Forecasting cash receipts requires an intimate knowledge of the internal and external sources of this revenue.
Describe how a company can use its cash receipts to receive short-term financing
A legal claim; a charge upon real or personal property for the satisfaction of some debt or duty.
A cash receipt is a term used to describe cash flowing into a business . In terms of cash flow forecasting, we typically think of cash receipts as:
Having a good banking relationship can be essential for a company when short-term cash solutions are needed. There are a couple of methods for obtaining short-term bank financing. A company can obtain a line of credit in order to address recurring cash deficits. It could also arrange a revolving loan, where the company borrows as deficits occur up to a maximum amount. The bank may require the firm to put up collateral, such as account receivables, inventory, etc. Key points to remember when obtaining bank financing include:
In addition to bank financing, a company can borrow against its assets from a financing company. Accounts receivable is a liquid asset that provides a form of financing. In order to obtain receivables financing, a company must meet the following criteria:
There are two forms of receivable financing, factoring and assignments. Under the forcing form, a company sells its receivables to the financing company, who in turn assumes all responsibility for collecting the receivable. Under the assignments form, a company retains ownership of the receivables. The company assigns the receivable to the financing company in exchange for an advance of 60% to 80% of the balance.
Similar to receivables financing, inventory financing has the following requirements:
There are three forms of inventory financing. A financing company can place a floating or blanket lien on a firm's inventory, meaning they obtain a security interest in it, in exchange for lending cash. A financing company may also look to obtain interest in a certain part of a firm's inventory. This form is known as warehouse receipts. Finally, a financing company may lend a firm money for a specific item in its inventory until the firm is able to sell it. When cash is received for the sale, the firm pays the financing company. This form is known as trust receipts.
For large corporations with financially sound operations, cash can be obtained on the credit worthiness of the corporation - known as unsecured financing. In the United States, commercial paper is perhaps the most popular form of unsecured financing. Commercial paper is sold at a discount in the form of a promissory note.
A company needs to understand the timing involved with cash-producing or cash-depleting activities before it can properly plan for cash flows. The receipt cycle is the total time between when products or services are delivered and when payment from the customer clears the bank. The overall objective within the receipt cycle is to decrease the cycle or shorten the time necessary to collect and have use of cash. We can shorten the receipt cycle by:
Cash payments describe cash flowing out of a business resulting from operating activities, investment activities and financing activities.
Analyze a company's disbursement cycle
Money paid out or spent.
Why is cash flow forecasting important? If a business runs out of cash and is not able to obtain new financing, it will become insolvent. It is no excuse for management to claim that they didn't see a cash flow crisis coming. So in business, "cash is king".
Cash payments describe cash flowing out of a business. These cash payments can result from operating activities, investment activities and financing activities.
Generally speaking, normal operating activities refer to the cash effects of transactions involving revenues and expenses that impact net income. Cash payments must be made for relevant expenses. Typical payments include those to:
Typical cash outflows from investing activities include:
Typical cash outflows from financing activities include:
Sample Pay stub
This is an example of a pay stub to an employee, one of the most significant cash disbursements necessary for a company.
The cash disbursement cycle is important to consider when analyzing cash payments. This is the total time between when an obligation occurs and when the payment clears the bank. A company's objective regarding the cash disbursement cycle should be to increase the cycle time, or delay making payments until they are due. A firm may delay payments by:
Therefore, when a company manages cash flow cycles, it tries to control three types of float times:
In order to determine the optical cash balance for a company, cash flows are estimated and a forecast is prepared.
Apply the appropriate cash flow forecasting method given a company's needs
Unable to pay one's bills as they fall due.
There is a saying in business that "cash is king." Cash is the most liquid of assets, and it represents the lifeblood for growth and investment, particularly for start-ups and small enterprises. One of the worst things that can happen to a company is to run short of cash unexpectedly. This can make it difficult to pay suppliers and employees without scurrying around to raise needed cash quickly. When cash must be raised quickly, it is often a difficult and expensive task. If a business runs out of cash and is not able to obtain new financing, it will become insolvent. In order to generate cash, businesses must efficiently and effectively manage the activities that provide cash. These activities include billing customers as quickly as possible, disbursing payments only when they come due, collecting cash on overdue accounts, and investing idle cash. Managing cash flow involves several objectives:
This last objective is of vital importance. If a business hold too much cash, it loses the opportunity to earn a return on idle cash. If it holds too little cash, it runs the risk of not making timely payments to suppliers, banks, and other parties. The optimal cash balance is determined by looking at the four reasons for holding cash:
One of the best ways to determine the optimal cash balance is to fully understand cash flow patterns. This requires that we plot cash flows and prepare a forecast. What a cash flow forecast does is estimate cash inputs and outputs over a period of time, usually at least 90 days, in order to give you assurance that your business will have the cash necessary to meet its obligations to others. Think of the cash flow forecast as an "early warning system. " A cash flow forecast also answers several questions, such as how long can we invest idle cash, when will it be necessary to borrow cash, and when can we purchase new capital assets? A typical cash flow forecast will include: cash on hand, expected receipts, and expected disbursements.
This is an example of a cash flow forecast.
The direct method of cash flow forecasting schedules the company's cash receipts and disbursements (R&D). This direct R&D method is best suited to the short-term forecasting horizon of 30 days or so because this is the period for which actual, as opposed to projected, data is available.Three indirect methods are based on the company's projected income statements and balance sheets.
The adjusted net income and pro-forma balance sheet methods are best suited for medium-term and long-term forecasting horizons. Both need to be adjusted for the difference between book cash and bank balances, which are often significantly different. The accrual reversal method is more complicated and best suited for medium-term forecasting. Consider the following points when preparing forecasts