financial officer (CFO) has set $15,000 as the minimum month-end cash balance and $40,000 as the maximum. Short-term investing and borrowing are for 30 days. At the end of 30 days, borrowed money must be repaid with interest at an annual rate of 8 percent. Each month, the company receives back the principal of any loans it made the previous month, plus interest at an annual rate of 6 percent.

Among the things the CFO wants to know are the estimates for how much cash will need to be borrowed each month, if any, in order to keep the month-end cash balance from dropping below $15,000. The CFO

(Continued)

Cash Budgeting ❧ 257

also wants to know how much cash will be needed to invest each month, if any, to keep the month-end cash balance from exceeding $40,000.

a. Provide a cash budget for the six months from January to June of the current year. b. Copy your spreadsheet from part a and edit it to analyze the effects of making the following changes: Ten percent of sales are cash sales, 70 percent of the sales are paid for the following month, and the

remainder is paid for two months after sale.

Keystone pays cash for 10 percent of the goods it purchases for retailing, it pays for 75 percent of its purchases the following month, and it pays the remainder two months after purchase. c. Which situation, a or b, is more favorable to Keystone? Give a justification for your response. d. If the situation in part b were to prevail in the future, what changes might Keystone’s CFO reasonably

make to the values for the minimum and maximum cash balances? Give justification for your response.

Solution:

a. Figure 8-3 is a cash budget for the first six months of the current year. Data values in Figure 8-3 are italicized. Cell entries for calculating monthly sales receipts (cash inflows) are as follows:

D8 =$B$8*D4

Copy฀to฀E8:I8

Cash฀sales฀are฀20%฀of฀current฀sales.

Current฀revenue฀includes฀50%฀from฀sales฀previous฀month. D10 =$B$10*B4

D9 =$B$9*C4

Copy฀to฀E9:I9

Copy฀to฀E10:I10 Current฀revenue฀includes฀30%฀from฀sales฀two฀months฀earlier. D11 =SUM(D8:D10) Copy฀to฀E11:I11 Total฀revenues฀are฀the฀sum฀of฀cash฀sales฀and฀revenues฀from฀

sales฀made฀one฀and฀two฀months฀earlier. The six-month sums are calculated by entering =SUM(D8:I8) in Cell J8 and copying to J9:J11.

The dollar values of the cost of goods sold each month are computed by entering =$B$14*B4 in Cell B15 and copying the entry to C15:I15. The six-month total is calculated in Cell J15 by the entry =SUM(D15:I15).

The payments for purchased goods are calculated by the following entries: D18 =$B$18*D15

Payments฀made฀in฀the฀month฀of฀purchase D19 =$B$19*C15

Copy฀to฀E18:I18

Payments฀made฀in฀the฀month฀following฀purchase D20 =$B$20*B15

Copy฀to฀E19:I19

Payments฀made฀two฀months฀after฀purchase D21 =SUM(D18:D20)

Copy฀to฀E20:I20

Monthly฀cash฀outflow฀to฀pay฀for฀goods฀purchased The six-month sums for payments are calculated by entering =SUM(D18:I18) in Cell J18 and copying

Copy฀to฀E21:I21

to J19:J21.

The monthly increments for wages and salaries when sales are above the January level are calculated by entering =IF(D4>$D$4,$B$25*(D4-$D$4),0) in Cell D26 and copying it to E26:I26. This IF statement first checks to see if the monthly sales are above the January level. If they are, it enters 20 percent of the incremental difference. Otherwise, if the monthly sales are not above the January level, it enters 0.

The total monthly payments for wages and salaries are the sums of the payments of $60,000 for the base cadre of workers plus the increments. These are calculated by entering =D24+D26 in Cell D27 and copying to E27:I27.

The monthly cash outflows for operating and other expenses are calculated by entering =SUM(D27:D32) in D33 and copying to E33:I33. The six-month totals in Column J (both here and all sections below) are calculated in the same manner as before for receipts and payments for goods—that is, by adding the entries in columns D to I.

(Continued)

258 ❧ Corporate Financial Analysis with Microsoft Excel ®

Figure฀8-3

Cash Budget for Keystone Department Store

1 KEYSTONE DEPARTMENT STORE: Part a

2 Cash Budget for First Six Months of Next Year

6-month

Total 4 Sales (Actuals and Forecasts)

