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    Sba

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    Snow Riego

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    © All Rights Reserved
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    of 46
    Cash and Marketable See Ccurities Management 928 REVIEW NOTES sic concepts B3 sa medium of exchange. Itis the i Most co) Si jue of assets received and nvenient way to measure cash! asset parted with in an arm's length the v2 ionsaclion. of exch i a medium of exchange is must be used or invested in business gertaking OF it will lose its opportunity of earnings. This gives rise to the sortunity costs of holding excess cash. tes includes currencies (eg, coins and bills), checks, demand deposits, checking accounts and cash equivalents that are used for working capital operations : technically, cash is an idle asset, unless an enterprise has a business purpose of maintaining it. The ideal cash balance therefore should be ef0 the areas of concern in cash management includes 174 determining the optimum cash balance to be maintained, 47.2 the synchronization of cash inflows and outflows, 47.3. identifying the temporary investments to place temporary excess cash, 17.4 knowing the effective interest rate of borrowing and other short- term financing, and 17.5 linking cash flows to receivables collection period and inventory conversion days (ie, days to obtain and sell inventory) Convenience as to unit of measure is not a controlling variable in developing an enterprise's applicable cash management technique. _ &ffective cash management is still measured using the cost-benefit criterion. Reasons for maintaining a minimum cash balance There are three (3) practical reasons for holding cash, such as: 24.1 Transactional motive. This is maintained to ‘meet routine payments of operating expenses where the use of check, credit card, ATM, coupons, and other modern means of payments may be impractical under the circumstances. Examples of this type of cash are petty cash, change fund, and vale fund. Another reason for holding cash balance is to comply with contractual requirements, covenants, and provisions of applicable laws such as compensating cash balances, interest funds, and dividend fund. 2.2 3.2 Cash and Marketable Securities Management Cha ey ; i Speculations affe ' tive motive. — ct 21.2 Specirton pattern, investment Opportunities Oy cine When changes in business Environment Owth ve ready cash to meet pPortunPPen in the business environment (ig es b,! f cash is optimized to reduce prices "abe ty always pays to ha about by changes where the power 0 7 in business environment and conditions may be related t ri industry life cycles and economic cycle © Prog at to cloth the nature of business environment pays to have ready cash especially at times of ‘eo slowdown. : : on 2.1.3 Contingency motive (or precautionary motive) Businesell conduct their operations in a web of complicated and una, Ss environment. Maintaining a fund for precautionary reasong a i of the wisest strategies in business to hedge against diversi (ie, investment risk and operating risk) and NON-diversifgy business risk (ie., financial risk) in order to minimize the doing business (ie. cost of money). Examples of busin uncertainties are strikes, fires, competitors’ marketing Campaig changes in laws and technology, seasonal and cyclical patte and trends in social demographics. The amount of cash to be held normally depends on the following factors: 2.2.1 Cash management policies. 2.2.2 Current liquidity position. 2.2.3 Management's liquidity and preferences. 2.2.4 Schedule of debt maturity. 2.2.5 The firm's ability to borrow. 2.2.6 Forecasted short and long-term cash flows. : 2.2.7 The probabilities of different cash flows under vari circumstances. Cash budgeting and cash flows management Cash budget is an indispensable tool in managing cash flows. a Wale fannagement Magnifies the inevitable relevance of budgeted ws tor a year. This budget provides working details on when ae than the need for the period and when is additional cash rod mmanagomett® ed requirements for a given period. d “atl in Nt pre-determi i givenvenen €rmines the excess cash inflows an vl ea ce budget gives a chance to management to prepare eye ere to invest the excess cash while maintaining sufficient "4 Cash and Marketable Securities Management 930 i gy future needs, and where to outsource additional cash for short- sali nd working capital needs at the lowest possible cost of money. 1 ; ee of the advantages of having an adequate cash and near-cash are Nalee dey increased savings from availed of suppliers’ trade discounts. > Maintained credit rating. a Lips ono 5 Opportunity to take advantage of favorable business conditions. the end of the day, the best cash management focuses in ash collections and decelerating cash outflows. assets 33! 33 33 stil. gocelerating C Cash receipts management and “deposit float” cash inflows and outflows should be synchronized. Cash inflows should be accelerated and cash outflows should be slowed down. One major variable that affects the cash inflows and outflows is the cash float Press a Float means delay. It is the time interval from the check is issued to the point the cash is transferred to the payee’s account. A float could either be a collection float (I.e., seller's float) or a disbursement float (i.e., ouyers float). The collection float should be minimized while the payment float should be maximized. From the point where a customer issued a(check, the enterprise should doall the necessary techniques to speed up the transfer of cash. in the process of realizing checks issued by customers into cash, the "enterprise has to manage a “check to cash conversion float’ 421 A float consists of the following: * Mail float. The time interval from the check is_issued to the point the mail is received by the collecting party. * Processing float) It is the time from the date the mail is received to the point the check is deposited to the\ payee’s account. | fd * Clearing float (financial system float). It represents the normal banking clearing time of checks. It is the time from the date of deposit is made up to the date the cash is already available The fal _for withdrawal. 5 : ollowing techniques are used in accelerating cash receipts: ; High credit standards. 