The Company's Cash Flows - Example

Executive summary This report is aimed at advising the CEO of Black Diamond Mining Limited on the financial policy that would be most suitable for the company as it embarks on a major maintenance project in December 2014 and January 2015. This is because such a huge project that would consume $33,000,000 may have the effect of affecting the company’s finances and hence its day to day operations and performance in the long run. In preparing the report, a number of assumptions have been made. For instance, it is assumed that the company can only take the loan at the month end and hence if a loan is taken for instance in January, the loan will only attract interest starting from February. Similarly, the report assumes that the company can only make a loan repayment at the end of the month after all other expenses have been paid and thus the repayment is made from the cash surpluses. In accordance to the company’s policy, it is assumed that the company will always acquire an overdraft whenever its ending cash balance is less than $7 million and that loan repayment is made from any amount in excess of the minimum cash balance. Another assumption is that although customers accepting discounts are expected to pay in cash, the foreign customer’s cash will be received after 30 days which is the period between making an order and delivering of goods since cash is not paid in advance. On the other hand, due to this period between ordering and receiving goods, 120 days lapse before foreign debtors’ cash can be received. From the report, it will be established that delaying payments is a better option than offering discounts. Overall however, maintaining the current policy on creditors and debtors have been found to be the cheapest option. Finally, the report advices the CEO that the company should stick to its original debtors and creditors’ policy since it has the lowest cost implications. Table of Contents Executive summary 1 Table of Contents 2 Effect of delaying payments to creditors on the company’s Cash flows 3 Effect of giving discounts to debtors on Cashflows 3 Delay of payments to creditors 4 Offering of discounts to trade debtors 5 Both delayed payments to creditors and discounts to debtors 6 No change is made from existing policy 7 Advice to the CEO 9 Conclusion 9 References: 10 Appendix 11 Effect of delaying payments to creditors on the company’s Cash flows In the attached Cashflow statement, it can be seen that the company by delaying payments to creditors would end up with a cash balance of $7,000,000 in January and February, $8,835,687.5 in March, $12,744,812.50 in April, $ 13,915,312.50 in May and $25,410,072.50 in June. The company’ would be able to collect cash amounting to $19,200,000 in January, $20,600,000 in February, $26,000,000 in March, $22,000,000 in April, $22,800,000 in May and $28,600,000 in June. The company would also have to pay creditors and other expenses amounts of $23,974,000, $23,814,000, $16,176,312.50, $18,090,875, $21,629,500 and $16,850,000 in January to June respectively. However, it is very important to notice the costs associated with this arrangement. First, the company has to pay 15% p.a or 1.25%p.m on all debts that remain unpaid for more than 30 days. In this regard, the company would have to pay interest in regard to delayed payments amounting to $54,000 in January, $99,000 in February, $61,312.50 in March, $70,875 in April and $49,500 in May. On the other hand, the company would still have to pay a 2% monthly interest on any loan it acquires which would be repayable in June. In this regard, the company would have to pay $255,240 interest in respect of the $7,988,000 loan it would accumulate in both January and February in a bid to ensure its cash balance at the end of the month is $7,000,000. Effect of giving discounts to debtors on Cashflows In the attached Cashflow statement, it can be seen that the company by delaying payments to creditors would end up with a cash balance of $7,000,000 in January and$7,757,000 in February, $10,197,000 in March, $15,297,000 in April, $ 15,497,000 in May and $22,818,700 in June. The company’ would be able to collect cash amounting to $21,785,000 in January, $24,222,000 in February, $20,040,000 in March, $18,800,000 in April, $19,800,000 in May and $24,200,000 in June. The company would also have to pay creditors and other expenses amounts of $23,200,000, $22,050,000, $17,600,000, $13,700,000, $19,600,000 and $22,818,700 in January to June respectively. However, it is very important to notice the costs associated with this arrangement. First, the company has to undergo some of the money it is owed when it gives discounts to the tune of 10% to foreign customers who pay in cash and 5% to Domestic customers who pay in cash. These discounts would amount to $435,000 in January and $638,000 in February. On