Ch.

9: Liquid Asset
Management

 2000, Prentice Hall, Inc.

 Liquid Asset Management
CASH- motives for holding cash:

 Transactions: to meet cash needs that

arise from doing business.
 Precautionary: having cash on hand for
unexpected needs.
 Speculative: to take advantage of
potential profit-making situations.
 Cash Management
CASH:

 Trade Off: cash decreases risk of

insolvency, but earns no returns!
Cash Management
CASH:

 Objectives:
 have enough cash on hand to meet
disbursal needs.
 Minimize investment in idle cash
balances.
 Marketable Securities
Considerations
 Financial Risk - uncertainty of
expected returns due to changes in
issuer’s ability to pay.
 Interest rate risk - uncertainty of
expected returns due to changes in
interest rates.
 Marketable Securities
Considerations
 Liquidity - ability to transform
securities into cash.
 Taxability - Taxability of interest
income and capital gains.
 Yield - Influenced by the previous 4
considerations.
 Marketable Securities
Types
 Treasury Bills - short term securities
issued by the U.S. government.
 Marketable Securities
Types
 Federal Agency Securities - Debt
issued by agencies, including:
 Federal National Mortgage Association
(Fannie Mae)
 Federal Home Loan Banks
 Federal Land Banks
 Federal Intermediate Credit Banks
 Banks for the Cooperatives
 Marketable Securities
Types
 Bankers’ Acceptances - short term
securities used in international
trade. Sold on discount basis.
 Negotiable CDs - short-term
securities issued by banks, with
typical deposits of $100,000,
$500,000 and $1 million.
 Accounts Receivable
Management
Size of Investment in Accounts Receivable
 Percent of Credit Sales to Total Sales
 Level of Sales
 Terms of Sale
 Quality of Customer
 Collection Efforts
 Accounts Receivable
Management
Terms of Sale
 quoted as a/b net c , which means
“deduct a% if paid within b days,
otherwise pay within c days.”
 example: 3/30 net 60, means
“deduct 3% if paid within 30 days,
otherwise pay the entire amount
within 60 days.”
 Accounts Receivable
Management

Terms of Sale
 annualized opportunity cost of
foregoing a discount:
 Accounts Receivable
Management

Terms of Sale
 annualized opportunity cost of
foregoing a discount:

a 360
x
1-a c - b
Accounts Receivable Management

a 360
x
1-a c - b
opportunity cost of forgoing 3/30 net 60:

.03 360
1 - .03
x 60 - 30

= 37.11%
 Inventory Management
 Too much inventory is expensive
and wasteful.
 Not enough inventory can result
in lost sales.
 Inventory Management
 Raw materials inventory - basic
materials to be used in the firm’s
production operations.
 Work-in-process inventory - partially
finished goods requiring additional
work before becoming finished goods.
 Finished-goods inventory - completed
products that are not yet sold.
 Stock of cash - inventory of cash to
allow payment of bills.
 Inventory Management
 Optimal inventory order size: the
Economic Order Quantity (EOQ)
model:
 Inventory Management
 Optimal inventory order size: the
Economic Order Quantity (EOQ)
model:

2SO
Q* =
C
 Inventory Management

Q* = 2SO
C
Q = inventory order size in units
C = cost of carrying 1 unit in inventory
S = total demand in units over planning
period
O = ordering cost per order
 Example: Inventory Management

Q* = 2SO
C
Q = inventory order size in units
C = cost of carrying 1 unit in inventory = 1.25
S = total demand in units over planning
period = 10,000 units
O = ordering cost per order = $250
Example: Inventory Management

2SO
Q* =C
Example: Inventory Management
2SO
C

Q* =
2x250x10,000
1.25

Q* =
Example: Inventory Management
2SO
C

Q* =
2x250x10,000
1.25

= 2,000 units

Q* =
 Order Point Problem

Average EOQ
= + safety stock
inventory 2
Calculate Average inventory if
safety stock is 575 units
 Average inventory = EOQ/2 + Safety stock

 2000/2+575
 1,575 Units