43 Efficient and effective billing system. min ffective and efficient collection policies. gaunimize the mail float, the following techniques may be used: Lockbox system. Applied by renting mail boxes in the post office ‘0 quicken segregation and delivery of mails. a |REVIEW NOTES| 931 48 |REVIEW NOTES | 5.0 5.1 6.0 6.1 6.2 6.3 Cash and Marketable Securities Managemen, 442 Direct sends To minimize the processing float the following may be 4.5.1 Wire transfer 45.2 ACH (Automatic clearing house) debit (ie, bank to bany automatic debit) HN, 4.53 Electronic fund transfer (EFT) 45.4 Electronic fund transfer on point of sale (EFTOS) 45.5 Concentration banking 456 Preauthorized check (PAC) 45.7 Depository transfer check 4.6.1 To minimize the financial system float, deposit the Cole before the cut-off time. Collect Applied Cash payments management and “disbursements float” The following techniques are used to slow down cash releases 5.1.1 Controlled disbursements 5.1.2 Playing the float © Use of draft. + Use of checks Issuing crossed check. Issuing check after the cut-off deposit time. Issuing check only on Fridays. Overdraft systems, zero-based accounts, and ACH crest ¢ Payroll management 5.1.3 Less frequent periodic payroll dates instead of dally W payment or weekly wage payment Temporary excess operating cash and short-term investments What are temporary investments or marketable securities? 6.1.1 Marketable securities are highly liquid, short-term, interes! money market placements or securities. 6.1.2 Marketable securities include cash equivalents, short placements, financial assets held for trading, and simlat instruments Who issues marketable securities? 6.2.1 National government and government agencies 6.2.2 Private enterprises Factors influencing the choice of marketable securities 6.3.1 Risk eat ¢ Default risk > Cash and Marketable Securities Management 932 r . Interest rate risk Inflation risk 53 Maturity a yield or return on securities marketability (liquidity risk) 5 evel of short-term securities investment may be determined as 623 g24 lows ’ [quid funds needed Px "Transactional cash balance aoe cash safety stock PX = Transferable to short-term investments cash deficit, borrowings, ard short-term financing ifthe operating cash budget shows a potential cash deficit at any given time during a budget period, an enterprise can immediately institute remedial actions to prevent such deficit. To improve its projected cash position and liquidity, the first thing an enterprise should do is to streamline its operating cash inflows and (or) reduce operating expenses, then, or unload non-performing long-term assets before borrowings as sources of financing should be tapped. . ? Borrowings may be long-term or short-term. Short-term borrowings are normally harnessed for working capital requirements. Short-term borrowing may classified as spontaneous or non-spontaneous. 1 Spontaneous short-term financing is derived from the natural sources of credit as defined by business practices. Examples are accounts payable, accrued expenses, and revolving line of credit. Non-spontaneous short-term financing requires extra effort on the part of the borrower before the fund may be secured. Examples are single-line and multiple-line bank: credits, factoring of accounts receivables, discounting of notes receivables, inventory liens, issuance of commercial ae and other short-term financial instruments. tor-term financing may also be classified as secured or unsecured al Examples of unsecured borrowings are trade credit and eh 7 expenses. Examples of short-term financing are back-to-back receiy loan, factoring of accounts receivable, pledging of accounts ables, discounting of notes receivables, floating inventory liens, and in Yentory warehouse receipts. Athi bitrage Pricing Rate (APR) Th j i hayes is the effective interest rate and is computed on a periodic ’ Single annualized basis, and continuing annualized basis. EE eS, ee ae j ; i : : F |REVIEW NOTES| [REVIEW NOTES | a nm ow ao a o o nN ~ Cash and Marketable Securities Management Chap slas in computing the different interest rates are: "Net interest payments / N t proceeds _ fi : inancing cost / Net proceeds” arbitrage pricing rate (or effective interest rate) compounded annual effective interest rate n no of periods ceriodic effective interest rate cing costs include interest payments plus transaction costs 5 ‘ocessing charges, regulatory fees, etc.) less income deriveg tt ercial use of borrowings found to be temporarily idle ‘oceeds is the principal less discounted interests, loan Processin 's deducted in advance, and incremental compensating balance. When the borrowing is expected to be continuous during the year, the compounded annual effective interest rate (CAEIR) shall be: CAEIR = [(1 + PEIR)" - 1] llustration: Say i Principal amount of short-term borrowing _|_ P500,000 Nominal interest rate, discounted | 10% Time period 2 months No. of periods [42 months / 2 mos. 6 Analysis: Hae E Annual Periodic Interest paid P500,000 x 10% P50,000 Net proceeds P500,000 - 450,000 P50,000 APR___P50,000/P450,000 11.11% _| PEIR 11.11% /6 1.8518% CAEIR | [(1 + 0.018518)°- 1] z 13.71% J Establishing desired cash balance Establishing a desired cash balance may be done using the subject® model, say, 10% of the following month's sales. Quantitative model is used to compute the optimum cash balance, Cash and Marketable Sceutties Management an the optimum cash balance ideally. the optimum cash balance is zero. requirements in business undertakings, maintained : Despite the prominence of cash balance in the management of working capital. tt would be unwise for the enterprise not to determine the optimum cash balance that would give it the lowest cost of carrying cash and transacting in cash. As aiscussed in the cash budgeting, excess cash is invested in temporary investments, while a potential cash deficit may be managed by streamlining operating activities or through borrowings. if these activities and notions are considered, there appear to have two cash costs, namely, the transaction costs and the carrying costs, and there standard computations are as follows: lowever, because of practical cash balance should be ‘Transaction —_|_No. of transactions x Cost per transaction _ costs | (Total cash need:/ Transaction cash) x Cost per | eee | transaction sree eeeeeaaeiaaa | ‘Carrying | Average cash balance x Cost of carrying cash _ | costs _| (Cash balance/2)xCostofcarryingcash