the other hand, the company would still have to pay a 2% monthly interest on any loan it acquires which would be repayable in June. In this regard, the company would have to pay $28,300 interest in respect of the $1,415,000 loan it would acquire in January in a bid to ensure its cash balance at the end of the month is $7,000,000. Delay of payments to creditors Black Diamond Company Limited Cash Flow Statement For the six months period ended 30th June 2015 Beginning cash balance $7,000,000 Add: Cash receipts $139,200,000 Total cash available for use $146,200,000 Less: Disbursements Supplies $70,200,000 Management expenses $12,000,000 Maintenance expenses $33,000,000 Dividends $5,000,000 Interest expenses $334,687.50 Total disbursements $120,534,687.50 Cash surplus $25,665,312.50 Financing: Borrowings $ 7,988,000.00 Repayments $ 7,988,000.00 Finance costs $ 255,240.00 Net cash from financing $ 255,240.00 Ending balance $ 25,410,072.50 From the above cash flow statement, it is worth noting that the company by delaying payments to trade creditors would end up with a cash balance of $25,410,072.50 after the six months. During the period, the company would have managed to collect $139,200,000 from its sales. Out of this, the company would have used $120,534,687.50 in paying for various expenses with $70,200,000 of this going to clearing debts owed to trade creditors. It is however worth noting that such an arrangement would entail the company paying 15% pa interest owing to delaying trade creditors’ payments for more than 30 days. In this regard, the company would pay a total of $334,687.50 for the interest that would accrue during the period. Further cost would be the bank interest that the company would need to pay for the loan of $7,988,000 that it would have taken during the period with an aim of bringing its monthly closing cash balance to $7,000,000 in line with its finance policy. The total interest paid would be $255,240. As such, the cost implications for the policy change would total $589,927.50. Offering of discounts to trade debtors Black Diamond Company Limited Cash Flow Statement For the six months period ended 30th June 2015 Beginning cash balance $7,000,000.00 Add: Cash receipts $ 128,847,000.00 Total cash available for use $ 135,847,000.00 Less: Disbursements Supplies $ 63,000,000.00 Interest $334,687.50.00 Management expenses $12,000,000.00 Maintenance expenses $33,000,000.00 Dividends $5,000,000.00 Total disbursements $113,000,000.00 Cash surplus $ 22,847,000.00 Financing: Borrowings $ 1,415,000.00 Repayments $ 1,415,000.00 Finance costs $ 28,300.00 Net cash from financing $ 28,300.00 Ending balance $ 22,818,700.00 As seen from the above cash flow statement, offering discounts to trade debtors would imply the company closing the six month period with a $22,818,700 cash balance. The company would have managed to collect a total of $28,847,000 from the sales it makes during the period. In addition, the company would have made payments totaling to $113,000,000 with $63,000,000 of this going to settle trade creditors. The only cost implication of this arrangement is the $28,300 loan interest that the company would have to pay for the $1,415,000 loan it would take during the period as well as the expenses related to the discounts that the company offers to its debtors. The discounts would amount to $2,465,000 and hence the overall cost implication for the alternative is $2,493,300 . Both delayed payments to creditors and discounts to debtors Black Diamond Company Limited Cash Flow Statement For the six months period ended 30th June 2015 Beginning cash balance $7,000,000.00 Add: Cash receipts $ 128,847,000.00 Total cash available for use $ 135,847,000.00 Less: Disbursements Supplies $70,200,000 Management expenses $12,000,000.00 Maintenance expenses $33,000,000.00 Interest $334,687.50.00 Dividends $5,000,000.00 Total disbursements $120,534,687.50 Cash surplus $15,647,000.00 Financing: Borrowings $ 2,189,000.00 Repayments $ 2,189,000.00 Finance costs $ 79,400.00 Net cash from financing $ 79,400.00 Ending balance $ 15,232,912.50 From the above cash flow statement, it is worth noting that the company by delaying payments to trade creditors would end up with a cash balance of $ 15,232,912.50 after the six months. During the period, the company would have managed to collect $128,847,000 from its sales. Out of this, the company would have used $120,534,687.50 in paying for various expenses with $70,200,000 of this going to clearing debts owed to trade creditors. It is however worth noting that such an arrangement would entail the company paying 15% pa interest owing to delaying trade creditors’ payments for more than 30 days. In this regard, the company would pay a total of $334,687.50 for the interest that would accrue during the period. Further cost would be the bank interest that the company would