Introductory Corporate Finance: Financial Planning Cash Budget Forecasting Cash Inflows and Outflows Minimum Cash Balance Requirement Determining Borrowing Needs

What This Is

A cash budget is a financial plan that forecasts a company's cash inflows and outflows over a specific period. It helps management determine the minimum cash balance required to meet short-term obligations and identify borrowing needs. For example, Tesla, Inc. (TSLA) needs to manage its cash flow to meet its production costs, pay suppliers, and invest in research and development. Let's say Tesla expects to receive $10 million in cash from customers in the next quarter and has $5 million in accounts receivable. However, it also needs to pay $8 million to suppliers and has $3 million in accounts payable.

Key Formulas & Models

• CF = NI + Dep + WC + NWC: Cash flow equals net income plus depreciation, plus working capital changes, plus non-cash working capital changes.
  • CF: Cash flow
  • NI: Net income
  • Dep: Depreciation
  • WC: Working capital
  • NWC: Non-cash working capital
• WC = (AR + AP + Inventory) - (Accounts Payable + Accrued Expenses): Working capital equals accounts receivable plus accounts payable plus inventory minus accounts payable minus accrued expenses.
  • WC: Working capital
  • AR: Accounts receivable
  • AP: Accounts payable
  • Inventory: Inventory level
  • Accrued Expenses: Accrued expenses level
• NWC = (AR - Accounts Receivable) + (AP - Accounts Payable) + (Inventory - Inventory Level): Non-cash working capital equals accounts receivable minus accounts receivable plus accounts payable minus accounts payable plus inventory minus inventory level.
  • NWC: Non-cash working capital
  • AR: Accounts receivable
  • AP: Accounts payable
  • Inventory: Inventory level
• Minimum Cash Balance = (Average Daily Operating Expenses) x (Number of Days): Minimum cash balance equals average daily operating expenses times the number of days.
  • Minimum Cash Balance: Minimum cash balance required
  • Average Daily Operating Expenses: Average daily operating expenses
  • Number of Days: Number of days
• Borrowing Needs = (Minimum Cash Balance) - (Available Cash): Borrowing needs equal minimum cash balance minus available cash.
  • Borrowing Needs: Borrowing needs
  • Minimum Cash Balance: Minimum cash balance required
  • Available Cash: Available cash
• Available Cash = (Cash on Hand) + (Cash from Operations) - (Cash Outflows): Available cash equals cash on hand plus cash from operations minus cash outflows.
  • Available Cash: Available cash
  • Cash on Hand: Cash on hand
  • Cash from Operations: Cash from operations
  • Cash Outflows: Cash outflows

Step-by-Step Calculation

1. Forecast cash inflows and outflows over the next quarter.
2. Calculate working capital and non-cash working capital.
3. Determine the minimum cash balance required to meet short-term obligations.
4. Calculate borrowing needs by subtracting available cash from the minimum cash balance required.
5. Verify that the borrowing needs are sufficient to meet short-term obligations.

Common Mistakes

• Mistake: Ignoring non-cash working capital changes when calculating cash flow.
  • Correction: Include non-cash working capital changes in the cash flow calculation to ensure accuracy.
  • Counterexample: A company has $10 million in accounts receivable and $5 million in accounts payable. If it sells $15 million in inventory, the non-cash working capital change is $10 million ($15 million - $5 million). If ignored, the cash flow calculation would be incorrect.
• Mistake: Failing to consider the number of days when calculating the minimum cash balance.
  • Correction: Use the number of days to calculate the minimum cash balance required to meet short-term obligations.
  • Counterexample: A company has average daily operating expenses of $10,000 and needs to meet short-term obligations for 30 days. The minimum cash balance required is $300,000 ($10,000 x 30).
• Mistake: Confusing available cash with minimum cash balance.
  • Correction: Available cash is the cash available to meet short-term obligations, while minimum cash balance is the cash required to meet short-term obligations.
  • Counterexample: A company has $100,000 in available cash but needs $150,000 in minimum cash balance to meet short-term obligations. It needs to borrow $50,000 to meet the minimum cash balance requirement.

Exam / CFA Tips

• Tip: When calculating cash flow, include non-cash working capital changes to ensure accuracy.
• Tip: Use the number of days to calculate the minimum cash balance required to meet short-term obligations.
• Tip: Distinguish between available cash and minimum cash balance to ensure accurate borrowing needs calculations.

Quick Practice Problem

A company has EBIT of $10 million, interest of $2 million, and tax of 25%. Compute the degree of operating leverage (DOL) using the following formula:

DOL = Q(P - V) / (Q(P - V) - F)

where Q is the quantity sold, P is the price per unit, V is the variable cost per unit, and F is the fixed cost.

Answer: DOL = 2.5

Explanation: The degree of operating leverage (DOL) measures the sensitivity of EBIT to changes in sales. In this case, the DOL is 2.5, indicating that a 1% increase in sales will result in a 2.5% increase in EBIT.

Last-Minute Cram Sheet

• Cash flow = net income + depreciation + working capital changes + non-cash working capital changes
• Working capital = (AR + AP + Inventory) - (Accounts Payable + Accrued Expenses)
• Non-cash working capital = (AR - Accounts Receivable) + (AP - Accounts Payable) + (Inventory - Inventory Level)
• Minimum cash balance = (Average Daily Operating Expenses) x (Number of Days)
• Borrowing needs = (Minimum Cash Balance) - (Available Cash)
• Available cash = (Cash on Hand) + (Cash from Operations) - (Cash Outflows)
• Degree of operating leverage (DOL) = Q(P - V) / (Q(P - V) - F)
• Weighted average cost of capital (WACC) = wd × rd(1 - T) + wps × rps + we × re
• Sustainable growth rate = (ROE x (1 - Retention Ratio))
• ⚠️ In M&M Proposition I (no taxes), firm value is independent of capital structure – but with taxes, value increases with debt due to the interest tax shield