Carrying cost is the opportunity lost in holding the cash and not being used in an investment activity. It is also referred to as opportunity costs. Transaction costs consist of the amounts paid to brokers, market regulatory agencies, and government agencies in buying and selling securities in the capital market. Theoretically, a desired cash balance is the optimum cash balance where the total relevant costs of cash would be at the minimum. The relevant Costs of cash are its holding costs and opportunity costs. io A desired cash balance may be established by using the subjective model or the quantitative model. : In ees model, the company sets the desired cash balance based on a related factor. Let us say, the minimum cash balance is 10% ; Of the following month's sales. * In the quantitative model, we have the Baumol model or the Miller-Orr Mode| ' The Baumol Model ie / (2 x Annual Demand x Cost per Transaction / Carrying costs rate 0c |REVIEW NOTES| |REVIEW NOTES| oo” 935 Cash and Marketable Securities Management Chae oct = \/ (2x AD x CPT)/CCR : where: — OCT "| optimal cash amount to be transferred to and fo ~ transfer cash balance AD | Annual demand refers to annual cash ©XCESS oF annag~ cash need a . CPT Cost per those incurred in buying and selling —~ transaction commercial papers in the mone marke CCR _| Carrying cost rate opportunity cost of holding cash am _————— 10.11.1 Illustration Say: Annual cash need P40 milion Cost per transaction P600 ROI on temporary investments 10% Therefore: 692,820 OcB \/ (2x P40 M x P600) / 10% Transaction costs (P40 M/ P692,820) x P600 34,641 Opportunity costs (P692,820 / 2) x 10% 34H! Total cash costs Peg2e * Average cash balance = OCT/ 2 : a * In the use of this model, it is assumed that cash inflows outflows are known with certainty. . 10.6 The Return Point Model (or the Miller-Orr Model) poit 10.6.1 The formula for the optimal cash balance using the Retum Model is as follows: _- EM a 74 x Dall RP = /(2 x Conversion Cost x Variances of Daily Net Cash Flows) Opportunity Cost) , where: Upper limit 3xRP RP. Return Point Upper limit - RP oun Cash transferred to MS - Cash and Marketable Securities Management 93h MS converted to Cash = Return Point a uu 406-2 Cash inflows and outflows are uncertain 5 1063 Cash balances fluctuate between the “upper limit” and “lower limit = 4064 Upper limit = 3 x Return Point 2 1065 Cash converted to marketable securities = Upper limit ~ Return > Point @ 1066 Marketable securities = Return Point . Fi Net cash cycle (NCC) 40.7.1 Net cash cycle = Operating cycle — Payment period 40.7.2 The NCC is positive if the operating cycle is longer than the payment period. The NCC is negative if the operating cycle is shorter than the payment period. 40.7.3 A business should maintain a negative net cash cycle to maintain liquidity in its operations 40.7.4 If, then, else, what to do (hen ation ___| Nonspontaneous Inventory ] Collection Payment tt financing days | says : Ip [days] Ws Positive |} ; | oe NOC= Negative wv ® ® pv ite Accounts payable = spontaneous financing (non-negotiated) tong-term payables = non-spontaneous financing (negotiated) _ 10.7.5 Say, Case 1 Case 2 Inventory days 20 days 30 days Collection period 30 days 40 days Operation cycle 50 days 70 days Payment period 60 days 50 days Net cash cycle (10) daysF 20 days UF Annual operating expenses P14.4M P14.4M Cash short (excess) [(P14.4 M/ 360) x 10] P(400,000) [(P14.4 M/ 360) x 20] P800,000 12% 12% Cost of capital Opportunity costs (savings) [P400,000 x 12%] P( 48,000) F [REVIEW NOTES | 11.0 Cash and Marketable Securities Management {[P800,000 x 12%] P95 000 Nonspontaneous financing v n Spontaneous financing ~ Vu Marketable Securities Marketable securities are highly liquid, short-term interes. government and nongovernment money market instruments 7. be easily converted to cash. To be truly marketable, a security must have two bas ‘) a ready market and (2) a safety of principal (i.e, no in value) Risk and maturity influence the choice of marketable securities 1131 Risk + Default risk. The issuer may not be able to Pay the the interest at due dates. + Interest rate risk. The decline in market values of the due to rising interest rates. + Inflation risk. The future deterioration of the purchasing cov of a currency * Marketability or liquidity risk. The security may ret % immediately sold or if sold is made at a substantal 9 concessions 11.3.2 Maturity. It should be aligned with the Projected working °2" needs of the business. Convertibility of marketable secures ? cash (€ , liquidity) is more important than yield on matuitty Examples of marketable securities 1141 Marketable securities May be divided into two g/curs government issues and (2) private corporation issues 1142 Examples of marketable securities are IC characters. ikelihoog princial a . ng | Security Issuer Description Risk @ Government issues | | e ell g,_ National | Regularly issued at Lowest * Pdey 60-day 91 Government | auction, sold at be aay 182 day | discount, strong Treasury notes secondary market National government | Low, sig™ ne 8 | Stated interest rate | aman te | strong secondary ~~ | Cash and Marketable Securities Management ave ' ment i won | a neues | | IE iable Commercial banks Represent specific Higher than 3 wea coat cash deposits in | government securities = et os) Commercial banks; | issues and comparable ins ep amount and tocommercial paper > | esin 30 maturities tailored to jw tut ts investment needs; Es gays ate 4 ff large denominations; | mon, wit | good secondary | genominations In market | milions of pesos | commercial papers Corporation with a Unsecured note of | Higher than if high credit rating issuer; large government securities | vetuities denominations issues and comparable | snyere from 3 to negotiable CDs cays to 270 days wth denominations inmillions of pesos | — Banks Results from a Slightly lower than | Banker's guarantee of a negotiable CDs and acceptances business commercial paper but heer transactions; sold at | higher than | discount from maturity | government securities ain 30 days, 90 value issues | days and 180 days | | Voney market Professional portfolio | Professionally | fe Pinel. | Mutual funds management managed portfolios of | poner (han Fhulippine | 28 Ol | treasury issues and | companies marketable securities; comparable to i provide instant negotiable CDs and liquidity commercial papers Re Mealiid Bank or secutity Bank or security Generally slightly ee dealer sells specific | below that associated dealer e securities to firm and | with the outright agrees to repurchase purchase of the them at a specific security price and time buy a deposits Deposits of currency Highest, due to less not native in the regulations of country in which the depository banks and | bank is located; large | some foreign | | denominations; active | exchange rate | secondary market | Foreign banks IREVIEW NOTES | Cash and Marketable Securities Management th 939 12.0 Internal controls for cash (the Iist is not intended to be all-inclusive!) 