Financial Management Principles Cash Balance

Question: Describe about the Financial Management Principles for Cash Balance. Answer: 1:- From the case study and financial statements, it can be stated that Jackson Limited has managed to generate profits for the last eight months. However, the company could not repay the loan on time. There are several issues, for which the company has requested to extend the term loan period. From the monthly income statement for the last eight months, it has been observed that the company could not maintain the net profit margin stable. It has decreased significantly over the period. Such fall in profit margin has been caused due to fall in sales for the last three month. From March2013 to May,2013, the actual sales figures were lesser than the budgeted sales (Channon and Jalland 2016). The fall in sales volume, as reported by the company, has happened due to the delay in the shipments. It could not complete the orders on time as some vital components arrived very lately. Therefore, the company could not generate the anticipated sales volume and accumulate enough cash balance. Moreover, it has also suffered from inadequate cash balance due to dividend payment on March2013 (Kaplan and Atkinson 2015). Hence, it can be concluded from the above discussions, that though the company has earned profit over the due period, it has failed to generate the budgeted sales volume due to operational hazards. It has caused a temporary shortfall in cash balance, for which the company could not repay the loan timely. The main sources and uses of funds for Jackson Limited is described in the following table:- Particulars Details Sources of Funds Sales Operation Loan from Bank Interest on cash Balance Uses of Funds Purchase of Raw Material Operating Expenses Tax Payment Interest on Loan Dividend Payment 2:- The company requires the new loan of $2.4 million to purchase new equipment for operational purpose. As the president of the company had mentioned, the company had not bought any new equipment for the last few year due to recession. Moreover, some of the components of the older equipments have worn out, which may cause interruption in production. The company has always focused on innovative designs to satisfy its customers. It has been one of the key strengths of the company, which has helped it to survive in the recession period successfully (Bryson 2012). In such scenario, if the company does not upgrade its machinery and equipments accordingly, it cannot maintain its goodwill in the market. Moreover, as mentioned earlier, due to poor conditions of the equipment, it may face disruptions in operation (Rausand 2013). In the current financial year, it has already suffered such disruption due to delay in shipments, which has caused fall in sales volumes. Now, if it again faces such problems, then it will be unable to recoup the losses. The quality of the end products may also hamper for the poor condition of the equipment and lead to customer dissatisfaction. Therefore, it can be suggested that the requirement of the additional borrowing can be considered as urgent. 3:- Cash Budget:- Partculars June'13 July'13 August'13 September'13 Cash Flow from Operating Activities Payment from Customers 3,744 12,681 7,374 4,501 Payment to Suppliers (5,969) (5,200) (5,200) (5,200) Payment for Operating Expenses (1,838) (1,838) (1,838) (1,838) Income Tax Payment (375) (375) Net Cash Inflow/(Outflow) from Operating Activities -4438 5643 336 -2912 Cash Flow from Investing Activities Purchase of New Equipment -2400 Net Cash Inflow/(Outflow) from Operating Activities 0 -2400 0 0 Cash Flow from Financing Activities Loan from bank 2400 Interest on Loan -25 -25 -37 -37 Interest Income 8 1 10 11 Repayment of Loan -7400 Dividend Paid -1200 Net Cash Inflow/(Outflow) from Operating Activities -17 2376 -27 -8626 Total Cash Inflow/(Outflow) -4455 5619 309 -11538 Add: Opening Cash Balance 4,994 539 6,158 6,468 Closing Cash Balance 539 6,158 6,468 (5,071) Income Statement:- Particulars June'13 July'13 Aug '13 Sep'13 TOTAL Net Sales 12,681 7,374 7,201 7,394 34,650 Less: COGS 9,765 5,381 5,381 5,381 25,909 Gross Profit 2,916 1,993 1,820 2,013 8,741 Operating expenses 750 750 750 750 3,000 Depreciation and amortization 120 120 130 130 500 Interest expense 25 25 37 37 124 Interest income 8 1 10 11 30 Profit (loss) before tax 2,013 1,097 892 1,085 5,086 Income taxes 684 373 303 369 1,729 Net income 1,328 724 589 716 3,357 Dividends 1200 1,200 Balance Sheet:- June'13 July'13 Aug'13 Sep'13 Cash 539 6,158 6,468 Accounts receivable 12,681 7,374 7,201 7,394 Inventory 7,317 7,728 5,541 8,822 Current assets 20,537 21,260 19,209 16,216 Gross PPE 45,500 47,900 47,900 47,900 Accumulated depreciation 30,488 30,608 30,738 30,868 Net PPE 15,012 17,292 17,162 17,032 Tax Refundable 6 Prepaid expenses 54 54 54 54 Total assets 35,603 38,606 36,425 33,308 Accounts payable 5,200 5,200 5,200 5,200 Bank Overdraft 5,071 Notes payable, bank 5,000 7,400 7,400 Accrued taxes 309 373 303 Other accrued expenses 1,142 1,142 1,142 1,142 Customer advance payments 2,700 2,700 0 0 Current liabilities 14,351 16,815 14,045 11,413 Shareholders' equity 21,251 21,791 22,380 21,896 Total liabilities and equity 35,603 38,606 36,425 33,308 4:- The projected income statement for the period from June,2013 to September,2013 exhibits quite satisfactory outcomes. The company is expected to earn high amount of profit in this period. However, from the cash budget for the same period, it can be stated that the company will not be able to repay the loan. The cash budget forecasts that though company will have adequate amount of opening cash balance on September, it cannot generate positive cash flow from operating activities due to the advance payment adjustment from customer. Hence, if the company repays the loan, the total cash balance will become negative and the company has to take short term loan again for its operational activities (Brigham and Ehrhardt 2013). The main risk, which is associated with the proposed loan, is the shortfall of cash balance. The company can reduce the risk level, if it negotiates with its suppliers to extend the credit period of 30 days to 60 days and does not pay the dividend on the month September. 