Cash Gap: Interest Clarification

I believe the interest saved per day in the first example of “Managing the Cash Gap” ( JofA , Oct.99, page 27) has been miscalculated. Assuming the interest is charged at an annual rate of 8%, the amount of interest saved per day on borrowing $108 million would be $23,671, not $96,000.

The total interest of $8.64 million, which represents a year’s interest, should be divided by 365 days, not 90 days, to get the correct daily rate of interest.

Ann Metcalfe, CPA
Juneau, Alaska

Author’s reply: Since I have received several e-mails about this same issue, perhaps I did not explain this as clearly as I could have in the article.

The cash gap represents the number of days on average between when cash goes out to purchase goods and when cash comes in. If a company has a 30-day cash gap, it must finance 30 days worth of goods all the time. This means it must pay interest for the whole year for 30 days worth of goods. Consequently, the interest cost is for the whole year for the dollar investment in goods caused by the 30-day cash gap.

In the example in the article, the company borrowed enough to cover 90 days worth of goods (90 x $1.2 million = $108 million), financed at 8%, for an annual cost of $8.64 million. The number of days in the cash gap tells how many days worth of goods must be financed, but the amount must be financed for the whole year. Shortening the cash gap by one day reduces the amount that must be financed, but it does not reduce the number of days that must be financed.

Germain Boer, CPA
Vanderbilt University
Nashville