MicroDrive will have $15 million on hand on July 1. The beginning cash balance
(Line 17) is then added to the net cash gain or loss during the month (Line 16) to ob-
tain the cumulative cash that would be on hand if no financing were done (Line 18). At
the end of July, MicroDrive forecasts a cumulative cash balance of $4 million in the
absence of borrowing.
The target cash balance, $10 million, is then subtracted from the cumulative cash
balance to determine the firm’s borrowing requirements, shown in parentheses, or its
surplus cash. Because MicroDrive expects to have cumulative cash, as shown on Line
18, of only $4 million in July, it will have to borrow $6 million to bring the cash ac-
count up to the target balance of $10 million. Assuming that this amount is indeed
borrowed, loans outstanding will total $6 million at the end of July. (MicroDrive did
not have any loans outstanding on July 1.) The cash surplus or required loan balance
is given on Line 20; a positive value indicates a cash surplus, whereas a negative value
indicates a loan requirement. Note that the surplus cash or loan requirement shown
on Line 20 is acumulative amount.MicroDrive must borrow $6 million in July. Then,
it has an additional cash shortfall during August of $37 million as reported on Line 16,
so its total loan requirement at the end of August is $6$37$43 million, as
reported on Line 20. MicroDrive’s arrangement with the bank permits it to increase
its outstanding loans on a daily basis, up to a prearranged maximum, just as you
could increase the amount you owe on a credit card. MicroDrive will use any surplus
funds it generates to pay off its loans, and because the loan can be paid down at any
time, on a daily basis, the firm will never have both a cash surplus and an outstanding
loan balance.
This same procedure is used in the following months. Sales will peak in Septem-
ber, accompanied by increased payments for purchases, wages, and other items. Re-
ceipts from sales will also go up, but the firm will still be left with a $57 million net
cash outflow during the month. The total loan requirement at the end of September
will hit a peak of $100 million, the cumulative cash plus the target cash balance. The
$100 million can also be found as the $43 million needed at the end of August plus
the $57 million cash deficit for September.
Sales, purchases, and payments for past purchases will fall sharply in October, but
collections will be the highest of any month because they will reflect the high Septem-
ber sales. As a result, MicroDrive will enjoy a healthy $44 million net cash gain during
October. This net gain can be used to pay off borrowings, so loans outstanding will
decline by $44 million, to $56 million.
MicroDrive will have an even larger cash surplus in November, which will permit
it to pay off all of its loans. In fact, the company is expected to have $58 million in sur-
plus cash by the month’s end, and another cash surplus in December will swell the ex-
cess cash to $92 million. With such a large amount of unneeded funds, MicroDrive’s
treasurer will certainly want to invest in interest-bearing securities or to put the funds
to use in some other way.
We intentionally kept this cash budget simple for illustrative purposes, but here
are some potential refinements that you could easily incorporate: (1) Add dividend
payments, stock issues, bond sales, interest income, and interest expenses. (2) Create a
cash budget to determine weekly, or even daily, cash requirements. (3) Use simulation
to estimate the probability distribution for the cash requirements. (4) Allow the target
cash balance to vary over time, reflecting the seasonal nature of sales and operating
activity.
What is the purpose of the cash budget?
What are the three major sections of a cash budget?
The Cash Budget 591
586 Working Capital Management