12.1 The cash department should be under the supervision of the treasure 12.2 The cash department should be separated from the accounting and ¢ departments that keep records of transactions and events. All cash transactions must be supported by available proof of accur, 12.3 All cash receipts must be issued with prenumbered official Teceipts check issuances must be supported by delivery receipts, sales inyoj, receiving reports, board resolutions, or official receipts All cash receipts must be deposited intact in the designated deposit 12.4 bank on the day of collection or in the following business day. 12.5 Bank deposit slips must always be on file, complete and available 12.6 Periodic reconciliation of bank and book records must be done. 12.7 Cash count should always be done and with an element of surprise 12.8 All checks must be properly signed and approved by at least two signatures 12.9 Cash personnel must be properly selected and trained 12.10 Cashiers must be bonded. 12.11 Cashiers should be rotated, periodically or surprisingly. 12.12 A cashier's manual must be made available. 12.13 Use mechanical or electronic equipment in issuing checks and official receipts 12.14 Preparation and verification of daily cash report. STRAIGHT PROBLEMS Optimum cash balance. Liquid Industries forecasts cash outlays of P48 million tors next fiscal year. A financial analyst for the company has estimated the convers® cost of converting marketable securities to cash to be P900 per converso” transaction and the annual operating cost of holding cash instead of marketabe securities to be 8%. Presently, the company converts cash to marketable secu’ and vice-versa on a monthly basis 1. Required: Using the Baumol model, calculate the following: a. The optimal cash conversion amount. The average cash balance. The number of conversion to be made during the year. b c d. The total cash costs. el e The net advantage if the company follows the optimal cash conversion mo * ie eee eee |REVIEW NOTES| Cash and Marketable Securities Manan: ment 940 aut " _qiON GUIDE na cash balance = V (2x an, a CPT)/CCR a = \/ (2x P48 million x P900)/8% = P1,039,230 syerage cash balance = P1,039,230/2 = p519.615 . b mber of conversions = P48 million / P1,039,230 = 46 18804 times © transaction costs (46.18804 x P900) P 41.569 ¢ opportunity costs (P519,615 x 8%) 41,569 Total cash costs P 83,138 transaction costs (12 x PS00) P 10,800 : Opportunity costs {(P48 million / 12 )/ 2] x 8%) 320,000 Total cash costs ~ monthly basis 330,800 . Total cash costs — optimal basis 7 — 83,139 Advantage of the optimal cash conversion model P247,661 Required: Calculate the following: 2 The retum point The upper limit using the current values 2 SOLUTION GUIDE —— a Return point = . / 2x Cost per transaction x Variance of daily net cash flows 4 x Daily opportunity cost —__——_ Srerunity cost = Ve x P50 x P2,000,000} / [4 x (.08/360)} 200 million / (4 x 0.000222) 474.580 + _Yeperlimit = 3x Return Point = 3x P474,580 = P1,423,740 GHective interest rate. EIR Corporation wants to raise P5 million through short-term “srowing. The company gathered data from several banks and financing institutions ‘Biassembledthefollowing oo Lending institutions A B_ cb | | Amount to be borrowed | P5M PEM P5M| P5M PSM] Nominal interest rate 10% | 12% discounted | 11.5% | 14% | 15%,discounted | ‘nsating balance none 5% 4% none | 10% | erage deposit | | ee even if the none none | none | P200,000 Is not granted one tyr, | Tem ofthe loan 1 yr. Lye Tye. Vye | y | ‘rest earned by the nla 6% 6% 6% | 6% | “petsating Balance | | | | 2, O41 Cash and Marketable Securities Management Ch “Apter | a Required: For each of the terms of the loan offered by the lending "NStitutio, BL calculate the effective interest rate. ns, oO 2 ey = _ - ———___ 2/3. SOLUTION GUIDE = A 8 Cc D wu Interest payments P 500,000 P 600,000 P 575,000 P 700,000 S ~ Interest income from if) compensating balance GO: 15000) 12000 418.000 in Net financing charges 500,000 585,000 563,000 "700,000 Trainee | Principal 5,000,000 5,000,000 5,000,000 5,000,000 pq 002 | = Increase in compensating balance 0 (250,000) —( 200,000) 2 (300,009 | - Discounted interest 0 C0000) ao 750 900 | Net proceeds 5,000,000 4,150,000 4,800,000 —_5,000,000 3.950.009, Effective interest rate —-10,00% 14.10% 11.73% 14.00% 7 igsay | Interest payment = (Principal x Nominal interest rate) _ | Interest income from compensating balance = Increase in compensating balance x Interest rate |___ Effective interest rate = Net financing charges / Net proceeds 7 - a 4. Effective interest rate, continuing basis. A local bank has just approved a 90-day, P200,000, 12% per annum line of credit to VJ Company. VJ plans to regularly avail of the credit line throughout the year. Determine the effective interest rate ona continuing basis. |4. SOLUTION GUIDE ] | a. Effective interest rate = P24,000 / (P200,000 — P24,000) = 13.64% b. No. of periods = 360 days/90 days =4 | c. Periodic effective interest rate = 13.64%/4 = 3.41% | gd. Annual effective interest rate = [(1 + 0.0341)*—1] = 18.25% 5. Cash flows management. a. Float. Tulips Company has daily cash receipts of P85,000. A recent analysis of its collection indicated that customers’ payments were in the mail an average of 2.5 days. Once received, the payments are processed in 1.5 days. After payments are deposited, it takes an average of three days for these receipts to clear the banking system Required: 1. How much collection float (in days) does the firm currently have? 2. If the firm’s opportunity cost is 11%, would it be economically advisable for the firm to pay at an annual.fee of P16,500 to reduce collection float by four days: —— 5a. SOLUTION GUIDE 1. Cash collection float = Average daily collection’ x Total float in days | P85,000 x (2.5 days + 1.5 days + 3 days) | P85,000 x 7 days P595,000 2. Potential income (P85,000 x 4 x 11%) P37,400 - Annual cost of reducing the float 16,500 Net advantage of reducing the float by4days P20,900 Cash and Marketable Securities Management 942 n wi xbox system... A firm that has an opportunity cost of 9% is contemplating 5 $ to alation of a lockbox system at an annual cost of P90,000. The system is > Tipected to reduce mailing time by 2.5 days and reduce clearing time by 1.5 2 ays. If the firm collects P300,000 per day, determine the net benefit (cost) of iit installing the lockbox system. z aw @ SOLUTION GUIDE a Benefit of using the lockbox system (P300,000 4 days x 9%) P108,000 - Cost of using the lockbox system 90,000 Net benefit of using the lockbox system P_18,000 ¢ Concentration banking. Mills Corporation sells to national market and bills all credit customers from the Makati office. Using a continuous billing System, the frm has collection of P1.2 million per day. Under consideration is a concentration banking system that would require customers to mail payments to the nearest regional office to be deposited in local banks. Mills estimates that the collection period for accounts will be shortened by an average of 2.5 days under this system. The firm also estimates that annual sevice charges and administrative costs of P300,000 will result from the Proposed system. The firm can earn 14% on equal-risk investments. Required: 1 How much cash will be made available for other uses if the firm accepts the Proposed concentration banking system? fe at Savings will the firm realize on the 2.5-day reduction in the collection TIO The net benefit (cost) of the concentration banking. E es e LUTION GUIDE | | ‘ash made available using the concentration banking Sa = P1.2 million x 2.5 days = P3 millon “3¥ings from teducing the collection days (P3 million x P14%) = P420,000 L 3, Net nt! Service charge from using the concentration banking 300,000 “———2tefit of using the concentration banking P120,000 1 * Dire Pata on! South Star Corporation just received a check in the amount of "omal om a customer in Baguio. If the firm processes the check in the Morass mer, the funds will become available in 7 days lo speed up the heck i es firm could send an employee to the bank in Baguio on which the me ayn to present it for payment. Such action will cause the funds to San Sarn, tapable after 3 days. If the cost of the direct send is P800 and the firm %* on these funds, calculate the net benefit (cost) of this system. ~ j|REVIEW NOTES] 943 Cash and Marketable Se Sd. SOLUTION GUIDE curitics Management | Napter | Benefit from accelerating collection (P800,000 x 4/365 days x 11%) P 964 - Cost of accelerating collection through direct sends 800 Net benefit from using the direct send e. Controlled disbursing. A large Bulacan firm has annual cash disbur. P360 million made continuously ove administrative costs would increase by P100,000, the firm is consid all disbursement checks on a small bank in Pangasinan. The firm e: this will allow an additional 1.5 days of cash usage. If the firm earn system i P 164 Sements of Service ang ering wtin, stimates, that r the year. Although annual IS @ return on other equally risky investment of 12%, determine the net advantage (disadvantage) of using this technique of cash disbursement. . Se. SOLUTION GUIDE Benefit from delaying payment (P360 million/360 days x 1.5 days x 11%) P 165. 000 - Cost of delaying payment f. Playing the float. Marikina Corporati cover all checks when written. A tl 100,000) Net benefit of delaying payment through controlled disbursing PB. 65,000) ion routinely funds its checking account to horough analysis of its checking account discloses that the firm could maintain an average account balance that is 25% below the current level and adequatel account balance is currently P900,001 ly cover all checks presented. The average 0. If the firm can earn 10% of short-term investments, what, if any, annual savings would result from maintaining the lower average account balance. [5f SOLUTION GUIDE ; Annual savings (P900,000 x 25% x 10%) P22,500 g Payroll account Management. Toys, transfers the same a Inc., has a weekly payroll of P250,000 and mount to the payroll account on the payroll date. The payroll checks are issued on Friday afternoon each week. cashing behavior of its employees, it has found the follo In examining the check- wing pattern: Business days from Percentage of issue of check checks cleared 1 20% 2 40 3 30 4 10 Business days do not include Satu investments earn 12% per year. funds its payroll account based on the How much savings would the firm general short-ter"” days and Sundays. Average stores iftt 9 employee check-cashing behavior - Cash and Marketable Securities Management one -—goLUTION GUIDE 60 savings from controlled transfer of payroll fund (P250,000 x 20% x 1/360 x 52 wks. x 12%) (P250,000 x 40% x-2/360 x 52 wks. x 12%) (P250,000 x 30% x 3/360 x 52 wks. x.12%) (P250,000 x 10% x 4/360 x 52 wks. x 12%) Total savings from controlled transfer of payroll fund Le h Zero-balance accou nt. Rita Company is considering the establishment of a Zero- balance account. The firm currently maintains an average cash balance of 420,000 in its disbursement account which does not earn interest. AS compensation to the bank for maintaining the zero-account balance, the firm will have to pay 4 monthly fee of P1,000 and maintain a P300,000 non-interest- earning deposits in the bank. The firm currently has other deposits in the bank and can earn 12% on short-term investments. Evaluate the proposed zero- account balance. - sh SOLUTION GUIDE interest income from released cash (P120,000 x 12%) P14,400 - Cost of maintaining a zero-balance account (P1,000 x 12) 12,000 0. Net benefit of maintaining a zero-balance account 2 Cost of issuing the commercial paper. Carmelo, Inc., will need P4 million over the next year to finance its short-term requirements. The company Is considering fnancing alternatives - ban'’ financing and the sale of commercial paper. Tatac Union Bank is willing to loan Carmelo the necessary funds providing the company maintains a 20% compensating balance. The effective cost of the bank ‘ean, considering the compensating balance requirement, is 10.4 percent on a Pretax basis. bal the other alternative Carmelo would sell P4 million of 90-day maturity a Paper every 3 months. The