Business Finance Week 3 and 4

BUSINESS FINANCE
TOOLS IN MANAGING CASH,

RECEIVABLES AND
INVENTORY
Prepared by: Ms. Jessa Gallardo

PREVIEW
 Cash Management is the stewardship or
proper use of an entity’s cash resources.
 Cash management is associated with
management of cash in such a way as to
realize the generally accepted objectives of
the firm, maximum productivity with
maximum liquidity.
 The notion of cash management is not new and it
has attained a greater significance in the modern
world of business due to change that took place in
business operation and ever increasing difficulties
and cost of borrowing.
-Howard, 1953
 It is the most liquid current assets, cash is the
common denominator to which all current assets
can be reduced because the other current assets i.e.
receivables and inventory get eventually converted
into cash.
-Khan, 1983
 The term cash management denotes to
the management of cash resources in
such a way generally accepted business
objectives could be accomplished
What do you think the importance of

cash management?
Define working capital in your
own sentence/s base on your
prior knowledge.
FINANCIAL PLANNING TOOLS AND
CONCEPTS
 Working Capital is the company’s investment in current
assets such as cash, accounts receivable, and inventories
while Net Working capital is the difference between current
assets and current liabilities.
 This flow of the operating cycle of the business
 The operating cycle is the sum of days of inventory
and days of receivables. This is how to compute the
Days of Inventory and Days of Receivables. Days of
Inventory or inventory conversion period or average
age of inventories is the average number of days to
sell its inventory. A DSI of 20 days means that on the
average it takes 20 days to sell its inventory. Since
the statement of Financial Position tells the financial
condition of a company at the end of the period; we
take Average Inventory for the year in our
calculation.
FORMULA:
Days of Inventory= 365 (or 360) days
Payables Turnover
Net Credit Purchases

Payables Turnover= Beginning Accounts Payables + Ending Accounts
Payables
2
 There are three types of working capital
financing polices the management can
choose from:
1. Maturity-matching working capital
financial policy
2. Aggressive working capital financial
policy.
3. Conservative working capital financing
policy.
PERMANENT AND TEMPORARY WORKING CAPITAL
 Permanent Working Capital is the minimum

level of current assets required by a firm to
carry on its business operations given its
production capacity or relevant sales range.
 Temporary Working Capital is the excess of
working capital over the permanent working
capital given its production capacity or
relevant sales range.
THE WORKING CAPITAL FINANCING POLICIES
 Financing policies can either

be aggressive, conservative or
maturity-matching
MATURITY-MATCHING WORKING CAPITAL
FINANCING POLICY
 Permanent working capital requirements should be financed
long-term sources while temporary working capital
requirements should be financed by short-term sources of
financing.
 Long-term sources of financing include long-term debt and
equity such as common stock and preferred stock.
 Short term sources include short-term loans from a bank.
These short-term loans from banks are called working capital
loans which perfectly describe the reasons why these loans are
incurred. In maturity-matching, all permanent working capital
must be financed by long-term sources while temporary
working capital requirements should be financed by short-term
sources.
AGGRESSIVE WORKING CAPITAL FINANCING POLICY
 Why do managers of some companies

adopt this policy?
 What is the trade-off?
CONSERVATIVE WORKING CAPITAL FINANCING
POLICY
 This policy minimizes liquidity risk and

reduces the company's profitability
because long-term sources of financing
entail higher cost.
CASH
 Being the most liquid asset, cash is an important account
in the balance sheet that will affect the liquidity, and
solvency of a company. A good internal control must be
properly implemented to safeguard this asset.
 Cash collections should be supported by official receipts
which are summarized in a daily collection report.
 The daily collection report is going to useful for the next
control measure for cash-depositing collections.
MOTIVES FOR HOLDING CASH
 These are the following reasons for

