NOTES IN CASH, RECEIVABLES, INVENTORY MANAGEMENT

OBJECTIVES

 Use the Baumol Model in determining the optimal cash balance

 Discuss the concept of cash float
 Illustrate the cost-benefit analysis of the lockbox system
 Determine the Days Sales Outstanding DSO or average collection period and the cost
of carrying receivables
 Analyze the effect on profit of either relaxing or tightening credit policy
 Use the Economic Order Quantity EOQ model in determining average inventory and
total inventory cost
 Compute the Reorder Point

SALIENT POINTS

 Cash Management refers to the collection, handling, control and investment of the

organizational cash and cash equivalents, to ensure optimum utilization of the firm’s
liquid resources. Money is the lifeline of the business, and therefore it is essential to
maintain a sound cash flow position in the organization.
Why do we need to manage cash flow in the organization? What is the use of cash
management in the business?

 Fulfil Working Capital Requirement: The organization needs to maintain ample

liquid cash to meet its routine expenses which possible only through effective cash
management.
 Planning Capital Expenditure: It helps in planning the capital expenditure and
determining the ratio of debt and equity to acquire finance for this purpose.
 Handling Unorganized Costs: There are times when the company encounters
unexpected circumstances like the breakdown of machinery. These are unforeseen
expenses to cope up with; cash surplus is a lifesaver in such conditions.
 Initiates Investment: The other aim of cash management is to invest the idle funds in
the right opportunity and the correct proportion.
 Better Utilization of Funds: It ensures the optimum utilization of the available funds
by creating a proper balance between the cash in hand and investment.
 Avoiding Insolvency: If the business does not plan for efficient cash management, the
situation of insolvency may arise. It is either due to lack of liquid cash or not making a
profit out of the money available.

Functions of Cash Management

Cash management is required by all kinds of organizations irrespective of their size, type and
location. Following are the multiple managerial functions related to cash management:

 Investing Idle Cash: The company needs to look for various short term investment
alternatives to utilize surplus funds.
 Controlling Cash Flows: Restricting the cash outflow and accelerating the cash
inflow is an essential function of the business.
 Planning of Cash: Cash management is all about planning and decision making in
terms of maintaining sufficient cash in hand and making wise investments.
 Managing Cash Flows: Maintaining the proper flow of cash in the organization
through cost-cutting and profit generation from investments is necessary to attain a
positive cash flow.
 Optimizing Cash Level: The organization should continuously function to maintain
 the required level of liquidity and cash for business operations.

Cash Management Strategies

Cash management involves decision making at every step. It is not an immediate solution but
a strategical approach to financial problems. Following are the strategies of cash management:

Business Line of Credit: The organization should opt for a business line of credit at an initial
stage to meet the urgent cash requirements and unexpected expenses.

Money Market Fund: While carrying on a business, the surplus fund should be invested in
the money market funds. These are readily convertible into cash whenever required and yield a
considerable profit over the period.

Lockbox Account: This facility provided by the banks enable the companies to get their
payments mailed to its post office box. This lockbox is managed by the banks to avoid manual
deposit of cash regularly.

Cash Deposits (CDs): If the company has a sound financial position and can predict the
expenses well along with availing of a lengthy period, it can invest the surplus cash in the cash
deposits. These CDs yield good interest, but early withdrawals are liable to penalties.

Cash Flow Management Techniques

Managing cash flow is a contemplative process and requires a lot of analytical thinking. The
various techniques or tools used by the managers to practice cash flow management are as
follows:

 Accelerating Collection of Accounts Receivable: One of the best ways to improve

cash inflow and increase liquid cash by collecting the debts and dues from the debtors
readily.
 Stretching of Accounts Payable: On the other hand, the company should try to extend
the payment of dues by acquiring an extended credit period from the creditors.
 Cost Cutting: The company must look for the ways of reducing its operating cost to
main a good cash flow in the business and improve profitability.
 Regular Cash Flow Monitoring: Keeping an eye on the cash inflow and outflow,
prioritizing the expenses and reducing the debts to be recovered, makes the
organization’s financial position sound.
 Wisely Using Banking Services: The services such as a business line of credit, cash
deposits, lockbox account and sweep account should be used efficiently and
intelligently.
 Upgrading with Technology: Digitalization makes it convenient for the organizations
to maintain the financial database and spreadsheets to be assessed from anywhere
anytime.

https://theinvestorsbook.com/cash-management.html

Objectives of Receivable Management

In order to keep business running, we need cash. The whole purpose or objective of
Receivables Management is to keep the inflow of cash healthy.
These are receivable management objectives:

 Collect receivables from our sundry debtors.

