A.

RISKS AND RATES OF RETURN

Risk can be measured in many ways, and different conclusions about an
asset’s riskiness can be reached depending upon on the measures used.
Stock Risk can be considered in two ways:
1. a stand-alone, or single-stock - in most cases stand-alone risk is
important in stock analysis primarily as lead-in to portfolio risk
analysis. However stand-alone risk is extremely important when
analysing real assets such as capital budgeting projects.
2. a portfolio context - where a number of stocks are combined and all
their consolidated cash flows are analysed.
RISKS AND RATES OF RETURN (Cont’d)
There is an important difference between stand-alone and portfolio risk,
and a stock that has great deal of risk held by itself may be less risky
when held as part of a larger portfolio.
In a portfolio context, a stock risk can be divided into two
components:
a. a diversifiable risk, which can be diversified away and is thus of
little concern to diversified investors, and
RISKS AND RATES OF RETURN (Cont’d)

b. market risk, which reflects the risk of a general stock market decline and
cannot be eliminated by diversification (hence, does concern investors) Only
market risk is relevant to rational investors because diversifiable risk can and
will be eliminated.

A stock with high market risk must offer a relatively high expected rate of
return to attract investors. Investors are in general are averse to risk, so they
will not buy risky assets unless they are compensated with high expected
returns.
 B. TIME VALUE OF MONEY

This explains how the time value of money works and discuss why it is such
an important concept in finance; calculate the present value and future value
of lump sums; identify the different types of annuities, calculate the present
and future value of both an ordinary annuity and an annuity due, and
calculate the relevant annuity payments; calculate the present and future
value of uneven cash flow stream.
 TIME VALUE OF MONEY (cont’d)
Set Up Time Line – an important tool used in time value analysis; it is a
graphical representation used to show the timing of cash flows. Time line is
presented in the following Diagram:
1. Step By Step Approach
To find the Future Value of P100 compounded for 3 years at 5% is:
Periods 0 5% 1 2 3

P100 P105 P110.25 P115.76

Where: PV is Present Value and FVN is Future Value or the Value N periods into
the future
CFt = Cash Flow where t is the period. Thus, CF0 = PV = Cash flow at time 0
whereas CF3 is Cash flow at Period 3
I = Interest rate earned per year
INT = Interest amount
N – Number of periods involved in the analysis
TIME VALUE OF MONEY (cont’d)

1. Formula approach
In this approach we use the equation FVN = PV(1+1)ⁿ
FVN = PV (1+I)ᴺ = P100(1.05)ᵌ = P115.76

2. Financial Calculator (Calculator Approach)

This approach makes use of the Financial Calculator
Where: N = Number of Periods
1/YR = Interest rate period
PV = Present Value
PMT = Payment
FV = Future Value where PV is negative
 TIME VALUE OF MONEY (cont’d)

3. Excel Approach
In your spreadsheet, use FV function
FVN = FV(rate,nper,pmt,pv,type)
FVN = FV(0.05,3,0,-100) = 115.76
In excel formula, the terms are entered in this sequence: interest, periods, 0 to
indicate no intermediate cash flows, and then the PV
Present Values
To find the Present Value, using Formula Approach the formula is:
PV = FVN (1+1)ᴺ
Excel Approach PV = PV(rate,nper,pmt,fv,type)
PV(0.05,3,0,115.76) = P100
 TIME VALUE OF MONEY (cont’d)
Finding Interest Rates
In finding interest rates, you can use equation using the existing Formula
approach and use Calculator approach.
Using excel approach - RATE = RATE(nper,pmt,pv,(fv),(type),(guess))
Thus for example – given bond has a cost of P100 and that it will return P150
after 10 years so we know PV, the N and the FV:
=RATE(10,0,-100,150) = 4.14%
 
Finding Number of Years in excel
=NPER(rate,pmt,pv,(fv),(type))
=NPER(0.0414,0,-100,150) =9.9990 or 10 years
 
C. BOND AND STOCK VALUATION
CONCEPT
What is a Bond? Who issues Bond?
A Bond is a long term contract under which a borrower agrees to make
payments of interest and principal on a specific dates to the holders of the
bond. Bonds are issued by the corporations and Government Agencies
that are looking for a long-term debt capital. Bonds may either be:
Treasury Bonds –referred to as government bonds; Corporate Bonds - bonds
issued by a corporation; Foreign Bonds – bonds issued by foreign
government.
Key Characteristics of Bonds:
Par Value Coupon Interest Rate Maturity Date
Call Provisions Sinking Funds Original Maturity Fixed-Rate
Bonds Zero Coupon Bonds Floating-Rate Bonds
 