May June

5 Sale of Goods

6 Sales Revenues or Income

7 Percent

110,000 $ 120,000 $ 575,000 9 Lagged 1 month

8 Same month as sale

300,000 $ 275,000 1,612,500 10 Lagged 2 months

11 Cash Inflow from Operating Revenues

12 Cost of Goods Purchased for Sale

13 Cost of Purchased Goods

14 As Percent of Sales

15 Dollar Value

16 Payments for Purchased Goods

17 Percent

38,500 $ 42,000 $ 201,250 19 Lagged 1 month

18 Same month as purchase

168,000 $ 154,000 903,000 20 Lagged 2 months

21 Cash Outflow to Pay for Goods Sold

22 Operating and Other Expenses

23 Wages and Salaries 24 Base

$60,000 $60,000 $ 360,000 Increment, as Percent of Sales 25 above January Sales

50,000 $ 60,000 215,000 27 Total Wages and Salaries

26 Increment, Dollar Value

$110,000 $120,000 $ 575,000 28 Monthly Mortgage Payment

3,000 3,000 18,000 30 Interest on Long-Term Loans

10,000 10,000 60,000 31 Dividends to Shareholders

33 Cash Outflow for Operating and Other Expenses

34 Summary of Cash Balances and Cash Flows

35 Beginning Cash Balance

15,000 $ 31,981 $ 40,000 36 Cash Inflows (Outflows) from Operations

545,000 575,000 3,170,000 38 Cash Flow to Purchase Goods Sold (Outflow)

37 Cash Flow from Sales (Inflow)

(364,000) (406,000) (2,250,500) 39 Cash Flow for Operating and Other Expenses (Outflow)

40 Total Cash Flow from Operations

41 Cash Flow from Previous Month’s Investing (Inflow) 42 Return of Principal Invested

0 0 0 0 43 Interest Earned

0 68 0 0 0 0 68 44 Cash Flow from Previous Month Borrowing (Outflow) 45 Loan Payoff

0 (20,880) 46 Interest Paid

Unadjusted Cash Balance before New 47 Borrowing or Investing

48 New Borrowing or Investing 49 Amount Invested

- $ 7,981 50 Amount Borrowed

51 Ending Cash Balance

52 Basis for Calculations of Short-Term Borrowing and Investing

53 Minimum Cash Balance

54 Maximum Cash Balance

55 Annual Rate for Investing

56 Annual Rate for Borrowing

(Conditions for part a)

(Continued)

Cash Budgeting ❧ 259

The beginning cash balance in January is the ending cash balance in December. December’s ending cash balance is the data value in Cell C51. The beginning cash balances are set by the entry =C51 in Cell D35, which is copied to E35:I35.

The cash flows from operations are calculated in Rows 37:40. The monthly cash inflows from sales are transferred from the upper section of the spreadsheet by entering =D11 in D37 and copying to E37:I37. The monthly cash outflows to pay for purchased goods are transferred from the upper section by entering =-D21 in D38 and copying to E38:I38. The monthly cash outflows to pay for operating and other expenses are transferred from the upper section by entering =-D33 in D39 and copying to E39:I39. The total monthly cash flows from operations are calculated by entering =SUM(D37:D39) in Cell D40 and copying to E40:I40.

The cash flows from the preceding month’s investing and borrowing are calculated in Rows 41:46. The returns of the sums invested in the preceding months are transferred by entering =C49 in Cell D42 and copying to E42:I42. The interest earned on the sums invested in the preceding months is calculated entering =C49*$F$55/12 in Cell D43 and copying to E43:I43. These are cash inflows and therefore positive.

The payments of the sums borrowed in the preceding months are transferred by entering =-C50 in Cell D45 and copying to E45:I45. The interest paid on the sums borrowed in the preceding months is calculated by entering =-C50*$F$56/12 in Cell D46 and copying to E46:I46. These are cash outflows and therefore negative.

The unadjusted cash balances before new investing or borrowing are calculated by entering =D35+D40+SUM(D42:D46) in Cell D47 and copying to E47:I47.

The monthly amounts of new investments are calculated by entering =IF(D47>$F$54,D47-$F$54,0) in Cell D49 and copying to E49:I49. The monthly amounts of new borrowings are calculated by entering =IF(D47<$F$53,$F$53-D47,0) in Cell D50 and copying to E50:I50.

The monthly ending cash balances are calculated by entering D47-D49+D50 in Cell D51 and copying to E51:I51. Figure 8-4 is a reconciliation of the cash inflows and the cash outflows from the beginning of the first month to the end of the last month. The item labeled “Capital Outlays” is included to show any outflows of cash to pay for purchases of capital assets. (The value of capital outlays is zero for Keystone.)

