Chapter 4

Asset Management and Valuation

At the end of this module, you will be able to:

LO 1. have a clear understanding of the different types of business assets and how these
are managed properly;
LO 2. compute the EOQ in worded problems; and
LO 3. examine and apply the principal methods of analysis and valuation of financial
assets

Lesson 1 ASSET MANAGEMENT

a. Cash Management

Cash management, also known as treasury

management, is the process that involves collecting and
managing cash flows from the operating, investing, and
financing activities of a company. In business, it is a key
aspect of an organization’s financial stability.

The Importance of Cash

Cash is the primary asset individuals and

Source: http://henryfuentes.com/wp- companies use regularly to settle their debt obligations
content/uploads/2015/07/ahk-cash-flow- and operating expenses, e.g., taxes, employee salaries,
management-300x300.jpg
inventory purchases, advertising costs, and rents, etc.

Cash is used as investment capital to be allocated to long-term assets, such as property,

plant, and equipment (PP&E) and other non-current assets. Excess cash after accounting for
expenses often goes towards dividend distributions.

Companies with a multitude of cash inflows and outflows must be properly managed
to maintain adequate business stability. For individuals, maintaining cash balances is also a
major concern.

Causes of Problems with Cash Management

Unfortunately, many businesses engage in poor cash management, and there are several
reasons for the problem. Let us look at some of them:
1. Poor understanding of the cash flow cycle
Business management should clearly understand the timing of cash inflows and
outflows from the entity, such as when to pay for accounts payable and purchase inventory.
During rapid growth, a company can end up running out of money because of over-
purchasing inventory, yet not receiving payment for it.

2. Lack of understanding of profit versus cash

A company can generate profits on its income statement and be burning cash on the
cash flow statement.

When a company generates revenue, it does not necessarily mean it already

received cash payment for that revenue. So, a very fast-growing business that requires a lot
of inventory may be generating lots of revenue but not receiving positive cash flows on it.

3. Lack of cash management skills

It is crucial for managers to acquire the necessary skills despite the understanding
of the abovementioned issues. The skills involve the ability to optimize and manage the
working capital. It can include discipline and putting the proper frameworks in place to
ensure the receivables are collected on time and that payables are not paid more quickly
than is needed.

4. Bad capital investments

A company may allocate capital to projects that ultimately do not generate
sufficient return on investment or sufficient cash flows to justify the investments. If such
is the case, the investments will be a net drain on the cash flow statement, and eventually,
on the company’s cash balance.

Objectives of Cash Management

Why do we need to manage cash flow in the organization? What is the use of cash
management in the business?

Following purposes of cash management will resolve the above queries:

 1. Fulfil Working Capital Requirement: The organization needs to maintain ample liquid cash
to meet its routine expenses which possible only through effective cash management.
2. Planning Capital Expenditure: It helps in planning the capital expenditure and determining
the ratio of debt and equity to acquire finance for this purpose.
3. 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.
4. Initiates Investment: The other aim of cash management is to invest the idle funds in the
right opportunity and the correct proportion.
5. 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.
6. 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:

1. Investing Idle Cash: The company

needs to look for various short term
investment alternatives to utilize surplus
funds.

2. Controlling Cash Flows: Restricting

the cash outflow and accelerating the cash
inflow is an essential function of the business.

3. Planning of Cash: Cash management

is all about planning and decision making in
terms of maintaining sufficient cash in hand
and making wise investments.

4. 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.

5. Optimizing Cash Level: The organization should continuously function to maintain the
required level of liquidity and cash for business operations.
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:

1. 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.

2. 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.

3. 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.

4. 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.

5. 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.

6. Upgrading with Technology: Digitalization makes it convenient for the organizations to

maintain the financial database and spreadsheets to be assessed from anywhere anytime.
 Limitations of Cash Management

Cash management is an inevitable part of business organizations. However, it has a few

shortcomings which make it unsuitable for small organizations; these are as follows:

Cash management is
a very time consuming and
skillful activity which is
required to be performed
regularly.

As it requires financial
expertise, the company may
need to hire consultants or
other experts to perform the
task by paying administrative and consultation charges.

Small business entities which are managed solely, face problems such as lack of
skills, knowledge, time and risk-taking ability to practice cash management.

For more on cash management, visit

➢ https://www.score.org/blog/cash-king-cash-management-best-practices
➢ https://www.educba.com/cash-management/
➢ https://www.hec.edu/en/knowledge/instants/cash-management-times-crisis
➢ https://brookscity.com/blog/cash-flow-management-strategies/
➢ https://www.behalf.com/customers/business-cash-flow/cash-flow-management/

b. Inventory Management

Source: Inventory management techniques

https://www.pinclipart.com/ are covered in depth in production
picdir/middle/361-
3612359_inventory- management courses. Still, financial
management-graphic- managers have a responsibility for raising
design-clipart.png
the capital needed to carry inventory and for
overseeing the firm’s overall profitability,
so it is appropriate that we cover the
financial aspects of inventory management
here.