 Maintain a healthy cash flow for the company, so that it can pay our creditors.
 Have proper Policy for Credit management.
  A working process and mechanism for managing payment follow-ups and timely
collection.

Why Receivables management is so important?

1. Cash flow is always considered as the bloodline of any business organization. Badly
managed Receivables can break the company.
2. Most of the companies that go bankrupt have Cash flow problems. Companies with a
lack of profit can survive, but a lack of cash flow is fatal.
3. Working Capital is one of the costliest forms of capital. One of the ways of calculating
working capital requirements can be defined as the difference between Sales and
Receivables. Bad collections can mean higher working capital requirements. Which
means higher interest costs for the company.
4. A reliable and predictable Receivables will ensure steady cash flow management of the
organization. Amounts receivables with no due dates are useless.

Revenue is Vanity, Profit is Sanity, but Cash is King

Benefits of Accounts Receivable Management

1. Better Cash Flow

All our Budgets and projections depend on how much we can spend. Predictable cash
flow enables us to manage our operations and expansion plans.

2. Lower Working Capital Requirements.

Effective receivables management ensures that our Working Capital requirements are
kept at a minimum.

3. Lowered Interest costs.

Working capital is also fixed capital, which attracts interest. Lower Debtors will reduce
our Interest burden.

4. Better Bargaining with Sellers.

When we are buying any goods or services, we can bargain mainly on quantity or
Payment terms. Having good receivable management provides us with enough cash
flow to bargain effectively with our Suppliers.

https://www.enjayworld.com/blog/definitive-guide-to-receivable-management/

Inventory management refers to having the right product in the right place at the right time.
This requires inventory visibility – knowing when to reorder, how much to order and where
to store stock.

Inventory can be a company’s most important asset. Inventory management is where all the
elements of the supply chain converge. Too little inventory when and where it's needed can
create unhappy customers. But a large inventory has its own liabilities — the cost to store
and insure it, and the risk of spoilage, theft and damage. Companies with complex supply
chains and manufacturing processes must find the right balance between having too much
inventory on hand or not enough.

https://www.ibm.com/supply-chain/inventory-management
CASH MANAGEMENT

 involves the maintenance of the appropriate level of cash and investment in marketable
securities to meet the firm's cash requirements and to maximize income on idle funds.

Objectives:
 to invest excess cash for a return while retaining sufficient liquidity to satisfy future
needs to provide the cash balance required
 to meet the firm’s liquidity requirements at the lowest possible cost of maintaining
liquidity.

REASONS FOR HOLDING CASH

1. Transaction purposes
 firms maintain cash balances that they can use to conduct the ordinary transactions; cash
balances are needed to meet cash outflow requirements for operational or financial
obligations.
2. Compensating balance requirements
 a certain amount of cash that a firm must leave in its checking account at all times as part
of a loan agreement.
 these balances give banks additional compensation because they can be relent or used to
satisfy reserve requirements.

3. Precautionary reserves
 firms hold cash balance in order to handle unexpected problems or contingencies due to
the uncertain pattern of cash inflows and outflows.

Cost of maintaining liquidity – income foregone on cash balance ; when cash balances earn no or
relatively low interest, companies have to give up earning a higher income when they maintain
cash balances instead of investing their cash in other investment opportunities.

4. Potential investment opportunities

 excess cash reserves are allowed to build up in anticipation of a future investment
opportunity such as a major capital expenditure project.

5. Speculation
 firms delay purchases and store up cash for use later to take advantage of possible
changes in prices of materials, equipment, and securities, as well as changes in currency
exchange rates

THE CONCEPT OF FLOAT IN CASH MANAGEMENT

FLOAT – the difference between the bank balance for a firm's account and the balance that the
firm shows on its own books

TWO ASPECTS OF FLOAT

1. The time it takes a company to process its
checks internally
2. The time consumed in clearing the check through the banking system
TYPES OF FLOAT
1. Negative float - book balance exceeds the bank balance, which means that there is more
cash tied up in the collection cycle and it earns a 0% rate of return.
 Mail Float - peso amount of customers' payments that have been mailed by a customer
but not yet received by the seller.
 Processing Float - peso amount of customers payments that have been received by the
seller but not yet deposited.
 Clearing Float - peso amount of customers' checks that have been deposited but not yet
cleared.