5:- The forecasts, made by the president, are based on sales volume and future cash outlays in form of raw material purchase and operating expenses. It can vary with the actual figures if any of these factors differs from the assumptions (McDONALD 2016). The company expects that the sales volume will rise quite significantly due to faster economic development. It has assumed such future developments according the recent sales figures of big three companies in this sector. The factors, which has helped these three companies to improve the sales, may not be effective for small companies, like Jackson Limited. Therefore, the company may not enjoy such significant sales growth in the coming four months (McDonald 2013). The company expects to reduce the raw material cost and maintain the same amount for all the four months. It should be noted that if the productivity increases, then the raw material consumption would increase subsequently (DRURY 2013). Moreover, if the industry will face a economi development, then raw material price also rise according to its increasing demand. In both the cases, the raw material cost cannot be reduced and maintained at same level for the period of 4 months. The operating expenses are mostly variable expenses, which changes as per production and sales volume. Hence, unlike the assumption of the company, it will not remain same for the specified period, when the production and sales volume both will increase at high rate. Therefore, it can be stated that the assumptions, made for future projection, are not quite satisfactory and logical. There is high risk that the actual figures may differ greatly with the forecast and the company may not achieve its target as per the anticipation (Fleischmann et al. 2015). Moreover, the main issue of the company is the shortage of cash balance, which relies greatly on the sales figures. The sensitivity analysis, shown below, describes how the cash balance would vary according to the change in sales forecast:- Sensitivity Analysis:- Particulars Actual Option 1 Option 2 Option 3 Option 4 Rise by 10% Rise by 15% Fall by 5% Fall by 10% Actual Sales for 8 months 44,014 44,014 44,014 44,014 44,014 Projected Sales for 4 months 34,650 38115 39848 32918 31185 Total Annual Sales 78,664 82,129 83,862 76,932 75,199 Cash Balance on year ending (5,071) (2,340) (974) (6,436) (7,802) It is clear from the above table that the company will be able to pay off the term loan without any interruption in its operations, only if it would be able to increase the sales volume by 15% from the forecasted figures and avoid the dividend payment in the end of September (Hope and Fraser 2013). 6:- From the banks point of view, it can be stated that the current loan should not be extended and the additional loan should not be approved also. The financial forecast statements, given above, exhibit that the company will not be able to save enough cash fund at the end of the fiscal year for repaying both the loans. In such scenario, the bank cannot take such huge risk (Bluhm et al. 2016). As mentioned in the case study, Jackson Limited has performed at the adverse conditions quite well in past. The pro-forma income statement indicates that it will continue to earn profit in the near future also. Hence, the bank can consider it for loan (Bessis and O'Kelly 2015). In that case, it can reduce the risk factors by providing the loan against the accounts receivable balances or the finished goods inventories (Grubel 2014). If the company will not be able to pay the loan on time, then the bank can ensure the payment on encashment of accounts receivable or by selling the finished inventory balances (Brealey et al. 2012). 7:- The repurchase of common outstanding stocks can be very helpful for the companies, which are very much active in the stock markets. The company can reduce the quantity of outstanding shares and thus, it will be able to increase the earning per share (Evgeniou et al. 2016). The company may pay lesser amount for dividends as the dividend per share will rise due to lower numbers of shares. Thus due to increase in earnings per shares and dividend per shares, the stock price of the company uses to get increase quite significantly (Horngren et al. 2013). It is not sure that Jackson Limited is active in share markets or not. If it would intend to rise its stock prices in the market, then the decision of share buy-back is surely a good decision. However, nothing is mentioned in the case study about such intention. Rather, for such repurchasing the company had to take loan from bank. It has led the company to generate higher debt ratio (Andriosopoulos et al. 2013). Moreover, the companies use to repurchase its shares out of its excess cash funds. Jackson Limited did not have enough cash balance when it had re-purchased its own shares (Hofstede 2012). Therefore, the decision of share buy-back cannot be considered as fruitful or effective for the company. 8:- The company should not pay dividends at the end of September,2013, as it is quite sure that the company will face shortage of cash in that particular month. The main aim of the company should be the loan repayment only. It should save cash funds as much as possible and for that reason, it should avoid any cash outflows, which can be paid in the following year (Lorange 2013). Dividends payment is not fixed expenses. It depends on the financial situation and cash balances of the company. Jackson Limited has already paid interim dividend on March,2013. Therefore, if it will pay dividends in the next fiscal year from the total profit of the current year, there will be no problem at all (Patton et al. 2015). References:- Andriosopoulos, D., Andriosopoulos, K. and Hoque, H., 2013. Information disclosure, CEO overconfidence, and share buyback completion rates.Journal of Banking Finance,37(12), pp.5486-5499. Bessis, J. and O'Kelly, B., 2015.Risk management in banking. John Wiley Sons Bluhm, C., Overbeck, L. and Wagner, C., 2016.Introduction to credit risk modeling. Crc Press. Brealey, R.A., Myers, S.C., Allen, F. and Mohanty, P., 2012.Principles of corporate finance. Tata McGraw-Hill Education Brigham, E.F. and Ehrhardt, M.C., 2013.Financial management: Theory practice. Cengage Learning. Bryson, J.M., 2012. 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