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THE CASH BALANCE

The forecast net inflow of cash (sources minus uses) is shown on the bottom row of Table 2.7. Note the large negative figure for the first quarter: a $45 million forecast outflow. There is a smaller forecast outflow in the second quarter, and then substantial cash inflows in the second half of the year.

Table 2.8 calculates how much financing Dynamic will have to raise if its cash-flow forecasts are right. It starts the year with $5 million in cash. There is a $45 million cash outflow in the first quarter, and so Dynamic will have to obtain at least $45 million $5 million = $40 million of additional financing. This would leave the firm with a forecast cash balance of exactly zero at the start of the second quarter.

Most financial managers regard a planned cash balance of zero as driving too close to the edge of the cliff. They establish a minimum operating cash balance to absorb unexpected cash inflows and outflows. We will assume that Dynamic`s minimum operating cash balance is $5 million. That means it will have to raise $45 million instead of $40 million in the first quarter, and $15 million more in the second quarter. Thus its cumulative financing requirement is $60 million in the second quarter. Fortunately, this is the peak; the cumulative requirement declines in the third quarter when its $26 million net cash inflow reduces its cumulative financing requirement to $34 million. (Notice that the change in cumulative short-term financing in Table 2.8 equals the net cash inflow in that quarter from Table 2.7.) In the final quarter Dynamic is out of the woods.

Its $35 million net cash inflow is enough to eliminate short-term financing and actually increase cash balances above the $5 million minimum acceptable balance. Before moving on, we offer two general observations about this example:

1. The large cash outflows in the first two quarters do not necessarily spell trouble for Dynamic Mattress. In part they reflect the capital investment made in the first quarter: Dynamic is spending $32.5 million, but it should be acquiring an asset worth that much or more. The cash outflows also reflect low sales in the first half of the year; sales recover in the second half.6 If this is a predictable seasonal pattern, the firm should have no trouble borrowing to help it get through the slow months.

2. Table 2.7 is only a best guess about future cash flows. It is a good idea to think about the uncertainty in your estimates. For example, you could undertake a sensitivity analysis, in which you inspect how Dynamic`s cash requirements would be affected by a shortfall in sales or by a delay in collections.

Our next step will be to develop a short-term financing plan that covers the forecast requirements in the most economical way possible. Before presenting such a plan, however, we should pause briefly to point out that short-term financial planning, like longterm planning, is best done on a computer. The nearby box presents the spreadsheet underlying Tables 2.6 to 2.8. The spreadsheet on the left presents the data appearing in the tables; the one on the right presents the underlying formulas. Examine those formulas and note which items are inputs (for example, rows 15 18) and which are calculatedfrom equations. The formulas also indicate the links from one table to another. For example, collections of receivables are calculated in Table 2.6 (row 6), and passed through as inputs in Table 2.7 (row 11). Similarly, net cash inflow in Table 2.7 (row 20) is passed

along to Table 2.8 (row 24).

Once the spreadsheet is set up, it becomes easy to explore the consequences of many “what-if ” questions. For example, Self-Test 4 asks you to recalculate the quarterly cash receipts, net cash inflow, and cumulative short-term financing required if the firm`s collections on accounts receivable slow down. You can obviously do this by hand, but it is quicker and easier to do it in a spreadsheet especially when there might be dozens of scenarios that you are responsible to work through!