Page 151 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes Y = a +a X (5)
t 0 1 1
There a term represents the base inventory level, the X the square root of the sales level, and at
0 t
the proportionality constant. If the firm’s base level of inventory is ` 50,000, the proportionality
constant is 15 and sales are expected to be ` 5,00,000, we could estimate inventory as:
Y = 50,000 + (15) ((500,000) ) = ` 60,607
1/2
t
In deciding which of these methods to use to forecast a particular variable, a primary consideration
is the term of the forecast: how far into the future are we projecting? To see this, the concepts of
the short-run and the long-run from economics can be employed. In the short-run, most things
are predetermined or preplanned; very little can be changed. In the long-run, almost everything
is variable. In terms of financial forecasting, this means that in short-term forecasts, many things
will result from plans and events that are already in place (contracts, capital budgets, long-range
financing plans, and so forth). But in the long run, most things can vary and are dependent on
outside influences such as the firm’s long-term growth rate. Since cash forecasts deal mostly
with the near future, many of the items on the cash forecast are estimated by some variation of
the spot method. The bases for these spot estimates are usually the firm’s other financial plans.
Remaining estimates are mostly in a “proportion of another account” basis, with this “other
account” often being a particular period’s scales; the other two methods are employed less
frequently. This is quite unlike longer-term forecasting. Where compounded growth and multiple
dependency methodologies play a more important role.

Self Assessment

Fill in the blanks:
4. In ………………..it is assumed that the variable to be forecast is independent of all other
variables, or alternatively, is predetermined.
5. ………………………technique is used to project financial variables that are expected to
vary directly with the level of another variable.

6. ……………………method is used when a particular financial variable is expected to grow
at a steady growth rate over time.

9.4 Forecasting Daily Cash Flows

Forecasters typically use scheduling for daily cash forecasts, especially for short horizons.
Statistical tools can be helpful for the recurrent, non-major elements in the forecast, however.
Many smaller and some medium-sized companies do not even forecast on a daily basis, relying
on funding from investments or credit lines to cover shortfalls. The uncertainty of cheque
clearing is managed with controlled disbursement accounts. As the opportunity cost for
suboptimal investing increases due to increasing interest rates. More companies find it profitable
to do daily forecasts.
For most companies doing daily forecasting, the immediate day’s flows are simply gathered
from balance-reporting systems. For the next day and up to two weeks in the future, historical
collection and payment patterns can be used in connection with sales and purchases to project
cash flows.

The shorter the horizon, the more detail shown in the cash forecast. Ideally, the format will
include columns for the forecast, the actual amount (as it materialises), the budgeted amount,
and variances. Typically, actual-versus-forecast and actual-versus-budget variances will be
calculated. Explanations of likely causes and corrective actions will accompany the numbers.

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