The twin goals of inventory

management are: (1) ensuring that the
inventories needed to sustain operations are available, while (2) holding the costs of ordering
and carrying inventories to the lowest possible level. In analyzing improvements in the cash
conversion cycle, we identified some of the cash flows associated with a reduction in
inventory. In addition to the points made earlier, lower inventory levels reduce costs due to
storage and handling, insurance, property taxes, spoilage, and obsolescence.
 Before the computer age, companies used simple inventory control techniques such as
the red line system, where a red line was drawn around the inside of a bin holding inventory
items; when the actual stock declined to the level where the red line showed, inventory would
be reordered. Now computers have taken over, and supply chains have been established that
provide inventory items just before they are needed—the just-intime (JIT) system. For
example, consider Trane Corporation, which makes air conditioners and currently uses just-in-
time procedures. In the past, Trane produced parts on a steady basis, stored them as inventory,
and had them ready whenever the company received an order for a batch of air conditioners.
However, the company’s inventory eventually covered an area equal to three football fields,
and it still could take as long as 15 days to fill an order. To make matters worse, occasionally
some of the necessary components simply could not be located; in other instances, the
components were located but found to have been damaged from long storage.

Then Trane adopted a new inventory policy—it began producing components only after
receiving an order and then sending the parts directly from the machines that make them to the
final assembly line. The net effect: Inventories fell nearly 40% even as sales were increasing
by 30%.

Such improvements in inventory management can free up considerable amounts of

cash. In the last section, we examined inventory reductions due to improvements in the
inventory conversion period. Many analysts also use the inventory turnover ratio as a
performance measure, so you should know how to estimate inventory reductions due to
improvements in turnover. Recall from Chapter 1 that the inventory turnover ratio is defined
as cost of goods sold (COGS) divided by inventory. If we know the turnover ratio and the
COGS, we can determine the inventory level. For example, suppose a company’s inventory
turnover ratio is 3 and its COGS is ₱120 million. Starting with the definition of the turnover
ratio and solving for inventory yields:

Inventory turnover ratio = COGS/Inventory

Inventory = COGS/Inventory turnover ratio
= ₱120/ 3
= ₱40 million

If the company can improve its inventory turnover ratio to 4, then its inventory
will fall to:
Inventory = ₱120/4
= ₱30 million

This ₱10 million reduction in inventory (₱40 - ₱30 = ₱10) boosts free cash flow by ₱10
million.

However, there are costs associated with holding too little inventory, and these costs
can be severe. If a business lowers its inventories, then it must reorder frequently, which
increases ordering costs. Even worse, if stocks become depleted then firms can miss out on
profitable sales and also suffer lost goodwill, which may lead to lower future sales. Therefore,
it is important to have enough inventory on hand to meet customer demands but not so much
as to incur the costs we discussed previously. Inventory optimization models have been
developed, but the best approach—and the one most firms today are following—is to use
supply chain management and monitor the system closely.

Reducing Inventory

Inventory is an inevitable consequence of trading in products. It can be in the form of

raw materials, work in progress (known as WIP; products in the process of being
manufactured) and finished goods ready for sale. There can also be spare-parts operations for
businesses such as car manufacturers.

A business needs to hold inventory for the following reasons:

→ as a buffer to manage uncertainty in supply such as lead times, quality and order fulfilment;
→ to purchase quantities that are economic;
→ to ensure continuous production runs with a complete set of components;
→ to stabilize manufacturing by using batch production;
→ to cope with unpredictable demand and the desire not to pass up a sales opportunity;
→ to provide customer choice.

The aim is to reduce inventory because it not only ties up cash in the business but also
exposes the business to other financial costs, such as:
→ storage – the cost of warehouse space, warehouse staff and any particular storage
conditions (such as chilled or secure storage);
→ management – the cost of management time in counting, finding, moving and inspecting;
→ obsolescence – the risk that the product will become unsaleable if held for too long or
because product enhancements are required;
→ damage – the inventory has the potential to become unsaleable;
→ theft – the removal of inventory.

Inventory can be seen as a reservoir holding water. The “supply” of rain is

unpredictable and therefore replenishment is unreliable. A large reservoir enables demand to
be consistently met (apart from at times of extreme drought). If supply were more reliable the
amount of water, or inventory that has to be held, could be reduced. Therefore, to optimize
inventory is to increase certainty in both supply and demand. The profile of inventory is
summarized in the figure below. Time is shown on the horizontal axis and the level of
inventory on the vertical axis. Four separate areas are identified:
➢ Pipeline inventory – the saw-tooth pattern in the middle of the chart. The points where it
peaks represent inventory arriving followed by sales, causing inventory to slowly fall over
the subsequent days or weeks. When inventory levels are low a reorder takes place and the
amount of inventory climbs back to a peak.
➢ Safety inventory. This is buffer inventory to ensure sales can continue with the
uncertainties in demand and supply. The amount of uncertainty dictates the amount of
safety inventory that needs to be held.
➢ Lost revenue. When inventory runs out this area represents the sales that could have been
captured. Although specific unfulfilled orders can be identified and measured, the impact
on long-term customer behaviour is more important as dissatisfaction can lead to customer
accounts being closed. Managing and inquiring about lapsing accounts is an effective way
of gathering feedback from defecting customers.
➢ Excess inventory. The needless holding of inventory that wastes resources in storage and
may become obsolete.

Economic Order Quantity (EOQ)

The economic order quantity is the level of quantity at which

the combined ordering and holding cost are at the minimum level.

