Page 147 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes Introduction

The cash forecast is an estimation of the flows in and out of the firm’s cash account over a
particular period of time, usually a quarter, month, week, or day. The cash forecast is primarily
intended to produce a very useful piece of information: an estimation of the firm’s borrowing
and lending needs and the uncertainties regarding these needs during various future periods.
Cash forecasting is extremely important to most firms. It enables them to anticipate periods of
surplus cash and periods where financing will be necessary. This anticipation is the reason that
cash forecasts are generated. Anticipation enables the firm to plan much more effectively for
investment and financing, and via these planning, produce superior returns.
Treasury Management function has changed dramatically during the last decade. From a mere
facilitator of transactions, with few analytical tools, the task of treasury management has become
a dynamic, quantitative function, providing service and often additional profits to the entire
organisation.
Treasury management is central to corporate finance in practice. Even in smaller businesses,
where no formalized treasury function exists, the main treasury activities of managing corporate
funding, risk, banking relationships, liquidity and working capital will still be
conducted. Government Bonds are also known as ‘Treasuries’. The reference is to all bonds with
no options such as call. Usually, government bonds do not have any options.

The terms like ‘bonds’, ‘treasuries’ or ‘securities’ are interchangeably used. We will cover some
of the basic concepts and then look at the different techniques that allow the bankers/investors
to measure the risks. By knowing the risks and the returns, one can make a proper decision
about buying or selling the security. Banks over the years have invested very heavily in
government treasuries.
The notion that money has a time value is one of the basic concepts in the analysis of any
financial instruments. Money has a time value because of the opportunities of investing money
at some interest rate. The three basic concepts those relate to the time value of money are:
 Future value of an investment
 Present value of an investment

 Internal rate of return or yield on an investment
Understand this concept will help the banks in making better investments and pricing the
products and services of the banks.

9.1 Objectives of Cash Forecasting

As with the other short-term financial systems, it is helpful to outline an objective function for
cash forecasting. Such an objective function might include the following factors:
1. Interest costs and Income: One major purpose of forecasting is to increase the firm’s yield
on its investment portfolio or depending on the firm’s financial position, to decrease
interest costs on its borrowing. Lack of an accurate forecast may force management either
to invest in very short-term securities (thereby often earning the lowest yields) or to
borrow unexpectedly at higher than usual interest rates.

2. Excess Balances: This may be considered a corollary to the first factor. Accurate daily cash
forecasts enable management to reduce balances in disbursement and/or deposit accounts
and thereby move otherwise non-interest- earning cash into other areas of the firm.

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