Introduction to Corporate Finance

PART 5: SPECIAL TOPICS

Dealing With Uncertainty in the Cash Budget

Because the cash budget provides only month-end totals, it does not ensure that the company has

sufficient credit to cover intra-month financing needs. For example, what if a company’s disbursements

occur before its receipts during a particular month? In that case, its intra-month borrowing needs will

exceed the monthly totals shown in its cash budget. To ensure sufficient credit, the company may

forecast its expected receipts and disbursement on a daily basis, and use these estimates, along with its

cash budget, when arranging adequate credit to cover its maximum expected cash deficit.

The monthly cash surpluses and deficits predicted in the budget are affected by virtually all facets

of a company’s operations. For example, changes in receivables collection, in payment patterns or in

inventory turnover can have a dramatic impact on financing needs. Any action that slows collections

from customers or accelerates payments to suppliers will increase monthly financial deficits (or reduce

surpluses). In that sense, almost any functional area in the company can affect, or be affected by, the

cash budget.

One key aspect of cash flow management is to maximise the time taken to pay suppliers (creditor days)

while minimising the time taken to collect payments from customers (debtor days). Consider a large retail

store. Typically, you need to pay for goods (either via cash or credit card) before you take possession of

them. This involves debtor days of zero (or perhaps a couple of days, in the case of EFTPOS or credit

card payments). However, the store usually will have negotiated very favourable credit terms with its

suppliers, and may have many months before it needs to pay suppliers. Thus, during this time period, it

has extra cash to fund other activities – meaning that in effect, the funding cost for this period is zero.

The online Chapter 18 discusses this concept in depth.

creditor days
A measure of the average
time a business takes to pay
its creditors

debtor days
A measure of the average
time a company takes to
collect payment from its
debtors

finance in practice

CAN I MAKE ENDS MEET?

In order to achieve your personal financial goals and

meet your financial obligations in a timely manner,

thereby avoiding late payments and maintaining a

strong credit rating, you should regularly prepare a

personal cash budget. Typically, these budgets cover

the coming year divided into months. They schedule

and net out cash inflows and cash outflows in order to

plan for cash surpluses and shortages. Surpluses can

be invested, and shortages can be met in a variety of

ways, such as drawing down savings or borrowing.

To demonstrate the personal cash budget, let’s

look at your total inflow and outflow estimates (detailed

cash flows not shown) for the next three months.

Month 1 Month 2 Month 3

(1) Total inflows $5,550 $5,555 $5,555

(2) Total outflows $6,265 $5,365 $6,240

Net cash flow

[(1) – (2)] –$ 715 $ 190 –$ 685

Reviewing your personal cash budgets for the

next three months, it is clear that you need to take

action in order to make ends meet. Specifically,

you need to cover the deficits in months 1 and 3

($715 + $685 = $1,400) net of the surplus in month

2 ($190), or a total of $1,210 ($1,400 – $190).

Your budgets can be brought into balance by:

(1) increasing inflows by $1,210; (2) cutting outflows

by $1,210; (3) drawing down savings by $1,210;

(4) borrowing $1,210; or (5) a combination of these

strategies that will reduce the $1,210 gap to zero.

Clearly, the best strategy would be to reduce

planned outflows by a total of $1,210 over the next

three months.