In day-to-day business, managers and retailers often face difficulty in determining the
exact number of items they should order to refill their stock of a particular item. Order quantity
is not a minor issue – ordering too many items increases your holding cost, and ordering too
little can result in an out-of-stock situation. Both are unfavorable for any business and should
be avoided to keep your business operations viable. The Economic Order Quantity (EOQ)
helps to avoid these mis-stocking situations.

Economic order quantity (EOQ) is the order size that minimizes the sum of ordering
and holding costs related to raw materials or merchandise inventories. In other words, it is the
optimal inventory size that should be ordered with the supplier to minimize annual inventory
cost of the business. Other names used for economic order quantity are optimal order size and
optimal order quantity.

The economic order quantity is computed by both manufacturing companies and

merchandising companies. Manufacturing companies compute it to find the optimal order size
of raw materials inventory and merchandising companies compute it to find the optimal order
size of ready to use merchandise inventory.

The ordering and holding costs

The two significant factors that are considered while determining the economic order
quantity (EOQ) for any business are the ordering costs and the holding costs.

A brief explanation of both the costs is given below:

Ordering costs. The ordering costs are the costs that are incurred every time an order for
inventory is placed with the supplier. Examples of these costs include telephone charges,
delivery charges, invoice verification expenses and payment processing expenses, etc. The
total ordering cost usually varies according to the frequency of placing orders. Mostly, it is
directly proportional to the number of orders placed during the year which means, if the number
of orders placed during the year increases, the annual ordering cost will also increase and if,
on the other hand, the number of orders placed during the year decreases, the annual ordering
cost will also decrease.

Holding costs. The holding cost (also known as carrying costs) are the costs that are incurred
to hold the inventory in a store or warehouse. Examples of costs associated with holding of
inventory include occupancy of storage space, rent, shrinkage, deterioration, obsolescence,
insurance and property tax, etc. The total holding cost usually depends upon the size of the
order placed for inventory. Mostly, the larger the order size, the higher the annual holding cost
and vice versa. The total holding cost is sometimes expressed as a percentage of total
investment in inventory.

Relationship between the ordering and holding cost:

There is an inverse relationship between ordering cost and holding cost. Keeping the
annual demand constant, if for example the number of orders decreases, the ordering cost will
also decrease but the holding cost will rise and vice versa.

Economic order quantity formula

The following formula is used to determine the economic order quantity (EOQ):
Where: D = Demand per year
Co = Cost per order
Ch = Cost of holding per unit of inventory

Example 1:

The material AY is used uniformly throughout the year. The data about annual
requirement, ordering cost and holding cost of this material is given below:

Annual requirement: 2,400 units

Ordering cost: ₱10 per order
Holding cost: ₱0.30 per unit

Required: Determine the economic order quantity (EOQ) of material AY using above data.

Solution:

The economic order quantity for material AY is 400 units. Now we can compute the
number of orders to be placed per year, annual ordering cost, annual holding cost and combined
annual and holding cost as follows:
Number of orders per year = Annual demand/EOQ
= 2,400 units/400 units
= 6 orders per year

Ordering cost = Number of orders per year x Cost per order

= 6 orders x ₱10
= ₱60

Holding cost = Average units x Holding cost per unit

= (400/2) x 0.3
= ₱60

Combined ordering and holding cost at EOQ:

= Ordering cost + Holding cost
= ₱60 + ₱60
= ₱120

Notice that both ordering cost and holding cost are ₱60 at economic order quantity. The
holding cost and ordering cost at EOQ tend to be the same.

Tabular determination of EOQ

Under tabular approach of determining economic order quantity, the combined ordering and
holding cost is computed at different number of orders and their respective order quantities.
This approach is also known as trial-and-error approach of determining economic order
quantity.

This approach is illustrated below using the same data as used in the above example:

No. of No. of Units per Average Units in Ordering and Holding Costs
Orders order Inventory Ordering Holding Combined
Cost Cost Cost
1 2,400 1,200 10 360 370
2 1,200 600 20 180 200
3 800 400 30 120 150
4 600 300 40 90 130
5 480 240 50 72 122
6 400 200 60 60 120
7 343 172 70 52 122
8 300 150 80 45 125
*Average units x Holding cost per unit: 1,200 units x 0.30 = ₱360

Notice that the quantity of 400 units with 6 annual orders and a combined ordering and holding
cost of ₱120 is the most economical quantity to order. Other quantities that result in more or
less than six orders per year are not so economical. For example, if only one order for the
whole annual requirement of 2,400 units is placed, the combined ordering and holding cost
comes to ₱370 which is far higher than the cost at EOQ of 400 units.
The application of tabular approach is not common as it is more time consuming as compared
to formula approach. Moreover, in some situations, it provides only an estimate of EOQ and
is therefore not as accurate as the formula approach.

Example 2:

The Thirdy Sports Inc. purchases tennis balls at ₱20 per dozen from its suppliers. The Thirdy
Sports will sell 34,300 dozens of tennis balls evenly throughout the year. The total cost to
handle a purchase order is ₱10. The insurance, property tax and rent for each dozen tennis
balls in the average inventory is ₱0.40. The company wants a 5% return on average inventory
investment.

Required:

1. Compute the EOQ

2. Compute the total annual inventory expenses to sell 34,300 dozens of tennis balls if orders
are placed according to EOQ computed in part 1.

