Page 136 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 8: Cash Planning

Such payments are subject to at least two uncertainties. First, the weather, a very risky variable, Notes
plays a significant part in the rate of construction completion. Second construction firms are
notorious for filing late progress reports and then expecting immediate payment. While only a
small percent of the firm’s total bills are from capital construction programmes, the amounts
involved are usually very large. One unexpected item of this sort can destroy a carefully planned
cash flow management strategy.

Estimating Uncertainty in Cash Forecasts

There are two basic approaches to the assessment of risk in cash forecasting. First, we could
assess the effects of individual sources of uncertainty on important individual outcome variables.
Second, we could assess the effect of all the uncertainties in all the risky estimated variables on
all the important outcome variables with all the uncertainties allowed to vary simultaneously
Both of these methodologies are very useful. The first requires sensitivity analysis; the second
requires simulation.

Sensitivity Analysis of the Cash Forecast

We know that there are uncertainties in the estimation of sales, collection rates, production and
other cost amounts, and the timing and amount of capital disbursements, at the least. Using
sensitivity analysis. We can assess some of the effects of these individual sources of uncertainty.
For example, recall that the direct labour payments were estimated as 34 percent of sales for the
last three months because of a new wage scale. If this new wage scale was the result of a new labour
contact that is yet to be negotiated when the forecast is made, the actual wage rate would be subject
to uncertainty. Let us assess the effects of variation in the direct labour payments as a percent of
sales on the projected surpluses and deficits in October, November, and December. This is done by
changing the input variable and observing changes in the output variable. The first step might be
to estimate the surpluses and deficits with direct labour at 36 percent of sales.
The results are presented in Table 8.1 The projected surplus in October drops from ` 12,300 to
` 7,800, the surplus in November drops from ` 1,01,400 to ` 93,000 and the project deficit in
December increases from ` 3,600 to ` 15,000.
Table 8.1: Sensitivity Analysis of Cash Forecast
(Direct Labour for October through December Changed to 36 Percent of Sales)

LOVELY PROFESSIONAL UNIVERSITY 131