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It is the art of synchronizing cash recepts and

payments for effective cash managment in a firm.
Cash is the most liquied current asset and there
are motives like transaction, speculation and
precaution which determine the need for cash in
an organisation. I order to meet the different
requirements of cash, there are certain
techniques, strategies and model which are
adopted for optimum cash balalnce
Cash consists of cheques, drafts, demand
deposits and currency. The broader view of cash
is to include those assets which are called 'near
cash assets'.

Transaction- For carrying out the day to day

Precautionary - To meet uncertainities of
business like in case of natural calamities, strikes
and lockouts.
Speculative - To avail the lucraatie opportunites
in the market.
Compensatory- To maintain a balance in the
bank as per the bank requirement
Meeting payment schedule
The receipts may not synchronize with the
payments, therefore to keep the operations in the
business going, the company has to keep extra
cash. Moreover the payment should be made on
time to create healthy relations with the creditors
and to avail cash discounts.
Minimising cash balances
As discussed earlier, idle csh is he most non-
productive asset. So the idle funds should be so
managed that they are not kept idle. For this
strategies like cash budget and cash cycles
should be adopted.
Factors determining cash requirements
Cash inflows and outflows- A cash budget can
be prepared for ascertaining the inflow and
outflow of cash to make cash available in times of
Cost of cash balance- A balance between the
cosst of carrying cash nad the cost of not carrying
cash has be created.
Cash cycle- the time period from cash to
conversion of cash is known as cash cycle. The
shorter is the cycle , lesser would be the cash
Short costs - The costs the compnay has to bear
because of shortage of cash should be
ascertained in order to reduce such costs.
cash cycle and cash turnover minimum cash
Cash cycle= Accounts receivable=Production
cycle-Accounts payable
Stretching accounts payable - This way the
company can reduce its cash requirements by
increasing the cash turnover.
Cash collection/inclows
Concentration banking
Lock box system
Surplus cash
Cash shortages
Baumol's model: Baumol suggested the model
same as EOQ model for the ppurchase of
optimum number of inventory units. He suggested
that point where the carrying cost is equal to the
transaction cost it is the optimum level of cash
Where C= Optimum cash balance
u= No. of units
t= Transaction cost
i= rate of interest.
Assumptions of the baumol model
The requirements of cash is estimated in
The cash payment are steady
It assumes the transaction costs but not cost of
Limitations of Baumol model
Measurement of trasaction cost is difficult as
every security has different rate and different
Baumol assumes that cash uses at constant
Miller-Orr model
This model expands Baumol's model and project
that the cash balance fluctuates and when the
balace is high, it should be transferred into
marketable securities. Whereas, when the cash is
low marketable securities hould be sold. Control
limits for the cash are to be set. When the higher
limit is reached, the cash should be invested and
when the lower limit is reached, the securites
should be sold.
Receivables management
It is another important area of working capital
management. This is an analysis of sales
made by the company on credit. Pure cash
sales do not get good return for the firm. When
firm sells on credit, it has to consider costs
attached to it and the risk of bad debts. In order
to streamline its credit sales it must make
cerain policies. These policies are bsed on
collection costs, credit standards, investment in
receivables and sales volume of he firm.
Finally in order to efficiently collect its cash it
has to make certain policies.
Objectives of Receivables management
Analyze the cost of receivables
Evaluate the benefits of receivables by
establishing a cost benefit analysis
Have a trade off between profitability and
Prepare credit policy by analysing credit
standards and credit terms like credit period
and discount
Evaluate and control receivables
Cost of Receivables
Cost of financing : The fund get locked in
transactions for the period of extension of
credit, so the firm has to create additional
resources to maintain its level of production
and sales.
Administration cost : The cost incurred in
collecting the debts, corresponding and also in
enquiring about the credit-worthiness of the
debtors which incurs extra cost.
Delinquency cost : The extension of the credit
period demanded by the debtors creates
further delay to the firm which is called
delinquency cost.
Cost of defaults : the loss born by the firm in
case of bad debts is cost of defaults.
Advantages of Receivables
Increased sales : Credit sales boost the
volume of sales. Liberal credit and easy
payment terms provides the benefit of growth
in a firm and higher profits.
Increased profits : Easy credit terms will
increase sales and the firm will be able to
attain its break even position and also fixed
Credit Policy
The credit policy has to be effective in
conducting the credit sales of the firm. To make
the policy effective a decision has to be taken
on the relaxation of the credit period and the
terms offer to the customers on such policy.
Credit standards: It consists of examimining
the credibility of the customer. The firm has to
take a decision on the basis of references,
credit rating and financial information of the
customer. For judging the credit standards 5Cs
are used, namely, character, capacity,
condition, capital
Character means willingness to pay
Capacity means ability to pay
Capital is financial position of customer
Collateral means security offered by customer for
Condition means the type of economic factors
which affect his ability to pay.
Credit Terms
The terms of credit can either be same for a group of
customers or separate for individual customers
depending on the abililty of the customers to pay.
Credit period: The extension of time given to the
customer. This can be done to increase the sales
volume. This depends on cash requirement of the
business firm and the credibility of the customers.
Discounts : A discount offer to the customers reduces
the inflow of cash. These terms consist of the period
extended for discounts and the rate of discount. For
example 4/10 net 40 means that a 4% discount will be
offered if the customer pays within 10 days. If he does
not pay within that period then payment should be
made within 40 days without any discount.
Credit Evaluation
The relaxed credit terms and discounts should
not be extended to all customers. A strict
evaluation policy should be prepared and only
those customers who qualify for easy credit
terms and sicounts should be allowed the
benefits. The reason for this is the risk of
default. After the customers qualify for easy
terms they should still be monitored and on the
basis of their continued evaluation support
should be extended to them.
The credit information can be collected from the
following sources:
Bankers references: Bankers provide information
of great value. Although they do not show the
financial records of their cusstomers, they do give
information whenver it is required depending on
the terms of the company with banks.
Published financial statements: Large companies
have published financial statements. When small
firms approach the firm for credit and discount,
personal information and analysis of audited
balance sheet provide information about the
Inspection to the office premises : The firm can
send its representatives to inspect the offices,
store and factory and take an estiate of the
credit worthiness of the customer and make
evaluation as per 5 Cs.
Credit agents reports : Credit rating is possible
by hiring a credit agent to give a report of the
Control of Receivables
Monitoring receivables
(a)The firm has to prepare the average collection
period by calculating the average receivables
and the credit sales per day. Monitoring has
tobe done on weekly basis:
Avg collection period=Avg receivables/Credit
sales per day
Avg rec turnover= No. of days/Avg Collection
(b)Ageing schedule: Receivables can also be
monitored by preparing an ageing schedule.
This is calcualted through the number of days
of default. For eg, if the firm has a policy for
allowing 15 days crdit then the ageing
schedule can be prepared in the following way:
% of outstanding
Age group
Above 15 days 20
15-30 10
30-45 5
45-60 1
This shows that the firms monitoring process is
good because there are hardly any debts
between 45 days and 60 days. 1% may be due
to bad debts.
(c)The degree of risk means the maximum credit
grant to a customer. Those customers who are
of high risk group should be given less credit
compared to those who are of a lower risk
group. Hence, customers should be classified
to see if credit facilities should be provided or
(d)Accounting ratios: The firm should monitor the
collection of credit by the use of accounting
ratios to find out the change inthe pattern of
receivables. Some of these ratios are the
receivable turnover ratio as well as the average
collection period.
Evaluation of credit policy
The credit policies must be evaluated carefully
on the basis of the both profit and cost. The
cost of each proposal should be analysed.
Further, the incremental cost and the
incremental profits should be evaluated.
Inventory management
Inventory consists of raw material, WIP and
finished goods. Raw materials are the basic
material used for manufacturing a product.
Usually raw materials are purchased for
production form different sources to ger
maximum benefit of price and qualilty. Firms
usually find the sources where such materials
actually exist and purchase form there after
calculating their own requirements. Inventory
must be controlled because lossses arise if it is
not safely and properly stored. techniques of
inventory management can be applied.
Objectives of inventory management
To minimise firm's investment in inventory
To ensure smooth flow of materials in
production and sales operations
To have an optimum level of inventory through
trade off between cost and benefits of storing
and not storing inventory in a firm.
Benefits of holding inventory
In production: Firms with seosonal production
can take advantage of making purchases in
bulk and at a discount and use it in production
when required by the firm.
In purchase : Bulk purchase entitles the firm to
avail discounts.
Benefits in sales : Large quantity of inventory
in the form of finished goods will enhance sales
in a company. Efforts can be made to push up
sales by vigourous advertising and such
increased demand can be met by increased
Cost of holding inventory
The objective of inventory managment is to see
there are no shortages in the supply, but the
objective is also to minimise the cost of
inventory. Thus an efficient management and
control is required. The costs can be classified
into following:
(a)Carrying costs : The costs which are incurred
for maintaining inventory in a firm are called
carrying costs. These can be rent, insurance,
cost of security, air-conditioning, fire-proofing.
(b)Ordering costs : Such cost is fixed per order
and includes requisition costs, cost of
transporting, clerical and administration costs.