commercial paper will carry a rate of ne interest rate is expected to remain, at this level throughout the year. of ter ape paper dealer's fee to place the issue would be a one-time charge Compa @ commercial paper dealer will require Carmelo to establish a P400,000 ‘Nsating balance. Man; fi ae prefers the flexibility of bank financing. However, if the cost of bank mele pias exceed the cost of the commercial paper by more than 1 percent, ued Ins to issue the commercial paper. Mey Uno, Calculate the effective cost of selling the commercial paper and based Ihe. n your cost calculation, recommend the method of financing Carmelo, select (ema) |REVIEW NOTES| 945 Cash and Marketable Securities Management [REVIEW NOTES | SOLUTION GUIDE: Interest expense ( P4 million x 7.75%) Dealer's fee (P4 million x 0.00125) Total cost of selling commercial papers Divided by net proceeds: Face value - Compensating balance Effective cost of the commercial Papers Effective cost of bank financing Itis advisable for Carmelo to use the 1.67% in effective interest rate. _ P 310,000 5,000 315,000 P 4,000,000 400,000 3,600,000 ———_ 8.78% % commercial paper financing and save ee Cash and Marketable Securities Management o MULTIPLE CHOICE QUESTIONS management fow f the following actions would not be consistent with good management? erased synchronization of cash flows i | A minimize the USE of float. iF Maintaining an average cash balance equal to that required as a compensating balance or that which minimizes total cost. 5 Use of checks and drafts in disbursing funds (rpcpa) spe one which is not consistent with good management. Cash management deals with balancing the cash inflows of the business with that of ‘5 cash outflows. In periods where additional cash is needed, the sources of ‘racing must be identified and activated. In periods of excessive cash, the viable sestments must be tapped. The following are indicative of good cash management: = Maintaining an optimum cash balance that minimizes the total cost of cash or maintaining a minimum cash balance that equals the required compensating balance. » Speed-up cash collections + Effective credit standards, analysis and approval. Effective collection policies such as use of mailbox, pick up points, electronic fund transfer, concentration banking, and updated and accurate billing system. * Delay cash payments Use of drafts Use of checks for better internal control and to maximize float Use of TGIF (Thank God, Its Friday) policy in the issuance of checks. Bill first, before payment policy. _froierletter “a’, “c” and “d" are all good cash management policies. Choice- “0 minimizing the use of payment float, is not a good cash payment policy _.<* of the following investments is not likely to be a proper investment for Paty idle cash? eo Public offering of an established profitable conglomerate mercial Tee Paper. S Su 2 Te SU bills, 16 @ury bonds due within one year. (rpepa) ie tegen 'S not likely to be a proper investment in temporary idle cash ™~ Contrib Cash ought to be used (or invested) somewhere to give a faw return ty ary, eS 'N increasing the common equity of the firm It the excess cash is berms, Place it in temporary investments _ If the excess cash Is permanent, place Nt investments, |MULTIPLE CHOICE| Ow a ~ b Maher Cash and Marketable Securities Management Temporary investments are those expected to be converteg i notice. Examples of temporary investments are short-term ti notes, Philippine Treasury Bills, negotiable instruments, commercial papers, and those in the securities but are rea temporary investments in shares of stocks and bonds). Initial public offering (IPO) of an established conglomerate, ¢, and treasury bills are examples of temporary investments. one year, are not temporary in nature (e.g., one year) investments are in bonds (where the bond market is not financial markets) and that bonds are in treasury. Hence, choi nto Cag) = Aeposits, bron, Shag " Other gy S80, dily Marketable oe as Hin Merciaj ple ban iret fact that a active in Phi the ice-letter “q” jg conent® A precautionary motive for holding excess cash is A. To enable a company to meet the cash dem business activity. B_ To enable a company to avail itself of a si rise to higher levels C. To enable a company to have cash to meet emergencies that may ati periodically We D. To avoid having to use the various t cover projected cash deficits lands from the AOMMAl flay ¢ pecial inventory purchase before pric lypes of lending arrangements available to (rpcpa) Cc A precautionary motive for holding cash. Under normal conditions, there are three (3) or emergencies where e: the company to stay ahead in competition by intellectually predicting business trends (2.g., buying more inventory before Prices increases in times of recession, also cal! as black-marketing) Choice-letter “c” is the c cash. Choice-letter “a” motive. Choice-letter he correct answer, it refers to precautionary motive of holding 's a transactional motive. Choice-letter “b" is a speculati? “d" relates to prudent cash Planning and management. The following practices will 1. Sales personnel are un 2. Sales commissions are 3. Statement of accounts sent for confirmation. 4. Automatic transfer of f branches Of the above, which will result A. All statements. B. Statements 1, 3, and 4 only. impact the cash flow of the company: lequivocally responsible for collecting their credit sales based on collected invoices. ula receivable are reconciled with customers and rea! so lunds is arranged with banks regarding depos! It to better cash flow? C. Statements 3 and 4 only (coc) D. Statement 4 only —_ ao er cash flows ® statements 4 Cash and Marketable Securities Management 948 ractice(S) that results to better cash flows “etter “C” IS correct. The practices mentioned in statements 3 and 4 refer to ion policies Reconciliation and confirmation of accounts with customers “and tic transfer of funds regarding bank deposits of branches are meant to result tt and 2 will result to weak cash flow controls since sales are tions while collection of credit sales is a custodianship (e g , treasurer's erating func ynction) Combining these two functional responsibilities into the hand of a person ish the effectiveness of internal control, and therefore, will not result to ul id dimin! better cash flows. : compensating balance ; a compensates a financial institution for services rendered by providing