GOOD CASH MANAGEMENT DICTATES THAT NEGATIVE FLOAT MUST BE MINIMIZED,

IF NOT ELIMINATED.

2. Positive float (disbursement float) - the firm's bank balance exceeds its book balance
Ex. checks written/issued by the firm that have not yet cleared. Management should
increase this type of float.

CASH FLOW MANAGEMENT

1. Preparing cash budgets

2. Preparing the cash break-even chart
3. Determining the optimal cash balance using the Baumol Cash Management Model

CASH BREAK-EVEN CHART

1. It shows the cash break-even point - the amount of sales in pesos or the number of units
to be sold so that the total cash inflows is equal to the cash outflows.
2. It shows the amount of cash deficiency when sales is below the cash break-even point, or
the amount of excess cash when sales is above the cash break-even point.

BAUMOL CASH MANAGEMENT MODEL

 an EOQ-type model which can be used to determine the optimal cash balance where the
costs of maintaining and obtaining cash are at the minimum.
Such costs are the:

(1) cost of securities transactions or cost of obtaining a loan

(2) opportunity cost of holding cash which includes the return foregone by not investing
in marketable securities or the cost of borrowing cash.
RECEIVABLES MANAGEMENT
 the process of ensuring that customers pay their dues on time
 It helps the businesses to prevent themselves from running out of working capital at any
point of time.
 It also prevents overdue payment or non-payment of the pending amounts of the
customers.

The main objective in Accounts Receivable management is to minimize the Days Sales

Outstanding (DSO) and processing costs while maintaining good customer relations. 

Days Sales Outstanding (DSO)

a.k.a. Average Collection Period or Average Days in Receivables
 DSO = 365 days / AR turnover
 Investment in Receivables = Average daily sales x DSO
 Cost of Carrying Receivables = Investment in Receivables x Cost of funds

Effect of either TIGHTENING or RELAXING Credit Policy

Effect on
 Total Sales
 Percentage of Credit Sales to Total Sales
 Percentage of Bad Debts
 Collection Costs
 Cost of Carrying Receivables

HOW TO COMPUTE AR-RELATED PROFIT

SALES
Less : VARIABLE COSTS
CONTRIBUTION MARGIN
Less : AR-RELATED COSTS
(1) Cost of Carrying Receivable
(2) Bad Debts expense
(3) Collection costs
Total
PROFIT BEFORE TAX
Less : Income-tax
PROFIT AFTER TAX

INVENTORY MANAGEMENT
 the process of efficiently monitoring the constant flow of units (materials/goods) into
(RECEIPTS) and out (ISSUANCES) of an existing inventory
 usually involves controlling the INFLOW of units in order to prevent the inventory from
becoming too high, or too low levels that could put the operation of the company into
jeopardy (stockouts)
 A component of supply chain management, inventory management supervises the flow
of goods from manufacturers to warehouses and from these facilities to point of sale.
  A key function of inventory management is to keep a detailed record of each new or
returned product as it enters or leaves a warehouse or point of sale.
 Inventory control is the area of inventory management that is concerned with
minimizing the total cost of inventory, while maximizing the ability to provide
customers with products in a timely manner.

The major production oriented methods and techniques of inventory

control for managing inventories efficiently
 the EOQ model
 safety stocks
 the re-order point.

TOTAL INVENTORY COST = TOTAL CARRYING COST + TOTAL ORDERING COST

At EOQ
Total Carrying Cost = Total Ordering Cost
(if there is no Safety Stock)

Total Carrying Cost = ( Average Inventory + Safety Stock) x Carrying Cost per Unit

Average Inventory = EOQ / 2

Total Ordering Cost = No. of Orders x Ordering Cost (per order)

No. of Orders = Annual Demand / EOQ

Re-Order Point = Lead Time Usage + Safety Stock

Lead Time Usage = Average Daily Usage x Lead Time in Days

Average Daily Usage = Annual Usage / no. of working days