Solution:
1. EOQ:

* ₱0.40 + (₱20 × 5/100) = ₱1.4

 2. Total annual inventory expenses to sell 34,300 dozens of tennis balls:
= Annual ordering cost + Annual holding cost
= (Number of orders x Cost per order) + (Average units x Holding cost per unit)
= (*49 orders x ₱10) + [(700/2) x 1.4]
= ₱490 + ₱490
= ₱980

*Number of orders to be placed: 34,300/700 = 49 orders

Relevant Costs

When calculating EOQ, it is important to include only those ordering and holding costs
that are relevant. Any costs that are not incremental should be ignored while calculating EOQ.
Following examples illustrate the application of relevant costing in the calculation of EOQ.
Order Costs Relevance to EOQ calculation

If increase in number of orders would not result in

overtime or hiring an additional clerk, the cost will
Salary paid to clerk who processes orders. not be relevant to EOQ.
The total delivery expense will be the same
Supplier charges ₱5 delivery cost for each irrespective of the number of order deliveries so it
unit of inventory supplied. should be ignored in EOQ calculation.
Delivery expense will increase with an increase in
Supplier charges ₱500 fixed delivery charge number of orders so it should be included in EOQ
for each delivery. calculation.
Auto dealer transports cars from the car
factory to its showroom using its own trucks.
Insurance premium is paid to cover for any
accidents during the transportation. ₱100 The annual insurance cost is fixed irrespective of
premium is paid for each vehicle that is how many cars are transported in one go and should
transported. therefore be ignored.
Holding Costs Relevance to EOQ calculation

The opportunity cost of holding one more unit of

inventory for one year is ₱15(15%x₱100) which
should be included in EOQ calculation because
more the number of units of inventory that are held,
Company earns a return of 15% on its higher the opportunity cost of capital tied in
projects. One unit of inventory costs ₱100. inventory purchase.
Warehouse rent is fixed and hence irrelevant to
Company pays lease rentals of ₱20,000 for EOQ calculation as the cost does not vary to
its warehouse. changes in the number of units of inventory held.
 Order Costs Relevance to EOQ calculation

Insurance premium of ₱10 per day is paid for

each unit of inventory stored in the The insurance cost rises with an increase in number
warehouse to cover the risk of fire and theft. of units held and is therefore relevant to EOQ.
The cost of damage and shrinkage (theft) of
0.2% of the average number of inventory inventory increases as more units of inventory are
units stored in the warehouse get damaged or held at the warehouse. The cost should therefore be
stolen. factored into EOQ calculation.

Underlying assumptions of EOQ

The computation of EOQ is based on the following assumptions:

1. The total number of units to be consumed during the period is known with certainty.
2. The total ordering cost remains constant throughout the period.
3. The inventory cost remains constant throughout the period.
4. There are no cash or quantity discounts available.
5. The whole quantity of ordered inventory is delivered in one batch.
6. The optimal quantity for each invariable or stock item is computed separately.
7. The lead time does not fluctuate and the order is received on time with the total order
quantity.

These assumptions are also known as the limitations of EOQ.

c. Receivables Management
Receivable Management or Managing Accounts
Receivables means collecting the payments due for
Sales in a timely manner. When we sell any services,
products or solutions to our clients or customers, they
owe us the money. Collecting that money is called
Receivables Management.

A common source of cash flow problems

(especially for small and mid-size businesses) is poorly
managed accounts receivable. The more cash you have
tied up in receivables due to slow paying customers and
delinquent accounts, the less cash you have available
Source: https://thumbs.dreamstime.com/b/accounts- for running your business.
receivable-money-financial-management-company-
hand-holding-money-top-invoice-payment-accounts-
receivable-170882032.jpg Furthermore, mismanaged revenue cycle
accounting (e.g., delayed invoicing or failure to invoice
the customer at all) will lead to cash flow disruption. This issue is typically compounded by
incurring internal labor costs or external vendor fees for providing products or services to
customers without having cash inflow to offset such costs.
Why Manage Receivables?

It looks easy to collect the payment on due date but it is not that easy. Due to intense
competition in the market, it is very important for a company to first sustain in the market and
therefore for survival company has to sell on credit basis to increase the sales and to attract
each and every potential customer through this offer of purchase on credit (for customers).

While every trustworthy customer will make the due payments at regular intervals
timely but definitely there will be some customers who will make default in payments either
by doing late payments or even non-payments.

And because of such defaults, the company faces huge loss, as the whole operations of
the company get hampered due to disturbed inflow of working capital. Cash happens to be the
most important working capital for any company.

To run a company without cash can be fatal as without sufficient and timely inflow of
cash there is no way to carry out daily operations. Hence, to ensure the smooth inflow of cash
in a timely manner, management of receivables is a must.

Since the company carry out its credit sales in huge volume, it is not possible for the
company to chase every customer to collect the payment if they default in making payment.

In this case, receivable management can contract with the collection agency to recover
the due payment from such default making customers.

Objectives of Receivable Management

Receivable management help to obtain various objectives and target set by the
manager. They are:

1. To build and improve customer relations. It is essential for every company to satisfy its
customers. Being considerate about customers’ needs and benefits is the key for every
company to establish a huge customer base by attracting new customers and sustaining the
existing ones.
→ By credit sales, the company gives an option of purchase to its customers who belong
to the financially weaker section as these customers can make payment in instalments
in a timely manner as per agreed terms. This will strengthen the relationship between
buyer and seller.

