Page 264 - DMGT207_MANAGEMENT_OF_FINANCES

2
3
1
4

Collection from debtors

From prior quarter
1.

3500
15000

(1/3 of sales)

(A) Cash inflows 3000 2500 Quarter 6000 Total
7000
2.
5000
12000
7000
31000
From current quarter
(2/3 of sales)
8000 9500 15500 13000 46000
(B) Cash outflows
Production costs 7000 10000 8000 8500 33500
Unit 11: Management of Cash
Selling, admn. and other costs 1000 2000 2900 1600 7500
Plant and other fixed assets purchased 100 1100 2100 2100 5400
Total cash payments 8100 13100 13000 12200 46400
Notes
(C) Surplus/(deficiency) (100) (3600) 2500 800 (400)
Beginning balance 650 550 500 500 650
Ending balance (indicated) 550 (3050) 3000 1300 250
Borrowing required (deficiency 3550 3550
+ min. cash reqd.)
Repayment mode (balance – min. cash reqd.) (2500) (800) (3300)
Ending balance 550 500 500 500 500

Loan outstanding is 35,50,000 – 33,00,000 = 250,000
Example: A firm uses a continuous billing system that results in an average daily receipt
of 40,00,000. It is contemplating the institution of concentration banking, instead of the current
system of centralized billing and collection. It is estimated that such a system would reduce the
collection period of accounts receivable by 2 days.
Concentration banking would cost 75,000 annually and 8% can be earned by the firm or its
investments. It is also found that a lock-box system can reduce its overall collection time by four
days and could cost annually 120,000.
1. How much cash would be released with the concentration banking system?
2. How much money can be saved due to reduction in the collection period by 2 days?
Should the firm institute the concentration banking system?
3. How much cash would be freed by lock-box system?
4. Between concentration banking and lock-box system, which is better?
Solution:
1. Cash released by the concentration banking system = 40,00,000 × 2 days = 80,00,000
2. Savings = 8% × 80,00,000 = 640,000. The firm should institute the concentration banking
system. It costs only 75,000 while the savings expected are 640,000.
3. Cash released by the lock-box system = 40,00,000 × 4 days = 160,00,000
Savings in lock box system 8% × 160,00,000 = 12,80,000
4. Lock-box system is better. Its net savings 11,60,000 ( 1280,000 – 120,000) are higher
than that of concentration banking.
Example: Assume, a firm which purchases raw materials on credit is required by the
credit terms to make payments within 60 days. The firm's experience has been that it takes on an
average, 35 days to pay its accounts payable and 70 days to collect its accounts receivable.
Moreover, 85 days elapse between the purchase of raw materials and the sale of finished goods,
that is to say, the average age of a firm's inventory is 85 days. What is the firm's cash cycle? Also
estimate the cash turnover.
Solution: The cash cycle of the firm can be calculated by finding the average number of days that
elapses between the cash outflows associated with paying accounts payable and the cash inflows
associated with collecting accounts receivable ,i.e.,
1. Cash cycle =85 days +70 days - 35 days =120 days

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