Figure฀8-4

Reconciliation of Cash Flows

57 Reconciliation of Cash Flows for January 1 to June 30

58 Cash Inflows

Cash Outflows

59 Beginning Balance

Repay Beginning Short-Term Loan $ 65,000 60 Total Collections

$ 2,250,500 61 Short-Term Interest Income

Inventory Payments

68 Wages and Salaries

Mortgage Payments

Interest on Long-Term Loans

Dividends to Shareholders

Capital Outlays

Interest on Short-Term Loans

Ending Cash Balance

Current Investing

(Continued)

260 ❧ ® Corporate Financial Analysis with Microsoft Excel

Figure฀8-5

Cash Budget for Keystone Department Store

1 KEYSTONE DEPARTMENT STORE: Part b 2 Cash Budget for First Six Months of Next Year

6-month

Total 4 Sales (Actuals and Forecasts)

May June

Sale of Goods

6 Sales Revenues or Income

7 Percent

55,000 $ 60,000 $ 287,500 9 Lagged 1 month

8 Same month as sale

420,000 $ 385,000 2,257,500 10 Lagged 2 months

11 Cash Inflow from Operating Revenues

12 Cost of Goods Purchased for Sale

13 Cost of Purchased Goods

14 As Percent of Sales

15 Dollar Value

16 Payments for Purchased Goods

17 Percent

38,500 $ 42,000 $ 201,250 19 Lagged 1 month

18 Same month as purchase

315,000 $ 288,750 1,693,125 20 Lagged 2 months

21 Cash Outflow to Pay for Goods Sold

22 Operating and Other Expenses

23 Wages and Salaries 24 Base

$60,000 $60,000 $ 360,000 Increment, as Percent of Sales 25 above January Sales

50,000 $ 60,000 215,000 27 Total Wages and Salaries

26 Increment, Dollar Value

$110,000 $120,000 $ 575,000 28 Monthly Mortgage Payment

3,000 3,000 18,000 30 Interest on Long-Term Loans

10,000 10,000 60,000 31 Dividends to Shareholders

33 Cash Outflow for Operating and Other Expenses

34 Summary of Cash Balances and Cash Flows

35 Beginning Cash Balance

40,000 $ 40,000 $ 40,000 36 Cash Inflows (Outflows) from Operations

565,000 565,000 3,200,000 38 Cash Flow to Purchase Goods Sold (Outflow)

37 Cash Flow from Sales (Inflow)

(400,750) (393,750) (2,238,250) 39 Cash Flow for Operating and Other Expenses (Outflow)

40 Total Cash Flow from Operations

41 Cash Flow from Previous Month’s Investing (Inflow) 42 Return of Principal Invested

11,620 32,928 43 Interest Earned

58 165 1,026 44 Cash Flow from Previous Month Borrowing (Outflow) 45 Loan Payoff

0 0 0 0 0 46 Interest Paid

Unadjusted Cash Balance before New 47 Borrowing or Investing

48 New Borrowing or Investing 49 Amount Invested

32,928 $ 51,343 50 Amount Borrowed

51 Ending Cash Balance

52 Basis for Calculations of Short-Term Borrowing and Investing

53 Minimum Cash Balance

54 Maximum Cash Balance

55 Annual Rate for Investing

56 Annual Rate for Borrowing

(Conditions for part b, with new values in Cells B8:B10 and B18:B20)

(Continued)

Cash Budgeting ❧ 261

b. Figure 8-5 is the spreadsheet solution for part b. This spreadsheet is prepared by copying Figure 8-3 and changing the values in Cells B8:B10 and B18:B20. Figure 8-6 is a reconciliation of the cash flows. Note that compared to the original conditions of part a, the new conditions of part b result in a larger cash inflow from collections and interest from short-term lending, as well as a larger amount of current investing at the end of the six-month period.

c. Situation b is more favorable to Keystone than situation a. On the positive side, situation b results in more interest earned on short-term investing, less interest paid for short-term borrowing, and a greater amount of short-term investing in June. On the negative side, situation b has more money owed for goods purchased at the end of the six months and less receipts still to be paid.

d. If the situation in part b continues, Keystone has less need to borrow and more opportunity to invest. It should lower the minimum cash balance to a value less than $15,000 and lower the maximum cash balance to a value less than $40,000. This might be done, for example, by reducing the minimum cash balance to $10,000 and the maximum cash balance to $30,000, which will increase the short-term interest income by $253.

Figure฀8-6

Reconciliation of Cash Flow from January 1 to June 30

57 Reconciliation of Cash Flows for January 1 to June 30

58 Cash Inflows

Cash Outflows

Repay Beginning Short-Term Loan $ 65,000 60 Total Collections

59 Beginning Balance

$ 2,238,250 61 Short-Term Interest Income

Inventory Payments

Wages and Salaries

Mortgage Payments

Interest on Long-Term Loans $ 60,000 65

Dividends to Shareholders

Capital Outlays

$ - 68

Interest on Short-Term Loans $ 433 69

Ending Cash Balance

Current Investing

(Conditions of part b)