2. To minimize bad debt losses. Bad debts will brutally hamper the growth and even the
survival of a company and it may also lead to heavy losses. Receivable management takes
all necessary steps in order to avoid bad debts.
→ The management also designs the whole schedule for timely collection of due payments
and also notifies the customer for the payment of the amount standing against them.
The company charges interest on delay in payments and in case of non-payment the
 company informs the collection agency or department on due dates to collect payments
from the customers.

3. To track and improve cash-in-flow. Credit facility is extended only after evaluating the
financial capacity, payment history and credit rating of the customer. Prospecting the
requirement of working-capital for carrying out day-to-day activities is also equally
important. Only after the evaluation and prospection, the company gives credit facility to
its customers.
→ Receivable management monitors and controls all the cash movements in the company.
→ The management records all the sales transaction and maintains a systematic record of
it to avoid any delay in collection of due payments. The management aims towards
achieving the smooth flow of sufficient cash for the daily operations of the company.
→ The automation in the management of receivables will help in easy maintenance of all
the sales transactions in very minimal time and will avoid any confusion from arising.

4. To boost up the sales volume. There is intense competition in the market, taking a form of
cut-throat competition. And to sustain in the market it is important to reach sales potential.
Sound receivable management helps in increasing the sales and the profitability of the
organization.
→ By extending credit facilities to the customers, the company is able to achieve its
objective of increasing the sales volume. Due to credit facilities, new customers are
attracted towards purchasing on credit basis and the existing customers make more
purchase due to credit facility.

5. To face competition and grab market. There are many players (competitors) in the market
giving a variety of credit options to the customers and in order to face such stiff competition
and to grab market it is important to have a sound receivable management which will study
the factors affecting the market and based on the analysis the management design (form)
its credit lending policies keeping customer satisfaction in mind and thereby to earn profit.

6. To address complaints. Receivable management plays an important role in avoiding any

disputes from arising. A sale is considered only when an invoice is generated and a copy
of the invoice is also given to the customer to make the payment on the due date.
→ The company should not make any mistake in the invoice as it will drastically hamper
the relationship between buyer and seller. The company should also generate the
invoice in time as any delay made in invoice generation will surely delay the collection
of payment.
→ A systematic record of all the sales transactions will avoid any complaints from arising.
→ Complete and fair record of all transactions will leave no space for any confusion to
arise and due payments will be received within the stipulated time-frame.

Importance

Receivable management plays a key role in deciding to whom the company should
extend its credit facilities. For effective receivable management, it becomes very important to
evaluate the customers before extending the credit facilities.
There are few parameters to evaluate a customer, these are:

Character: It is utmost important to check the character of a customer by evaluating

his/her financial background and also the moral background as extending credit facility to a
person with a criminal background will sure shot be risky and to check the credit rating of a
person is equally important.

Capacity: Whether the customer is financially sound and capable to make the payment
at a due date is essential to be checked. The credit score and previous records of payment of
the customer should be thoroughly checked.

Capital: The company should not over credit or under credit the customer. The credit
facilities should be given according to the financial stability of a person.
• If the company lend more on credit to a customer who is not very financially sound then
there are high chances of bad debts and in case of under credit, the customer will not be
fully satisfied. So, both the conditions are brutal for the growth of the company.

Collateral: In many cases, the customers make default in payments. In late payments,
the company charges interest but in case of non-payments the company informs the collection
department on the due date to collect the payments and if the customer is unable to pay, the
customer becomes legally bound to keep book debts, stocks or immovable property as
collateral security with the company.

Conditions: There are many times when the customer is trustworthy and makes timely
payment but due to the drastic shift in the economy and cut-throat competition, things might
to what it wasn’t before.
• Therefore, economic conditions, market conditions, the financial condition of the
customer, the intensity of the competition should be studied with due care and
concentration.

Advantages of Receivable Management

Due to effective management of receivables the company is all allowed to open its
doors to grab all the benefits arising from it, the benefits are:

1. Improves the liquidity position of the company.

2. Gains control over cash and other working capital.
3. Improves the efficiency of accounts receivable management.
4. Strengthens the relationship between buyer and seller.
5. Improves customer satisfaction by addressing all the complaints in due time.
6. Reduces the time gap between credit sales and receipt of payment.
7. Minimizes the credit risk.
8. Improves sales volume.
9. Receives profit as consideration for effective receivable management.
Steps Involved in Receivable Management

1. To establish credit practices

After doing market research, the company should frame its own credit policies
keeping in mind the target customers. The credit policies should be flexible enough to meet
the needs of every type of customers and thereby to satisfy the needs of each and every
customer.

2. To generate invoice
A sale is taken into consideration only when the invoice generated. A copy of the
invoice is also given to the customer so as to make the payment on the due date. The invoice
should contain all the details regarding the product sold or services rendered and the
stipulated time period as per the agreed terms.

3. To monitor accounts receivable

It is very important to track the accounts receivable and collect the payment in time
without leaving any room for any kind of delay in payments, non-payments or confusion.

4. To account for accounts receivable

An accountant is responsible for maintaining a systematic record of all the sales
transaction and the due dates for receiving the payments in the financial books of the
company. There should not be any delay in making the records of the sales transaction.
Complete and fair record of all the transactions will help in collecting the payments in time
and it will be easy to find out the due payments which are yet to be received.

