CASH FLOW PLANNING IN BORDEAUX The year 2000 was considered
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Read the Focus On International Issues on p. 1,025 in Fundamental Financial & Managerial Accounting Concepts. What other businesses may use this technique or a similar technique to speed up cash flow? What are some of the risks involved? What are the benefits?
FOCUS ON INTERNATIONAL ISSUES
CASH FLOW PLANNING IN BORDEAUX
The year 2000 was considered the greatest year for wine in the Bordeaux region
of France since at least 1982, and the winemakers could look forward to selling
their wines for record prices, but there was one catch: these wines would
not be released to consumers until late in 2003. The winemakers had incurred
most of their costs in 2000 when the vines were being tended and the grapes
were being processed into wine. In many industries this would mean the companies
would have to finance their inventories for almost four years--not an insignificant
cost. A company must finance its inventory by either borrowing the
money, which results in out-of-pocket interest expense, or using its own funds.
The second option generates an opportunity cost resulting from the interest revenue
that could have been earned if these funds were not being used to finance
the inventory.
To address this potential cash flow problem, many of the winemakers in
Bordeaux offer some of their wines for sale as futures. That means the
wines are purchased and paid for while they are still aging in barrels in
France. Selling wine as futures reduces the time inventory must be financed
from four years to only one to two years. Of course there are other types of
costs in such deals. For one, the wines must be offered at lower prices than
they are expected to sell for upon release. The winemakers have obviously decided
this cost is less than the cost of financing inventory through borrowed
money, or they would not do it.
Companies in other industries use similar techniques to speed up cash
flow, such as factoring of accounts receivable. A major reason entities prepare cash
budgets is to be sure they will have enough cash on hand to pay bills as they come
due. If the budget indicates a temporary cash flow deficit, action must be taken to
avoid the problem, and revised budgets must be prepared. Budgeting is not a static
process.
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Solution Summary
CASH FLOW PLANNING IN BORDEAUX
The year 2000 was considered the greatest year for wine in the Bordeaux region
of France since at least 1982, and the winemakers could look forward to selling
their wines for record prices, but there was one catch: these wines would
not be released to consumers until late in 2003. The winemakers had incurred
most of their costs in 2000 when the vines were being tended and the grapes
were being processed into wine. In many industries this would mean the companies
would have to finance their inventories for almost four years--not an insignificant
cost. A company must finance its inventory by either borrowing the
money, which results in out-of-pocket interest expense, or using its own funds.
The second option generates an opportunity cost resulting from the interest revenue
that could have been earned if these funds were not being used to finance
the inventory.
To address this potential cash flow problem, many of the winemakers in
Bordeaux offer some of their wines for sale as futures. That means the
wines are purchased and paid for while they are still aging in barrels in
France. Selling wine as futures reduces the time inventory must be financed
from four years to only one to two years. Of course there are other types of
costs in such deals. For one, the wines must be offered at lower prices than
they are expected to sell for upon release. The winemakers have obviously decided
this cost is less than the cost of financing inventory through borrowed
money, or they would not do it.
Companies in other industries use similar techniques to speed up cash
flow, such as factoring of accounts receivable. A major reason entities prepare cash
budgets is to be sure they will have enough cash on hand to pay bills as they come
due. If the budget indicates a temporary cash flow deficit, action must be taken to
avoid the problem, and revised budgets must be prepared. Budgeting is not a static
process.
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CASH FLOW PLANNING IN BORDEAUX
The year 2000 was considered the greatest year for wine in the Bordeaux region
of France since at least 1982, and the winemakers could look forward to selling
their wines for record prices, but there was one catch: these wines would
not be released to consumers until late in 2003. The winemakers had incurred
most of their costs in 2000 when the vines were being tended and the grapes
were being processed into wine. In many industries this would mean the companies
would have to finance their inventories for almost four years--not an insignificant
cost. A company must finance its inventory by either borrowing the
money, which results in out-of-pocket interest expense, or using its own funds.
The second option generates an opportunity cost resulting from the interest revenue
that could have been earned if these funds were not being used to finance
the inventory.
To address this potential cash flow problem, many of the winemakers in
Bordeaux offer some of their wines for sale as futures. That means the
wines are purchased and paid for while they are still aging in barrels in
France. Selling wine as futures reduces the time inventory must be ...
Purchase this Solution
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