Financial Budgeting at Black Diamond Mining Australia Company Limited - Example

Executive summary This report is prepared for the management of Black Diamond Mining Australia Company Limited. Owing to the fact that the company intends to undertake a high cost maintenance project worth $33,000,000 during the months of December 2015 and January 2016, the company anticipates that it may experience some financial difficulties and hence the need to alter its financial policy as regards debtors and creditors so as to ensure it does not enter into financial difficulties. The report therefore considers all factors available and advices the management on the best alternative that will mean the least cost to the company while maintaining financial soundness. The report first introduces the financial problem at the company before undertaking an analysis of all financing options available. The report then compares all the alternatives and comes up with the best alternative that the company should adopt In addition; the report also recommends the non-financial factors that the company ought to consider in making the policy change decision. The report then concludes by recommending the best option to the management. The appendix of the report (excel) is financial computations of all the alternatives. Table of Contents Executive summary 1 Table of Contents 2 Introduction 3 Key options and assumptions considered 3 Effects on cashflows 3 Advice to CEO 4 Discussion of each cash flow statement 4 Advice to CEO whether the policy should remain the same or be changed 7 Other matters to consider 7 Conclusion 8 References: 9 Introduction Financial budgeting is of paramount importance for any organization since the company is able to prioritize expenses depending on the availability of cash. Where there is no adequate cash, the company is able to make adequate financial policy decisions that would help the company maintain its financial health. Such decisions include the ones faced by Black Diamond Mining Australia Company Limited. As such, this report is aimed at advising the company’s management on the best financial policy that it should adopt so that it undertakes the maintenance project successfully without getting into financial difficulties after undertaking an analysis of all the alternatives given, it will be concluded that the company would be better off not effecting any policy changes. However, the management will be advised to base the decision of whether or not to change the company’s finance on both financial and non-financial factors. Key options and assumptions considered In preparing this report, a number of assumptions are made. These include; i) It is assumed that any loan is taken at the end of the month hence it attracts interest in the next month ii) it is also assumed that any loan is repaid at the end of the month iii) Any short term borrowing is repaid whenever the company ends the month with a balance of more than $7,000,000 iv) On offering discounts, it is expected that there will still be a one month difference between the time an export sale is made and when a cash payment is made on delivering the goods. It is also assumed that the earlier terms of credit will apply to the portion of sales made in credit that will not take advantage of the discounts. v) The export sales cash is received 90 days after invoicing. However, bearing in mind the 1 month difference between the time of making sales and when they are invoiced, this translates to four months difference between the time a sale is recorded and when the cash is received. Effects on cashflows a) Delays payments to creditors in respect of November to February Purchases The computation of the cashflows after delaying payment for purchases has been shown in the attached excel sheet as alternative 1 cash flow . From the cash flow computation, the following monthly cash balances at the months would be achieved if the company delays payments for its November to February purchases. Month Closing cash balance January $7,000,000 February $7,000,000 March $7,126,000 April $10,458,250 May $11,381,250 June $22,839,110 b) Offering discounts to trade debtors in respect of November to February sales The computation of the cashflows on offering discounts has been shown in the attached excel sheet as alternative 2 cash flow. From the cash flow computation, the following monthly cash balances at the end of the six months would be achieved if the company delays payments for its November to February purchases. Month Closing cash balance January $7,000,000 February $7,877,000 March $9,877,000 April $14,977,000 May $15,177,000 June $22,498,300 Advice to CEO Based on the above computations, the company ought to adopt delaying of payment to creditors since it will lead to more cash balances in the long run. However, the final decision should be based on analyzing all the four options available as discussed below; Discussion of each cash flow statement a) No change to policy If the company does not undertake any policy change, the company will have a cash balance of $33,011,000 at the end of the six months period. The company will have collected cash amounting to $139,200,000 and paid suppliers cash amounting to $63,000,000 while the total cash disbursements will have amounted to $113,000,000. In addition, the company will have incurred financing costs amounting to $189,000 in respect to the loan that the company would have to take in January and February so as to bridge the deficit. The cash flow for the company if no policy change takes place is shown in the attached excel file. It should however be noted that the only cost implication for the decision not to undertake any policy change would be the finance costs that would result from the loans. This is because the option does not imply paying interest for delayed payments nor does it have any cost implications in terms of the cash that the company would have to undergo by offering discounts. Consequently, this option would result in the highest cash balances at the end of the period if all other factors are held constant. Consequently, the total cost implication for adopting this option is $189,000 which is the finance cost associated with the loans. b) Delay of payments to creditors If the company opts to delay payment to suppliers, it will have a closing cash balance of $22,839,110 at the end of the period as shown in the attached excel sheet. The company will have collected cash amounting to $139,200,000 by the end of the period while it will have made payments to suppliers amounting to $70,200,000. The total expenses paid by the company will have amounted to $123,068,750. The company will have incurred additional financing costs amounting to $292,140 in respect of loans taken in January and February to bridge the cash deficits in January and February. It should however be noted that the company will have to incur 15% interest expense for any payment it delays for more than 30 days. The calculation of the interest are contained in the attached excel sheet. In this regard, the company would have to pay interest expenses amounting to $2,868,750 for the six months period. As such, though this method would be preferred under certain conditions, it is a more expensive option for the company compared to adopting no policy change owing to the interest expenses incurred. In fact, delaying payments does add payment pressure to the company especially after February when the company has to revert to the original payment policy while still clearing the balances it incurred during November –February period when it had delayed payments. Consequently, the total costs associated with this adoption being adopted are $3,160,890. c) Discounts to trade creditors If the company decides to give discounts to creditors, it will have cash balances amounting to $22,498,300 at the end of the six months period. The company will have received cash amounting to $128,527,000. This implies that giving discounts to the debtors does actually reduce the amount of cash that the company collects since the normal debtor s collection policy results in $139,200,000 for the six months. It means that the company should either reduce the discount or ensure a greater number of debtors take up the discounts so that more cash can be collected. The total cash disbursements that the company will undertake during the six months period will be $113,000,000 in addition to financing costs of $28,700 for the loan taken in January. It should however be noted that despite the reduced financing cost, this comes with increased costs of the discounts given to debtors as this implies that portion of the cash owed will not be collected. The total expenses relating to trade discounts will amount to $2,256, 750 for the period. As such, the company ought to consider whether there is a less expensive option that would result in more cash being collected. Consequently, the total costs associated with the decision to adopt this option amounts to $2,285,450 for the six months period in addition to less cash being collected. d) Delay of payment to creditors and offering discounts to trade debtors This seems to be the worst option for the company. Apart from delaying payments to creditors thus incurring huge expenses for the company in terms of the 15% interest charged, the plan would also mean that the company incurs huge discounts related expenses that it would allow to the customers. In addition, the option results in the company making more cash disbursements while collecting less cash. Consequently, the option would result in the company having collected cash amounting to $128,527,000 and paying expenses amounting to $123,068,750 during the six months period as shown in the attached excel sheet. In addition, the company will have incurred financing expenses amounting to $155,840 for the loans that the company would take. However, the costs related to the option as a result of discounts and interest expenses would amount to $5,125,500. Consequently, the total expenses related to this option amounts to $5,281,340. Advice to CEO whether the policy should remain the same or be changed With all other factors remaining constant, the decision on which option the company should adopt ought to be based on its cost implications to the company. In this regard, the least costly option ought to be adopted provided it does not lead to disputes with the contractor in terms of delayed payments. Arising from the above analysis, delaying payments to creditors and offering discounts to trade debtors has been found to be the most expensive option followed by delaying of payments to creditors and offering discounts to debtors respectively. Adopting no change to policy emerges to be the least expensive option for the company and hence this is the option that the company ought to adopt. In other words, the company should continue using its old policy since it will be able to undertake the maintenance project successfully without necessarily running into financial difficulties while incurring the least cost. Other matters to consider The company should base its decision not only on financial matters addressed above but also on non-financial factors. Such factors include the following; i) Whether the company will be able to make the actual sales envisaged in the forecasts and hence the cash collections above. This is because there can be economic changes or increase in competition that can affect the company’s ability to hit its target sales. If that be the case, then the company might not be able to hit its cash collection targets which would have an effect on the kind of policy decisions taken. In addition, an improvement in economic performance of the country may mean increased demand and hence more cash collection which would also affect the policy decisions taken. ii) Whether the company will be able to collect the envisaged cash before and after offering the discounts. When fewer customers decide to take advantage of the discounts as envisaged, this will negatively affect the policy change decision. On the other hand, if more customers than envisaged decide to take advantage of the discount, this will positively affect the policy change decision. iii) Whether the creditors will agree to the new terms. This is because if they are not willing to accept the new terms, the company can only work with the second alternative of offering discounts. iv) Whether there will be bad debts or all the debtors will pay in their cash as envisaged. This is because availability of bad debts will negatively affect the company’s finance policy. Conclusion Financial management and hence financial budgeting is of paramount importance to the company’s financial health. This is because the company is able to make adequate financial preparation and hence financial policy decisions in anticipation to its future plans. This ensures that the company does not run into financial difficulties in future. In such financial decisions as the ones faced by Black Diamond Mining Australia Company Limited, financial management enables the company to adopt the best alternative. From the above analysis and if all factors are held constant, the company would be better off not effecting any policy changes. However, whether or not to change the company’s finance policy should also be based on non-financial factors as explained above. References: Jared, B2010, Financial management, London, Rutledge Read More