Accounts Receivable Best Practices

What can you do to ensure your revenue cycle is properly managed by your accounting
team and cash inflows are maximized? For starters, follow these six accounting best practices
for revenue cycle management:

#1 Provide Customers with an Estimate or Quote

Create an estimate that includes the specific products or services being sold, sales price,
credit terms, etc. This will allow your customers to have an understanding of the required costs
in advance, avoiding surprises when the invoice arrives and resulting in quicker approval.

#2 Confirm Invoices are Sent for Completed Sales Orders

Create a sales order from the approved estimate or from the customer’s purchase order.
Management should review the Open Sales Order report to ensure visibility to services that
have been provided or products that have been shipped for which no invoice has been prepared.

#3 Review Accounts Receivables Regularly

Proactively manage the receivable collections process immediately upon invoicing.
Management should review the Receivable Aging report weekly to create accountability for
the person responsible for collections. It is also important to establish a plan for following up
with all delinquent, or almost delinquent, invoices.
 #4 Offer a Variety of Payment Methods
Providing customers with the option to pay via ACH (automated clearing house) and
credit cards can shorten the length of time from invoicing to customer payment compared to
signing and mailing a physical check. In today’s world, electronic payments can be made from
a mobile phone or device, making it even easier to approve payments.

#5 Input Customer Payments Immediately

Payments from customers should immediately be applied in the accounting records to
the specific invoice. This process ensures that management has an up-to-date and accurate
Receivable Aging report to review.

#6 Forecast Recurring Revenue

Businesses with customers who are charged monthly, quarterly, or annually for services
should establish additional accounting procedures to forecast and schedule the future
invoicing. Forecasting allows you to compare invoicing for these recurring charges against
expectations to determine if there was a failure to issue invoices to any customers. If charges
are identical each month, consider automating the process so that invoices are sent on the same
day each month to avoid any unexpected delays.

For more accounts receivables management, visit

➢ https://abcadda.com/accounts-receivables-collection-tips-and-process/
➢ https://www.enjayworld.com/blog/definitive-guide-to-receivable-management/

d. Fixed Asset Management

Fixed assets are long-term items that

add value to your business. In terms of
accounting, fixed assets are the assets and
property that can be easily converted into cash.

Fixed assets can be defined as a long-

Source: https://tracet.in/wp-
content/uploads/2020/02/Defining-Fixed-Assets.jpg
term tangible part of a property or equipment
that an organization owns and uses its operation
to generate income. Long-term intangible
property can also be called a fixed asset, like
a trademark or patent.

It is anticipated that the fixed assets cannot be consumed or converted into income
within a year. These fixed assets basically appear on the balance sheet as property, plant, and
equipment (PP&E).

The Importance of Fixed Assets

Information about organization’s assets helps in creating accurate financial reporting,

business valuation and thorough financial analysis. Investors use these reports to determine a
company’s financial health and decide whether to buy shares in or lend money to the business.
Because a company may use a range of accepted methods for recording, depreciating
and disposing of its assets, analysts need to study the notes on the corporation’s financial
statements to find out how the numbers were determined.

Fixed assets often comprise a significant portion of the total assets of an enterprise, and
therefore are important in the presentation of financial position. Furthermore, the determination
of whether expenditure represents an asset or an expense can have a material effect on an
enterprise’s results of operations. There are definite measures taken by every organization to
manage these assets effectively.

What are the examples of Fixed Assets?

Here are a few examples of Fixed Assets:

→ Office equipment
→ Computer equipment
→ Buildings
→ Furniture
→ Manufacturing equipment
→ Vehicles
→ Machinery
→ Land
→ Intangible assets

Basically, these assets depreciate over their useful life.

What is Fixed Asset Management?

According to Business Dictionary,

“Fixed Asset Management is the management of fixed assets that cannot be converted
to a fair cash value in a timely manner. Fixed assets are often managed through the use of asset
tags, which are tracked through serial numbers or bar codes, for easier organization, and are
filed for the purpose of accounting, maintenance, and theft deterrence.”

In simpler words, it is the process of tracking and maintaining the organization’s

physical equipment and assets. They can be managed by asset tagging or barcoding. The main
reason for implementing fixed asset management is asset maintenance, asset tracking &
preventing losses.

With the fixed asset management system, an organization can do the following:
→ Track and Monitor fixed assets
→ Overlook equipment and machinery at multiple locations
→ Low maintenance costs
→ Improves operational efficiency
→ Maintain a record of retired, sold, stolen or lost assets
 Fixed Asset Management allows an organization to monitor equipment and vehicles,
to assess their location, and to keep them in good working order.

This also helps to minimize lost inventory, equipment failures, and downtime, thus,
improving the overall value of an asset.

Fixed Asset Management is a comprehensive term that describes the origin of the
process of managing an organization’s assets in every aspect (from the time it is acquired to
its disposal).

It also keeps detailed asset records of an organization’s valuable property. The

information it records are as follows:
→ Purchasing Details
→ Inventory
→ Maintenance Schedules
→ Upgrades
→ Quantity
→ Location
→ Depreciation
→ Pattern of Use

Why is Fixed Asset Management important?