it with deposits of funds. ; g. Isused to compensate for possible losses on a marketable securities portfolio ¢ isa level of inventory held to compensate for variations in usage rate and lead- time p isthe amount of prepaid interest on a loan. (cma) 5A 7 Astatement about compensating balance. institutions to be Py compensating bal maintained or deposit borrowed. Choice-letter “a” is correc’ the effective borrowing rate by reducin: Choice-letter "b” is incorrect because a Co! borrowings and ssincorrect because it refers to safe lance is normally required by financing ited by the borrower as his equity contribution on the amount . Effectively, a compensating balance increases g the net proceeds of the amount borrowed. mpensating balance is used for cash not for marketable securities portfolio transactions. Choice-letter “c” sty stock. Choice-letter “d” is incorrect because it tefers to discounted interest on the loan. # Anautomated clearing house (ACH) electronic tr A Electronic payment to a company’s account ai 8 Check that must be immediate! © Computer-generated deposit ticket veri D Check 'like instrument drawn against the paye' A 2geseipton about automated clearing house ( a is transfer (or electronic fund trans coll account to another using electron' lecting companies to expedite coll an Mstity lutions Choice-letter “a” is correct. 8 not ansfer is a(an) t a concentration bank. ly cleared by the Bangko Sentral ng Pilipinas. ifying deposit of funds. rand not against the bank. ACH) electronic transfer. fer or EFT) is a movement of cash balance ics technology. This is normally harnessed lections from customers, near or far, by Ss of electronic fund transfer services offered by banks and other financing pcedetter “b" is incorrect because it refers to outstanding checks, and a check Involved in EFT. Choice-letter “c’ is incorrect because it relates to deposits |MULTIPLE CHOICE| |MULTIPLE CHOICE| — 949 Cash and Marketable Securities Management Chapter 17 from various sources and not transfer of funds from specific customers Choice-tette, “d" is incorrect because an EFT is not a check-like instrument 7. A working capital technique that increases the payable float and therefore delays the outflow of cash is A. Concentration banking. C. Electronic data interchange (EDI). B. Adraft. D. A lockbox system. (cma) 7. B 2 Aworking capital technique that increases the payable float and delays the outflow of cash. 2 Float refers to the period of time a check or a draft is cleared through the banking system. A draft is a 3-party instrument in which a drawer orders the drawee to pay the money to the payee, and is a means of slowing cash outflows. It normally takes an extra day to clear a draft than a check. Hence, choice-letter “b” is correct. Choice-letters “a” and “d” are incorrect because concentration banking and lockbox system are means of accelerating cash inflows. Choice-letter “c” is incorrect because an EDI is an electronic technique used by suppliers and customers to facilitate faster delivery of quality materials. 8. Which one of the following is not a characteristic of a negotiable certificate of deposit? Negotiable certificates of deposit A. Have a secondary market for investors. B. Are regulated by the Bangko Sentral ng Pilipinas. C. Are usually sold in denominations of a minimum of P100,000. D. Have yields considerably greater than bankers’ acceptances and commercial paper. (cma) 8. D The description that is not a characteristic of negotiable certificate of deposit. © A certificate of deposit (CD) is a form of savings deposit that cannot be withdrawn before its maturity without incurring a higher penalty. Sometimes, it is called as tne certificate of time deposit. Other CDs may be traded, hence they are called as negotiable certificate of deposit. This form of temporary investment is less risky than that of commercial paper and bankers’ acceptances, and therefore yields a lower, not higher, rate. Choice-letter “d" is correct. ‘i Choice-letters ‘a’, “b", and c” are incorrect because negotiable cettificate of deposits are negotiable and therefore have secondary market, regulated by BSP since they are channeled through the banking sector, and are usually sold with minimum denominations 9. The most direct way to prepare a cash budget for a manufacturing firm is to include A. Projected sales, credit terms, and net invoice. B. Projected net income, depreciation and goodwill amortization. C. Projected purchases, percentages of purchases paid, and net income. Cash and Marketable Securities Management 950 chapter ui projected sales and purchases, percentages of collections, and terms of payments. (cma) D e items included in the direct way of preparing cash budget. 7 cash budget is the financial plan regarding cash inflows and outflows of a firm in a | o riod. A cash budget prepared on a direct way itemizes cash receipts and qisbursements. The more visible components of a cash budget prepared on a direct way are collections - from customers and payments to merchandise suppliers, salaries, and other important Operating expenses. As such, choice-letter “d” 1s Budgeted collections from customers are coming from projected sales while budgeted payments to suppliers originate from purchases. Choice-letter “a” is incorrect because it does not include cash payments. Choice- letter “b” is incorrect because depreciation and goodwill amortizations are added back to net income in computing the net cash flows from operations using the indirect method of cash flows presentation. Choice-letter “c” is incorrect because it does not include sources of cash receipts. Given the following events, which affect cash flows from operations? 1. Cash sale 2. Cash dividends paid 3. Purchase of a long-term asset 4. Purchase of inventory 5. Paid employees i 2and 5. 1 4and 5. (rpcpa) eo » o 3 a a oa 1 The transactions that affect cash flows from operations. ‘Q Choice-letter “a “is correct; cash sale is a cash inflow from operations and payment ‘oemployees is a cash outflow to operations. tem no. 2, payment of cash dividend, is a financing activity. Item no. 3 does not Specify whether the purchase is cash or non-cash and if ever purchased on cash is to be classified as an investing activity. Item no. 4 does not mention whether the Purchase of inventory is on cash, hence, assumed to have been made on account : Yea Corporation had income before taxes of P60,000 for the year 2006 Included in 's amount was depreciation of P5,000, a charge of P6,000 for the amortization of discounts, and P4,000 for interest expense. The estimated cash flow for the Is § °80,000 C. P49,000 68,000 D. P71,000 (cma) i 7 The Sstimated cash flow for the period. |MULTIPLE CHOICE| |MULTIPLE CHOICE| 951 Q 12. 