need to pay for the loan of $2,189,000 that it would have taken during the period with an aim of bringing its monthly closing cash balance to $7,000,000 in line with its finance policy. The total interest paid would be $79,400. The arrangement would also attract a cost of $2,493,300. As such, the cost implications for the policy change would total $2,907,388. No change is made from existing policy Black Diamond Company Limited Cash Flow Statement For the six months period ended 30th June 2015 Beginning cash balance $7,000,000.00.00 Add: Cash receipts $139,200,000.00 Total cash available for use $ 146,200,000 .00 Less: Disbursements Supplies $ 63,000,000.00 Management expenses $12,000,000.00 Maintenance expenses $33,000,000.00 Dividends $5,000,000.00 Total disbursements $113,000,000.00 Cash surplus $33,200,000.00 Financing: Borrowings $ 5,450,000.00 Repayments $ 5,450,000.00 Finance costs $189,000.00 Net cash from financing $ 189,000.00 Ending balance $ 33,011,000.00 As seen from the above cash flow statement, offering discounts to trade debtors would imply the company closing the six month period with a $33,011,000 cash balance. The company would have managed to collect a total of $139,200,000 from the sales it makes during the period. In addition, the company would have made payments totaling to $113,000,000 with $63,000,000 of this going to settle trade creditors. The only cost implication of this arrangement is the $189,000 loan interest that the company would have to pay for the $5,450,000 loan it would take during the period. Advice to the CEO Advice on whether delaying payments to creditors or the offering of discounts to debtors is worthwhile and any matters not included above that should be considered in arriving at their decision on whether to temporarily change their existing policies relating to trade creditors and trade debtors. Arising from the above discussion, it is clear that adopting a policy that incorporates both delaying payment to creditors while offering discounts to debtors would have the biggest cost implications to the company thus eating into its profitability. On the other hand, maintaining the current policy on trade creditors and debtors would have the least cost implications to the company. If there would be other factors that would affect the current financial policy to an extent that affects the company’s financial status during the six months period negatively, then I would advise the company to take the policy change that entails delaying payment to creditors as opposed to offering trade discounts. This is because the option is less costly than offering discounts. However, the future or long run implications of both policy changes to both the company’s relationship with creditors as well as debtors ought to be thoroughly considered since both are important pillars for the company. It is also worth considering whether offering lower discounts to traders would still have similar effect to the customers since from the analysis above, it can be observed that discounts are too much costly for the company as they are relatively high. Other factors should be considered include whether there would be cheaper forms of financing other than the ones examined above. The company also needs to consider the acceptability of the option to delay payments to creditors since if they reject it, then the company can only use the discount option. Overall however, I would advise the company to stick to its current policy since it has the least cost implications while the customers and creditors are least affected. Conclusion It is important for companies such as Black Diamond limited to undertake financial planning and forecasting at all times and especially so when they are faced with projects that consume huge amounts of money such as the $33,000,000 maintenance expenses over two months. This is because failure to adequately plan may lead the company to run into financial difficulties. However, planning in advance makes the company to anticipate expenses and hence plan for the best financing option that is beneficial to the company yet with the least cost implications. In this regard, the above analysis indicates that the company would be better off remaining with its current financing policy as it has the least cost implication to the company and hence profitability. In addition, considering that the other alternatives are temporary, they might have a disrupting tendency to both customers and creditors. All these factors are the basis of my advice to the CEO that the company ought not to alter its policy on both creditors and debtors during the six months period. References: Josephine, J2011, Advances in financial management, Nairobi, McMillan Publishers. Appendix Book 1 in the attached excel sheet showing the analysis of cash flow implications of various policy change alternatives. Read More