Here are the few reasons why Fixed Asset Management is important:
→ Optimization of Assets
→ Precise asset management can assist you in optimizing your daily action & operation
that involves the planning, resources use, and in the executing management program.
→ Extending the life cycle

Optimization of Assets

Precise asset management can assist you in optimizing your daily action & operation
that involves the planning, resources use, and in the executing management program.

Extending the Life Cycle

Every asset requires support service, in case if not given can result in a tremendous
expense. The asset management keeps check on all such information and assures that assets
are accurately managed, thus prolonging their lifecycle and optimizing your property. It is very
effective in monitoring & managing the asset.

Saving Money on Maintenance

At the operational stage of the life cycle of an asset, a business firm can confront several
maintenance issues. Maintenance issues can cut into the benefits of the organization. Then
again, under-maintenance can prompt diminished efficiency. So, maintenance should be done
on a regular basis.

Removing Ghosts Assets

These assets will be expelled from books that before were mistakenly recorded,
tempering the inventory records. In this way, Fixed Asset Management can be beneficial in
monitoring the assets as well as in asset recovery.

Without fixed asset management, an organization may experience:

→ Unplanned downtime
→ Equipment failures
→ Misplaced or lost inventory
→ Safety or environmental breaches
→ Failure to meet compliance or regulatory standards

Ways through which Fixed Asset Management is practiced:

There are many ways through which fixed asset management can be practiced. Few of
them are as follows:

1) Accountability and Safe Custody of Assets:

One of the most important functions of fixed asset management is the safe custody
of assets. This safety of assets is accomplished through an assigned responsible person.

Accountability of assets is done to increase the level of security and reduction of

theft incidents or misuse of assets, otherwise, they reduce the bottom line as well as cash
flows.

Also, good risk management measures include the maintenance of high standards
of data integrity and custody of ownership documents.

2) Fixed Asset Tracking:

Some organizations have a large number of assets, movable assets in focus need to
be tracked in order to keep them safe and productive.

It helps to manage data and asset information up to date by keeping track of

asset location, usage, assigned person, maintenance, insurance, etc. And assists the
associated managers in maintaining, the asset’s safety, productivity, and efficiency.

3) Asset Lifecycle Management:

Asset lifecycle management is a process of controlling, monitoring, and accounting
of assets throughout their life. And keeping track and record of every detail and every
action was taken on the asset by any user from its acquisition date to its disposal, alongside
saving the data as history.
 Therefore, fixed asset management helps to improve asset lifecycle planning,
monitoring of asset utilization, planning its maintenance along with its replacement if
required any.

Keeping the track of warranty, annual maintenance contracts, and related insurance
reduces the risk of undue cost because of mismanagement.

4) Asset Labelling:
The practice of asset tagging gives you effective and appropriate management and
control of assets in terms of asset’s long run.

Asset tracking is done easily with the asset tagging of fixed assets with unique
identification codes example, barcodes, QR codes, RFID, NFC, etc.

This asset labeling also boosts up the physical audit process by identifying assets
on the floor with asset tags.

5) Conducting Physical Asset Verification:

Periodic physical asset verification is done to ensure the existence of assets.
Physical verification would reach for reconciliation of the results with asset records in the
record books.

Physical asset verification helps in identifying ghost assets. The ghost asset is one
that is lost, stolen, or unusable, yet it is recorded as a functioning asset. Assets that
physically exist but not mentioned in books, can also create a problem.

Conclusion

Fixed asset management is capable of the asset acquisition and control process that
requires necessary attention and correction for safeguarding assets.

Fixed asset management is important for any business as it directly affects the
future planning and vision of the organization.

This is done by proper planning and data-driven information which helps in

effective decision-making to enhance the outcome of a business.

To learn more about fixed assets management, find time to visit

• https://comparesoft.com/asset-management-software/fixed-assets/
• https://blog.ezofficeinventory.com/fixed-assets/
• https://nawatt.com/30-tips-tricks-in-fixed-assets-management/
Lesson 2 ASSET VALUATION

a. Definition
Asset valuation simply pertains to the
process to determine the value of a specific
property, including stocks, options, bonds,
buildings, machinery, or land, that is conducted
usually when a company or asset is to be sold,
insured, or taken over. The assets may be
categorized into tangible and intangible assets.
Valuations can be done on either an asset or a
liability, such as bonds issued by a company.

Source: https://thumbs.dreamstime.com/b/valuation- Valuing Tangible Assets

word-under-lens-little-d-man-white-background-
concept-right-evaluation-test-30647516.jpg
Tangible assets refer to a company’s assets
that have a physical form, which have been purchased by an organization to produce its
products or goods or to provide the services that it offers. Tangible assets can be categorized
as either fixed asset, such as structures, land, and machinery, or as a current asset, such as cash.

Other examples of assets are company vehicles, IT equipment, investments, payments,

and on-hand stocks.

To compute the net tangible assets of a company:

• The company needs to look at its balance sheet and identify tangible and intangible assets.
• From the total assets, deduct the total value of the intangible assets.
• From what is left, deduct the total value of the liabilities. What is left are the net tangible
assets or net asset value.

Consider the following simple example:

Balance sheet total assets: ₱5 million
Total intangible assets: ₱1.5 million
Total liabilities: ₱1 million
Total tangible assets: ₱2.5 million

In the example above, the total assets of Company ABC equal ₱5 million. When the
total intangible assets of ₱1.5 million are deducted, that leaves ₱3.5 million. After the total
liabilities are deducted, which is another ₱1 million, only ₱2.5 million is left, which is the value
of the net tangible assets.

