Mountain Village Clinic's Target Cash Balance Paper Example

Paper Type:  Case study
Pages:  6
Wordcount:  1536 Words
Date:  2022-06-06

Mountain Village Clinic operates in the area of providing treatment to skiing-related injuries. It is the reason the firm experiences seasonal business with summer months like December and January, where there is a lot of skiing activities, having high traffic of patients. Cash budgeting and development of cash flow statement are two important activities for such a company. The cash budget and cash flow statement will enable the accountants to determine the Clinic's estimated borrowing requirements as required by First Bank.

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A cash budget refers to a detailed schedule, which normally indicates the cash flows of a company over a specified period. The point of focus on any cash budget is the balance at its end. A cash balance is a net gain or loss calculated as total collections minus the sum of payments for the given period. Companies usually have target cash balances. A target cash balance means the desired net gain, which a company intends to maintain the cash budget to enable it to conduct business. Notably, the target cash balance refers to the ideal cash level that the company wants to hold in its reserve at a given time.

The essence of target cash balance in a firm is simply balancing between the opportunity costs incurred when too much cash is held and the real balance sheet costs, which arise when little cash is held. Therefore, the need for investment funds and liquidity demands must be balanced through coming up with a viable target cash balance level. The standard business practice is that target cash balances are always varied in accordance with the prevailing business flow and economic conditions in terms of investment opportunities and inflation rate. For instance, in the event of an easy monetary environment, keeping high target cash balance is not a costly action. It implies that Mountain Village Clinic needs to incorporate the seasonal variations in business within its target cash balance. The target cash balance should be higher in the course of months when the demands for cash are greater. Equally, the target cash balance should be kept lower during months when the demand for cash is minimal.

Understandably, seasonal businesses are common in the areas where travel and tourism are main industries (Turner, 2016). In such areas, seasons play a major toll on business flow. The level of business activities significantly declines during the winter period. Specifically, Mountain Village will always experience little business activity during winter seasons when the number of skiing tourists goes down greatly. It is important to note that firms affected by the seasonal tourist activities always experience challenges with their cash flows.

A cash budget that is well prepared is able to show the manner in which cash flows in and out of a firm. A firm must refer to a soundly developed cash budget for making a tautological capital investment, borrowing and expenditure decisions. The cash budget of Mountain Village Clinic should allow it to mark cash inflows and outflows in relation to the existing business activity level. The high cash inflows received during the peak business season of summer from December to March should be put in reserve for the purpose of use during the low market activity period of winter. It means the firm must always incorporate variations present in the local market into its target cash balance decision (Turner, 2016).

It is evident from the company's cash budget that it experiences cash deficits during the months of January, February and March. The most affected month is February. During these months, the target cash balance should be high.

Credit line amount to seek from First Bank

It is vital to observe that company's whose businesses experience seasonal activity always rely on the commercial banks for the purpose of covering cash deficits in the course of minimal inflow periods. However, the decision about a sound credit line to follow must be based on sufficient information. Notably, the commercial banks usually require that a firm furnish them with the desired credit line in terms of amounts (Burroughs, 2012). The decision must be premised on expert recommendations made by accountants.

Credit line refers to a short-term loan agreement in which a commercial bank agrees to lend a firm the specified amount of cash. Importantly, a business is allowed to borrow against the line of credit at any desired time within its enforceable period, which does not last for over one year. Firms use the credit line to fund current cash demands hence it is not a source of permanent long-term financing.

Mountain Village Clinic will need a credit line to finance its short-term cash needs from January through March when it has a deficit. However, to estimate the credit line amount, more information is needed apart from just the cash budget showing company's expenses. Although the cash budget is enough to decide the absolute figure to be borrowed, it does not tell the ability of the firm to repay the short-term liability, which will be created. Therefore, a balance sheet showing the current assets and short-term liabilities of the firm is needed for proper recommendation to be made. The reason for demanding the firm's balance sheet is that it is possible to calculate the current ration from it. The current and quick ratios of the clinic will enable accountants to determine the ability of the firm to repay the estimated amount of credit line. Moreover, it will be important to visualise the firm's overall debt-equity and debt-asset ratios. Provision of Mountain Village Clinic's balance sheet in addition to the cash budget is, thus, quite necessary.

The other information that must be provided by Mountain Village Clinic for informed recommendations is the income statement. The focus on the firm's income statement will be its monthly profitability. It is important to understand whether the clinic has positive net profits, which can support the repayment of the credit line amount to be taken.

From the cash budget of Mountain Village Clinic shown above, it is clear that its maximum cash deficit for June is 60,750 dollars. The maximum amount of loan needed by the firm is 99,000 dollars. Importantly, the loan payoff will happen from March to May. Therefore, the cumulative loan amount is 171,752 dollars, which is the cash deficit for January, February and March. It implies that the optimal credit line amount recommendable is 200,000 dollars.

Three Key Learning Points

There are different lessons notable from this case study. The first key lesson from this case study is the fact that financial information is crucial for sound decisions about cash balances to hold and credit line amount to take from banks. It was evident from the analysis of this case study that firms cannot just decide to take short-term loans without care to deep analysis of financial performance information to decide a debt level, which is manageable. It was interesting to learn from this case study that firms must always develop and keep regularly updated financial statements like cash budgets, income statements and balance sheets. These statements serve the significant purpose of ensuring maintenance of good funds management.

The second lesson from this case study was the challenge experienced by seasonal businesses. It was enlightening to learn that firms are relying on seasonal events like tourism and hospitality experience fluctuations in their cash flows. The fact that Mountain's management is contemplating shutting down the clinic for the low season proves the daunting times faced by such companies when business declines. A key point learnt from this case study was that cash budgets are quite instrumental for firms, which experience seasonal business peaks. Seasonal businesses demand adaptation to the processes. For example, expenses have to be structured in a manner, which conforms to the available revenue level. It is the reason companies lay off workers during low business seasons and recall them in the course of the peak period. For instance, the labour costs at Mountain Village Clinic in the months of April, May and June are lower than between January and March because of the decision to reduce the workforce size. Such a decision must have been taken with a view of matching expenses to available revenues.

Conclusion

Finally, the importance of diversification in business was the third key point learnt from this case study. Diversification means investment in various lines of business to overcome shocks in one industry. It was learnt that Mountain Village Clinic would survive easily if it opened other lines of business away from the skiing activity sector. The diversification plan would enable it to still have stable cash inflows even when there is much skiing in winter months. However, the decision being contemplated by the clinic's management is also viable, though not the best. Some firms dealing with seasonal businesses usually close their shops when the market falls in terms of demand.

References

Burroughs, A. (2012, July 1). How to determine what your businesses line of credit should be. Smart Business. Retrieved from http://www.sbnonline.com/article/how-to-determine-what-your-businesss-line-of-credit-should-be/.

Gapenski, L. & Pink, G. (2013). Cases in Healthcare Finance, Fifth Edition. Chicago, IL: Health Administration Press.

Turner, J. A. (2016). Net Operating Working Capital, Capital Budgeting, And Cash Budgets: A Teaching Example. American Journal of Business Education, 9(1), 15-21. Available at https://files.eric.ed.gov/fulltext/EJ1088192.pdf.

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Mountain Village Clinic's Target Cash Balance Paper Example. (2022, Jun 06). Retrieved from https://proessays.net/essays/mountain-village-clinics-target-cash-balance-paper-example

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