A comprehensive discussion of budgeting is beyond the scope or this chapter. Budgeting issues are the majolica of discussion in Chapter 22 of this textbook. What Priority Should Managers Give to Increasing Net Cash Flows? Creditors and investors look to a company’s cash flows to protect their investment and provide future returns. Trends in key cash flows (such as from operations and from free cash flow) affect a company’s credit rating, stock price, and access to additional investment capital. For these reasons, management is under constant pressure to improve the key measures of cash flow. Unfortunately, the pressure to report higher cash flows in the current period may conflict with managers’ long-run responsibilities.
Short-Term Results·Versus Long-Term Growth Often, short-term operating results can.
be improved at the expense of long-term growth. For example, reducing expenditures for developing pew products will increase earnings and net cash flows in the’ current period. But over time, this strategy may lessen the company’s competitiveness. In contrast, the strategies most likely to promote long-term growth usually” reduce earnings and cash flows in the near term-often by large amounts:
•One-Time Boosts to Cash Flows Some strategies can increase the net cash flows of the
current period, but without having much effect on future cash flows. Such strategies include collecting receivables more quickly and reducing the size of inventory. Assume, for example, that a company offers 6O-qay terms to its credit customers. Thus credit sales made in January are collected in March, and credit sales made in February are collected in April.
Notice that in each month, the company is collecting about one month’s worth of’ credit sales.
Now assume that on March I, the company changes its policies to allow only 30-day credit terms. In April, the company will collect two months of credit sales-those made in February (under the former 6O-day terms) and those made in March (under the new 30-day terms). This significantly increases the cash received from customers for the month of April. But it does not signal higher cash flows for the months ahead. In May, the company will collect only those credit sales made in April.
Thus it quickly returns to the pattern of collecting about one month’s credit sales in the current month. Shortening thecollection period provided only a one-time boost in cash receipts.A ‘similar one-time boost may be achieved by reducing the size of inventory. This reduces the need for purchasing merchandise, but only while inventory levels are falling.
Once the company stabilizes the size of its inventory at the new and lower level, its monthly purchases must return to approximately the quantity of goods sold during the period Some Strategies for Permanent Improvements in Cash Flow Several strategies may improve cash flows in both the short and long term. These are deferring income taxes, peak pricing, and developing an effective product mix.Deferring Income Taxes
Deferring income taxes means uslng.accounting methods for income tax purposes that legally postpone the payment of income taxes. An example is usi:.ng an accelerated depreciation method fo.r. income tax purposes.Deferring taxes may benefit a growing business every year.
Thus it is an effective and popular cash management strategy Peak Pricing Some businesses have more customers than they can handle-at least at certain times of the day or year. Examples of such businesses include popular restaurants, resort hotels, telephone companies, and providers of electricity. Peak pricing is a strategy of. using sales prices both to increase revenue and to ration goods and services when total demand exceeds supply (or capacity). A higher price . is’ charged during the peak periods of customer demand, and a lower price during off peak periods. Peak pricing has two related goals.
First, -it increases the seller’s revenue during the periods of greatest demand. Second, it.shifts some of the demand to off-peak periods, when the business is better able to service additional customers.In many situations, peak pricing benefits the business and the public. Off-Peak prices generally are lower than if peak pricing were not employed.
Thus peak pricing may make goods and services available -to customers who otherwise could not afford them.
Also, peacemaking may prevent systems, such as cellular telephones, from becoming so overloaded that they simply cannot ‘function. It is important to recognize, however, that peak pricing is not always appropriate.
For example, we would not expect hospitals or physicians to raise their prices during epidemics or natural disasters. The alternative to peak pricing is a single price all the time. In a single-price situation, demand in excess of capacity normally is handled on the basis of first-come, first-serve
Develop an Effectlv’e Product Mix Another. tool for increasing
revenue. and’ cash receipts is the mix of products offered for sale. The dual purposes of an effective product mix are to (I) increase total sales and (Z) increase gross margins (that is, the excess of the selling price over the cost of the product)”
The Modified Accelerated Cost Recovery System (MACRS) is an accelerated method widely used for income tax purposes. It is explained in, Deferred income taxes were discussed furthering
The reason a growing business can benefit from deferred taxes every year is that each yeat: it defers a 8fYater amo/Ull than comes due from the past.Some products complement one another, meaning the customer who buys one product often may purchase the other.
Common examples of complementary products include french fries at a hamburger stand, snacks at a movie-theater. and a car wash connected to a gas station. Some complementary products are essential to satisfying the customer. (Would you be happy at a sports stadium that didn’t sell food?) Others increase-sales by attracting customers who also purchase other types of merchandise.
Some complementary products appear to be only incidental to the company’s main product lines. But. in reality, these incidental items may be the company’s most important products.