Working capital management : CASH, RECEIVABLE, INVENTORY

- Primary objective: LIQUIDITY (ability to settle STL immediately when in it falls due)
- LIQUIDITY:
o Must have sufficient cash to pay dues andOPEX
o Not healthy to maintain excessive cas
o CASH IS NOT A PRODUCTIVE ASSET
o Cash must be invested in order to grow
- How much cash is considered efficient?
o It might be POSITIVE or NEGATIVE depending on business requirement
o CASH is ENOUGH when it is in its OPTIMUM LEVEL: ability to pay dues at the same
time no excess amount remains idle
- HOW TO ACHIEVE OPTIMUM LEVEL: CASH MANAGEMENT TOOL
- CMT: financial mgt that determine EXPECTED cash IF and cash reqts and assists in obtaining
CMT

 CASH MANAGEMENT TOOLS:

o Cash budget preparation – discussed in CH7
o Cash break-even computation -
o Cash management model

1. Cash budget preparation – ch7

2. Cash break even
 Cash sales < cash break even point = shortage
 Cash sales > cash break even point = excess
 Cash sales = cash break even point
o Cash break-even point?

a. Determine CASH CONTRIBUTION MARGIN

Cash sales
Less: Variable cash pmt
Cash contribution margin(CCM)

(variable cash pmt – varies with sales volume; fx cash pmt – fxd monthly)

b. Determine CASH CONTRIBUTION MARGIN RATIO

Cash contribution margin(CCM)
Divide by: cash sales
Cash contribution margin ratio(CMR)

c. Determine CASH BREAK-EVEN POINT

Fixed cash outlay
Divide by: (CMR)
Cash break-even

xx Break-even units in cash = cash break even sales / selling price

*cash sales ONLY

3. Cash Management Model (cash level = cash reqd) **not too much, not too little cash
o Baumol model
o Miller-orr model
o Stone model
 *assumptions
Cash reqts - certain
cash pay-off – uniform applied and regular intervals
opportunity cost – known and the same
transaction cost – same

a. Baumol model:
Answers the question: what is the optimal level of cash balance where holding
and transaction cost of holding cash are at their lowest level?

OPTIMAL CASH BALANCE = COST OF HANDLING CASH IS AT LOWEST LEVEL

𝟐 (𝑻)(𝑭)
C* = √
𝒌

C* - OPTIMAL CASH BALANCE

T – NEW cash needed/reqt for the pd
F – FIXED COST or COST of borrowings
k – OPPORTUNITY COST of handling cash

TCC = HC + TC
TCC = (Cr/2)k + (T/Cr)Cpt

TCC – total COST of handling cash

HC – HOLDING cost
TC – transaction cost

**HC = (Cr/2) x k

Cr – average cash balance

-CASHraised in SELLING securities or borrowing from bank
k – opportunity cost

**TC = (T/Cr) x Cpt

T – NEW cash needed/reqt for the pd

Cr – CASHraised in SELLING securities or borrowing from bank
Cpt – COSTpertransaction

 CASH MANAGEMENT TECHNIQUES

o Collection of receivables
o Payment of payables
o Maintaining optimum cash balance
1. Collection of receivables – sales on account ↑ = receivable ↑
CMTx: ACCELERATE or SPEED UP COLLECTION

2. Payment of payables – OPEX and COS pmts

CMTx: REDUCE or SLOW DOWN DISBURSEMENTS

3. Maintaining optimum cash balance – too much or too little cash?

CMTx:usage of cash management model
 RECEIVABLE MANAGEMENT TECHNIQUE
Underlying concept: proper management of granting credits and the collection of
receivable with high consideration of risk
-because selling goods on account bears risk and cost of
a. admin cost
b. capital cost
c. credit and collection cost
d. default cost

TRC = Ad + Cp + Cln + Dfx

TRC = total receivable cost
-Total cost of extending credit

1. Granting of Credit
*credit standards
 Liberal credit policy – relaxed
 Optimal credit policy – strict
**5Cs:
Character – reputation
Capacity – ability to repay
Collateral – assets to be pledged
Capital – financial position if stable and solvent
Condition – industry of the business
* credit terms
Standard or negotiated conditions offered by the seller
 Credit period – length of time for the pmt
 Discount period – time to avail cash discount
 Discount – amt deducted from invoice if availed

THEREFORE: ↑credit period = ↑ sales = ↑investment in receivable = unfavourable

↓credit period = ↓ sales = ↓ investment in receivable = favourable

2. Collection of Receivable
*collection efforts and program
 Monitoring of receivable – making of AR to full collection
-preparing of AGING SCHEDULE
-must concentrate on the PAST DUE ACCTS
 Sending Billings – billing of invoice
 Charges on overdue account – imposition of INTEREST

UNDERLYING QUESTION: SHOULD THE COMPANY CHANGE OR MODIFY ITS CURRENT RMP?
Yes or No thru MARGINAL ANALYSIS OF CREDIT POLICY
RECEIVABLE MANAGEMENT TOOL:
o MARGINAL ANALYSIS OF CREDIT POLICY
a. Incremental profit > incremental cost = ADOPT
b. Incremental profit < incremental cost = REJECT
c. Incremental profit = incremental cost = RETAIN
 INVENTORY MANAGEMENT TOOLS
UNDERLYING CONCEPT: to determine appropriate level or quantity to be maintained
to reduce the cost to its optimum level. Inventory should not be too high or too low

1. ABC classification system,

A – high value
B – average value
C – low cost
2. Barcode technology – used to increase efficiency and control of managing
inventories
3. Fixed – order quantity system – predetermined quantity level is maintained for
the inventory. If inventory ↓= predetermined quantity will be ordered
Quantity level – level of inventory to trigger ordering
Reorder quantity – number of units to order
4. Fixed Reorder cycle system – reorder quantity varies
how: U = B + D (T + L)
U = units to reorder
B = Buffer Stock
D = Average daily demand = # of units sold / days between review
T = time interval between reviews
L = lead time in days

INVENTORY MANAGEMENT TOOLS

o Economic Order Quantity model – level of inventory to order (when inv costs are
minimal)
o Reorder point – number of units that serves as trigger point when to place an order
o Sensitivity analysis
o Price-break model