590 CHAPTER 16 Working Capital Managementgives the sales forecast for the period from May through December. (May and June
sales are necessary to determine collections for July and August.) Next, Lines 2through
5 show cash collections. Line 2shows that 20 percent of the sales during any
given month are collected during that month. Customers who pay in the first month,
however, take the discount, so the cash collected in the month of sale is reduced by
2percent; for example, collections during July for the $300 million of sales in that
month will be 20 percent times sales times 1.0 minus the 2 percent discount
(0.20)($300)(0.98)$59 million. Line 3 shows the collections on the previous month’s
sales, or 70 percent of sales in the preceding month; for example, in July, 70 percent of
the $250 million June sales, or $175 million, will be collected. Line 4 gives collections
from sales two months earlier, or 10 percent of sales in that month; for example, the July
collections for May sales are (0.10)($200)$20 million. The collections during each
month are summed and shown on Line 5; thus, the July collections represent 20 percent
of July sales (minus the discount) plus 70 percent of June sales plus 10 percent of May
sales, or $254 million in total.
Next, payments for purchases of raw materials are shown. July sales are forecasted
at $300 million, so MicroDrive will purchase $210 million of materials in June (Line
6) and pay for these purchases in July (Line 7). Similarly, MicroDrive will purchase
$280 million of materials in July to meet August’s forecasted sales of $400 million.
With Section I completed, Section II can be constructed. Cash from collections is
shown on Line 8. Lines 9 through 14 list payments made during each month, and
these payments are summed on Line 15. The difference between cash receipts and
cash payments (Line 8 minus Line 15) is the net cash gain or loss during the month.
For July there is a net cash loss of $11 million, as shown on Line 16.
In Section III, we first determine the cash balance MicroDrive would have at
the start of each month, assuming no borrowing is done. This is shown on Line 17.The Great Debate: How Much Cash Is Enough?
“I hate cash on hand,” says Fred Salerno, Bell Atlantic’s
CFO. According to a recent survey, Salerno has backed up
his talk with actions. When rated on the number of days of
operating expenses held in cash (DOEHIC), Bell Atlantic
leads its industry with a DOEHIC of 6 days versus an indus-
try average of 27. Put another way, Bell Atlantic has cash
holdings equal to only 0.90 percent of sales as compared
with an industry median cash/sales ratio of 5.20 percent.
A great relationship with its banks is a key to keeping low
cash levels. Jim Hopwood, treasurer of Wickes, says, “We
have a credit revolver if we ever need it.” The same is true at
Haverty Furniture, where CFO Dennis Fink says, “You
don’t have to worry about predicting short-term fluctuations
in cash flow,” if you have solid bank commitments.
Treasurer Wayne Smith of Avery Dennison says that
their low cash holdings have reduced their net operating
working capital to such an extent that their return on in-
vested capital (ROIC) is 3 percentage points higher than it
would be if their cash holdings were at the industry average.
He goes on to say that this adds a lot of economic value to
their company.
Despite these and other comments about the advantages
of low cash holdings, many companies still hold extremely
large amounts of cash and marketable securities, including
Procter & Gamble ($2.6 billion, 32 days DOEHIC, 7.1 per-
cent cash/sales) and Ford Motor Company ($24 billion,
76 DOEHIC). When asked about the appropriate level of
cash holdings, Ford CFO Henry Wallace refused to be
pinned down, saying, “There is no answer for a company
this size.” However, it is interesting to note that Ford re-
cently completed a huge stock repurchase, reducing its cash
by about $10 billion.Source:S. L. Mintz, “Lean Green Machine,” CFO,July 2000, 76–94.