holding cash:
Primary Reasons
Secondary Reasons
PRIMARY REASONS
a. Transactional
This is the cash used for paying expenses such as
salaries, utilities, rent and taxes, among others.
b. Compensating balance
This is the cash held to meet bank requirements such as
the minimum cash balance you maintain for checking
accounts and if you have existing loans, banks may also
require a minimum amount of deposit with them.
SECONDARY REASONS
a. Precautionary
This is the cash maintained for emergencies such as the
additional cash you keep during political and economic uncertainties.
b. Speculative
This refers to the cash held by the company to take advantage of
opportunities (e.g. buying stocks during major corrections such as
what happened at the height of the global financial crisis in 2008
and 2009 where stock valuations went down by as much as 80% for
some companies).
BUDGETING CASH
 Cash Budget provides information regarding the company’s
expected cash receipts and disbursements over a given
period. It is useful for identifying future funding
requirements or excess cash within a given period.
 This allows managers to find possible sources of financing if
the cash budget shows cash shortage or identify appropriate
tenors for money for excess cash.
 Normally, a cash budget is prepared for a one year period
broken down into smaller intervals like months. This allow
managers to see the seasonality of the business which affects
the cash flows.
 Cash Receipts include all a firm’s
inflows of cash in each financial
period. The most common
components of cash receipts are
cash sales, collections of accounts
receivable, and other cash receipts.
 Cash Disbursements include all outlays of cash by
the firm during a given financial period. The most
common cash disbursements are:
1. Cash purchases
2. Purchasing fixed assets
3. Payments of accounts payable
4. Interest payments
5. Rent (and lease) payments
6. Cash dividend payments
7. Wages and salaries
8. Principal payments (loans)
9. Tax
NET CASH FLOW, ENDING CASH,
FINANCING, AND EXCESS CASH
…
NET INCOME = TOTAL REVENUE – TOTAL EXPENSES
HOW TO GET THE DEPRECIATION AMOUNT
ACCOUNTS PAYABLES
ACCOUNTS RECEIVABLE
 Accounts receivable (AR) is the balance of

money due to a firm for goods or services
delivered or used but not yet paid for by
customers. Accounts receivables are listed on
the balance sheet as a current asset. AR is
any amount of money owed by customers for
purchases made on credit.
 The collectability of accounts receivables depends largely on
the quality of customers. The quality of customers depends
on the standards or credit policies set up and used by an
organization. Credit policies are an integral part of the credit
evaluation.
 There are 5C’s used in credit evaluation. These are:
• Character- The willingness of the borrower to repay the loan
• Capacity- a customer’s ability to generate cash flows
• Collateral- security pledged for payment of the loan
• Capital- a customer’s financial resources
• Condition- current economic or business conditions
INVENTORY MANAGEMENT
 Inventory management involves the

formulation and administration of plans
and policies to efficiently and
satisfactorily meet production and
merchandising requirements and
minimize costs relative to inventories.
INVENTORY IN A MANUFACTURING
COMPANY
 Three Types of Inventory:
1. Raw materials- These are purchased materials not yet put

into production
2. Work in Progress- These are goods and labor put into
production but not yet finished
3. Finished goods- these are goods put into production and
finished.
After it, these are ready to be sold.

OBJECTIVE OD CASH
MANAGEMENT
1. To make Payment According

to Payment Schedule
2. To minimise Cash Balance
 An effective management is considered to be
importance for the following reasons:
1. Cash management guarantees that the firm
has sufficient cash during peak times for
purchase and for other purposes.
2. Cash management supports to meet
obligatory cash out flows when they fall due.
3. Cash management helps in planning capital
expenditure projects.
4. Cash management helps to organize for
outside financing at favourable terms and
conditions, if necessary.
5. Cash management helps to allow the firm to
take advantage of discount, special purchases
and business opportunities.
6. Cash management helps to invest surplus
cash for short or long-term periods to keep the
idle funds fully employed.
GENERAL PRINCIPLES OF CASH
MANAGEMENT
Harry Gross has recommended certain general principles of
cash management
1. Determinable Variations of Cash Needs.
2. Contingency Cash Requirement
3. Availability of External Cash
4. Maximizing Cash Receipts
a. Concentration Banking c. Reviewing Credit Procedures
b. Local Box system d. Minimizing Credit Period
e. others
5. Minimizing Cash Disbursements
6. Maximizing Cash Utilization
FUNCTION OF CASH MANAGEMENT
1. Cash Planning
2. Managing Cash Flows
3. Controlling the Cash Flows
4. Optimizing the Cash Level
5. Investing Idle Cash
BENEFITS OF CASH MANAGEMENT SYSTEM
1. Funds availability as per need on day zero, day

one, day two, day three etc. i.e. Corporate can plan
their cash flows.
2. Bank interest saved as instruments are collected
faster.
3. Affordable and competitive rates.
4. Single point inquiry for all queries.
5. Pooling of funds at desired locations.

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BUSINESS FINANCE

TOOLS IN MANAGING CASH,

Prepared by: Ms. Jessa Gallardo

What do you think the importance of

Net Credit Purchases

 Permanent Working Capital is the minimum

 Financing policies can either

 Why do managers of some companies

 This policy minimizes liquidity risk and

 These are the following reasons for

 Accounts receivable (AR) is the balance of

 Inventory management involves the

1. Raw materials- These are purchased materials not yet put

After it, these are ready to be sold.

1. To make Payment According

1. Funds availability as per need on day zero, day

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