13. BYS ee Cash and Marketable Securities Management co ter The cash flow from operations may be computed using the indirect me! flow presentation, as follows: Income before income taxes P60,000 + Non-cash items: Depreciation expense 5,000 Bond discounts amortization 6,000 Net cash inflow from operations P71,000 The income before income taxes automatically becomes the net inco, there is no applicable tax rate given. thd ot cap ME because Bing and Bong’s Store is on the cash basis of preparing it funds stat EMENt. These data are available: Decrease in working capital P50,000 Depreciation 13,000 Increase in cash 25,000 Repairs and maintenance 19,500 Total uses of cash 454,000 Calculate the total sources of cash of Bing and Bong's Store A. P472,500 C. P479,000 B. P492,000 D. P467,000 c The total sources of cash. The total use of cash is the data given in the below: (rpcpa) given together with the increase in cash balance. Based or problem, the total sources of ash is P479,000, as determinet Total uses of cash P454,000 Add: Increase in cash 25,000 Total sources of cash P479.000 Better still, if the cash balance beginning is given. The total sources of cash s"8 then be cash bal: 7 oe lance beginning plus total uses of cash. Shown below is a forecast of sales fol T Carlos Inc, for the first four months of 2008 3 amounts are in thousand of Pesos). 2006 Cash sales me ae roa Pd Sales on credit 100 120 90 70 ane eee sales are paid for in the month of sale, 30% in a petite ga ea Mainder is paid 2 months after the month © lebts, t! 5 > March's A. P138,000 he expected cash inflow for Carlos in 2.000 C P119.000 nal 2 D. P108,000 (or a Cash and Marketable Securities Management xpected cash inflows in March 2006. [ credit sales collection pattern is 50-30-20, which means that March credit sales Tre Gon will come from January sales (20%), February sales (30%), and March co (50%), 28 follows: se sgliections from credit sales: January sales (P100,000 x 20%) P 20,000 February sales (P120,000 x 30%) 36,000 , March sales (P90,000 x 50%) 45,000 Cash sales 18,000 Cash inflows in March 2006 P119,000 assume that each day a company writes and received checks totaling P10,000_ If it takes 5 days for the checks to clear and be deducted from the company’s account, and only 4 days for the deposits to clear, what is the float? & P10,000 C. P(10,000) ap O D. P50,000 (cma) A The amount of the float. ) The float referred here is the net float. A float is a time spent between the day the check is written until the day the check is withdrawable or the deposit is cleared The net float refers to the difference of the check float and the deposit float, as follows Check float (P10,000 x 5 days) P50,000 Deposit float (P10,000 x 4 days) 40,000) Net float (P10,000 x 1 day) P10,000 t Deposit float is sometimes referred to as “availability float” while the check float is aso called as “disbursement float’ Butt is a newly established janitorial firm, and the owner is deciding what type of checking account to open. Butit is planning to keep a P500 minimum balance in the acount for emergencies and plans to write roughly 80 checks per month. The bank cherges P10 per month plus P0.10 per check charge for a standard business ecking account with no minimum balance. Butit also has the option of a premium business balance that requires a P2,500 minimum balance but has no monthly fees slag check charges. If Butit's cost of funds Is 10%, which account should Butit Shoose’ A Standard account, because the savings is P34 per year. ue account, because the savings is P34 per year. ndard account because the savings is P16 per year. emium account because the savings is P16 per year Coo wav (cma) % he checking account that should be chosen a |MULTIPLE CHOICE| . . 2? Adisadvantage using EDI in dealing with a supplier. |MULTIPLE-CHOICE}. +, = GODyY _. Ch hey Cash and Marketable Sccurities Management The checking account to be maintained should give the lower checking account facility, as follows: Cost of using a standard checking account Bank charges [P10 + (80 x P0.10) x 12 mos] P216 00 Cost of funds (P500 x 10%) 50.00 P265 9) Cost of using premium checking account (P2,500 x 10%) 250 09 Advantage of using the premium checking account P t60¢ Globe Products has received proposals from several banks to estabjish 8 lock system to speed up receipts. Globe receives an average of 700 checxs : = averaging P1,800 each, and its cost of short-term funds is 7% per year Assim! that all proposals will produce equivalent processing results and using a oat year, which one of the following proposals is optimal for Globe? te) A PO.50 per check. A flat fee of P125,000 per year. A fee of 0.03% of the amount collected. A compensating balance of P4,750,000. OSt Of 9), a» 4 hy D The optimal proposal received from several banks. 3 The business receives 700 checks per day, an average of P1,800 a day, and a cost of funds of 7% per year. The costs of the several proposals are: Cost of proposals a. P0.50 per check (700 checks x P0.50 x 360 days) P126,000 b. Flat fee 125,000 c. 0.03% of amount collected (P1,800 x 700 checks x 360 days x 0,03%) 136,080 d. Compensating balance (P1,750,000 x T%) 122,500 (lowest) Proposal “d”, maintaining a compensating balance of 1,750,000 would only co: business P122,500, and has the lowest cost among the proposals submitted 2° therefore is the most desirable and optimal proposal. Franklin, Inc., is a medium-size manufacturer of toys that makes 25% of its saes® Mel Company, a major national discount retailing firm. Mel will be requiring ie and other suppliers to use Electronic Data Interchange (EDI) for iv replenishment and trade payments transactions as opposed to the pape" systems previously used. advantages using EDI in its d A. Access to Mel's inventory balances of Franklin's products. B. Better status of deliveries and Payments. C. Compatibility with Franklin's of ‘ ther procedures and systems D. Reduction in the payment float. oy x Franklin would consider all of the following © lealings with Mel except ona) yom 17.D |

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