Valuing Intangible Assets

Intangible assets are assets that take no physical form, but still provide a future benefit
to the company. They may include patents, logos, franchises, and trademarks.
 Say, for example, a multinational company with assets of ₱15 billion goes bankrupt
one day, and none of its tangible assets are left. It can still have value because of its intangible
assets, such as its logo and patents, that many investors and other companies may be interested
in acquiring.

b. Methods
Valuing fixed assets can be done using various methods, which include the following:

1. Cost Method
The cost method is the easiest way of asset valuation. It is done by basing the
value on the historical price for which the asset was bought.

2. Market Value Method

The market value method bases the value of the asset on its market price or its
projected price when sold in the open market. In the absence of similar assets in the open
market, the replacement value method or the net realizable value method is used.

3. Base Stock Method

The base stock method requires a company to keep a certain level of stocks whose
value is assessed based on the value of a base stock.

4. Standard Cost Method

The standard cost method uses expected costs instead of actual costs, often based
on the company’s past experience. The costs are obtained by recording differences between
expected and actual costs.

c. Importance
Asset valuation is one of the most important things that need to be done by companies
and organizations. There are many reasons for valuing assets, including the following:

1. Right Price
Asset valuation helps identify the right price for an asset, especially when it is
offered to be bought or sold. It is beneficial to both the buyer and the seller because the
former won’t mistakenly overpay for the asset, nor will the latter erroneously accept a
discounted price to sell the asset.

2. Company Merger
In the event that two companies are merging, or if a company is to be taken over,
asset valuation is important because it helps both parties determine the true value of the
business.

3. Loan Application
When a company applies for a loan, the bank or financial institution may require
collateral as protection against possible debt default. Asset valuation is needed for the
lender to determine whether the loan amount is covered by the assets as collateral.
 4. Audit
All public companies are regulated, which means they need to present audited
financial statements for transparency. Part of the audit process involves verifying the value
of assets.

Self-Check Test (SCT)

After answering the self-assessment question, kindly take a picture and email to
ma.dampilag@bsu.edu.ph or DM to Mary-Ann Marcos Dampilag. You’ll be given 10 points for
answering and sending an image of the self-assessment question which will be part of your class
standing.

SCT 4. MATCHING TYPE. Match Column A with Column B.

Column A Column B
1. Bases the value of the asset on its market price or its A. Asset Lifecycle Management
projected price when sold in the open market B. Base Stock Method
2. Collecting the payments due for sales in a timely C. Cash
manner D. Cash Management
3. Done by basing the value on the historical price for E. Cost Method
which the asset was bought F. Excess Inventory
4. Ensure sales can continue with the uncertainties in G. Holding Cost
demand and supply H. Intangible Assets
5. Incurred every time an order for inventory is placed I. Market Value Method
with the supplier J. Ordering Costs
6. Incurred to hold the inventory in a store or warehouse K. Pipeline Inventory
7. Primary asset individuals and companies use regularly L. Receivable Management
to settle their debt obligations and operating expenses M. Safety Inventory
8. Process of controlling, monitoring, and accounting of N. Standard Cost Method
assets throughout their life O. Tangible Assets
9. Requires a company to keep a certain level of stocks
whose value is assessed based on the value of a base stock
10. Take no physical form, but still provide a future benefit to the
company

How many questions did you answer correctly? If you answered…

8-10 Very good You gained much knowledge on the topics
4-7 Good You have gained adequate learning on the topics
0-3 Fair You can study the topics again to improve
*Please refer back to the lessons to check your answers.
Assignment
After each chapter, you’ll be given assignment/s to be answered either individually, by
pair, or by group. These assignments are graded and are part of your class standing. After
answering the assignments, kindly take a picture and email to ma.dampilag@bsu.edu.ph or DM to
Mary-Ann Marcos Dampilag.

Assgnment 4. To be done individually. Compute for what are asked in the following problems .
Highest Possible Score: 30 POINTS

1. Willy Wonka operates a chocolate factory. The annual demand for chocolate-covered
strawberries is 2,500 units. The order cost is ₱15 per order. The cost per order is ₱15 while
the holding cost per unit per year is ₱0.25. What is the EOQ? What is the expected number
of orders per year? What are the total annual inventory costs?

2. A retail clothing shop is into men’s jeans and sells roughly around 1000 pairs of jeans every
year. It takes ₱50 for the shop to hold a pair of jeans for the entire year, and the fixed cost to
place an order is ₱20.
a. Determine the EOQ.
b. How many orders will be placed per year using the EOQ?
c. Determine the ordering, holding, and total inventory costs for the EOQ.

3. An auto parts supplier sells Motolite batteries to car dealers and auto mechanics. The annual
demand is approximately 1,200 batteries. The supplier pays ₱2,600 for each battery and
estimates that the annual holding cost is 30% of the battery’s value. It costs approximately
₱200 to place an order (managerial and clerical costs). The supplier currently orders 100
batteries per month.
a. Determine the ordering, holding, and total inventory costs for the current order quantity.
b. Determine the EOQ.
c. How many orders will be placed per year using the EOQ?
d. Determine the ordering, holding, and total inventory costs for the EOQ. How has
ordering cost changed? Holding cost? Total inventory cost?