Page 149 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes helps firms to determining the makeup of their short-term investment portfolio. When a
firm performs the task called budgeting, it generally designates the most likely (or most
desirable) scenario of the medium-range forecasts as the budget. The budget is used to
compare actual performance during the course of the year.

9.2.3 Daily Cash Forecasts

Daily cash forecasts attempt to project cash inflows and outflows on a daily basis one or more days
into the future. This is perhaps the most difficult forecasting to perform accurately. Even though a
firm may know precisely its revenues for the month, it may have difficulty determining specific
cash inflows for given days of the month. For some firms, A daily forecast several months into the
future is possible. For most, however, a forecast even 2 days into the future is difficult.

Did u know? What is the purpose of daily forecasting?

The purposes of daily forecasting are to assist management in scheduling transfer in cash
concentration, funding disbursement accounts, controlling field deposits, and making
short-term investing and borrowing decisions.

Self Assessment

Fill in the blanks:
1. ………………………….are also known as ‘Treasuries’.
2. …………………………give planners an idea of how much cash the firm needs to raise
through debt or equity issues.
3. ……………………….forecasts attempt to project cash inflows and outflows on a daily
basis one or more days into the future.

9.3 Methods of Financial Forecasting

Financial forecasting is the estimation of the future level of a financial variable, often a cash
flow, asset level, or liability level. It is usually assumed that the relationship between the
financial variable and other variables is linear. The general linear model can then be used.
Y = a + a X +a X …….. a X (1)
t a 1 1 2 2 n n
Here, Y is the financial variable (Y) to be forecast in period t. This X’s are the explanatory
variables, they are assumed to cause the level of Y in period t. The a term represents a constant
unaffected by the X’s. The other terms are the estimated Coefficients of the explanatory X
variables. There are n terms with X’s in them. This general methodology will be clearer as
examples are presented. It is understood that any forecast made in this way is subject to some
prediction error because of uncertainty about the exact relationship between the explanatory
variables (the X’s) and the outcome variable (the Y; that is, uncertainty about the a coefficients).
There are four common approaches to forecasting financial variables, but they are all special
cases of the general linear model. These four methods are discussed as follows.

9.3.1 Spot Method

Here it is assumed that the variable to be forecast is independent of all other variables, or
alternatively, is predetermined. The variable is forecast by using its expected or predetermined
level. All other explanatory variables are presumed to be irrelevant and the formula used is

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