(c)Hidden costs : These arise when a demand

for a material arises but the level of inventory
of that material is completely finished. This is
called stock-out situation. When such costs
arise it can be said that it is oppurtunity lose
because of not carryint inventory.
Techniques of inventory management
ABC analysis: This technique classifies
inventories into different types and then
controls them. The objective of ABC analysis is
to find those items which are most expensive
but are used in small quantity. Such items
would be called 'A' class
invntory. The items
which are less expensive and also their
requirement is higher would be given less
security then 'A'. SO it gives priority according
to investment value.
Economic order quantity
After making an analysis on the basis of ABC
categories, the finanial manager shold focus
his attention to the quantity of inventory which
is to be purchased. In particular, it is important
to assess the annual requirements and then to
find out the EOQ.The EOQ would help to
provide a trade off between costs and benefits.
It identifies the level of inventory which
minimises the total cost of inventory.
R=Annual requirement, Cp=Cost of placing an
order, Ch= Cost of holding
Setting levels
EOQ has many limitations, therefore the firm
should maintain a safety stock so that if
supplies are not received in time, such stock
can be used as a buffer. A firm should also
maintain its inventory in such a way that the
reoder point is defined and stock is immediately
replenished. At least the order should be sent
for replacement of inventory. Reorder level is
calculated of the basis of the daily use of hte
inventory and the lead time which is necessary
between placing of order and receiving of
delivery of materials.
Reorder level= Average daily usage of
inventoryxlead time
Bin card: It is a card attched toa materials shelf which indicates
the lead time, reorder level and minimum stock level.
Rorder level + re-order qtty-(Minimum
consumption X minimum re-order period)
Reorder level-(Normal consumption X normal
reorder perid)
reorder level
Max reorder period X maximum consumption
average stock level
1/2(MIN level+Maximum level)
Min level +1/2(ReOrder qtty)