C. BOND AND STOCK VALUATION
CONCEPT
Other Features of Bonds
•Convertible Bonds – bonds convertible to common stock
•Warrants – giving the holder the right to buy a security at a particular price
•Putable bonds – provides the holder to force the issuer to redeem the b4 maturity
•Income Bond – only the face value of the bond is promised to be paid by the holder
•Callable Bond – can be redeemed by the issuer before maturity
•Indexed (Purchasing Power) Bond – interest payments is based on P-index
•The following general equation can be solved to find the value of any bond:
Bond’s Value = Bν = INT + INT + INT + INT
(1+rd)1 (1+rd)2 (1+rd)n (1+rd)n

= N + INT + N (1+rd)t
(1+rd)n
Where: VB = Value of the bond
INT = Interest
Rd = Coupon rate
M = Maturity
BOND AND STOCK VALUATION CONCEPT (cont’d)

Using Excel’s PV function you can calculate the present value of the Bond
Example: A friend of yours invested in an outstanding Bond with 5% annual
coupon and a remaining 10 maturity years and annual coupon payment of
P50. The par value of the bond is P1,000 and the market interest rate is
currently 7%. How much did your friend pay for the bond? Is it a discount
bond or premium bond?
 Solution: = PV(0.07,10,50,1000) = P859.53 = A discount bond
Note: A discount bond is a bond that sells below its par value A
premium bond is a bond that sells above its par value

to counter check using Excel Function - =PMT(.07,10,-859.53,1000) = P50

BOND AND STOCK VALUATION CONCEPT (cont’d)

Yield to Maturity
Supposed you were offered a 14-year, 10% annual coupon, P1,000 par value
bond at a price of P1,494.93. What rate of interest would you earn on your
investment if you bought the bond, held it to maturity, and received the promised
interest and maturity payments? This rate is called Yield to Maturity (YTM). You
need to solve it through equation but using the Excel’s RATE function it would go
like this:
  =RATE(14,100,-1494.93,1000) = 5%
  Note: to find PMT of P100: =PMT(0.05,14,-1494.93,1000) = P100
Now assume that this bond is callable in 7 years at a price of P1,075, what is the
bond’s Yield to Call (YTC)?
= RATE(7,100,-1494.93,1075) = 3%
where: PMT =PMT(.03,7,-1494.93,1075)=P100
BOND AND STOCK VALUATION CONCEPT (cont’d)

Stocks
Generally, Stocks is an ownership in a corporation. Stocks represent
partial ownership, or equity, in a company. When you buy stock, you’re
actually purchasing a tiny slice of the company — one or more "shares."
And the more shares you buy, the more of the company you own.
Preferred Stock
A main difference from common stock is that preferred stock comes with
no voting rights. So when it comes time for a company to elect a board of
directors or vote on any form of corporate policy, preferred shareholders have
no voice in the future of the company. In fact, preferred stock functions
similarly to bonds since with preferred shares, investors are usually
guaranteed a fixed dividend in perpetuity.
BOND AND STOCK VALUATION CONCEPT (cont’d)

Common stock
Common Stock represents shares of ownership in a corporation
and the type of stock in which most people invest. Common
shares represent a claim on profits (dividends) and confer voting
rights. Investors most often get one vote per share- owned to elect
board members who oversee the major decisions made by
management. Stockholders thus have the ability to exercise control
over corporate policy and management issues compared to
preferred shareholders.
BOND AND STOCK VALUATION CONCEPT (cont’d)

Intrinsic Value of a Stock

Intrinsic value is an estimate of the actual value of a company,
separate from how the market values it. Value investors look for
companies with higher intrinsic value than market value. They see this
as a good investment opportunity.
Market Value of Stock
Market value is simply a measure of how much the market values
the company, or how much it would cost to buy it. Market value is easy
to determine for publicly traded companies but can be a little more
complicated for private companies.
BOND AND STOCK VALUATION CONCEPT (cont’d)

a. Dividend Discount Model

When figuring out a stock's intrinsic value, cash is king. Many models
that calculate the fundamental value of a security factor in variables largely
pertaining to cash: dividends and future cash flows, as well as utilize the 
time value of money. One model popularly used for finding a company's
intrinsic value is the dividend discount model. The basic formula of the DDM
is:
Value of Stock EDPS P6 CCE –DGR
0.08 - .05 P200
Where: EDPS = Expected Dividend per share
CCE = Cost of Capital Equity
DGR = Dividend Growth Rate
BOND AND STOCK VALUATION CONCEPT (cont’d)

b. Gordon Growth Model

One variety of this dividend-based model is the Gordon Growth
Model, which assumes the company in consideration is within a
steady-state—that is, with growing dividends in perpetuity. It is
expressed as the following:
Intrinsic value of stock = D÷(k-g)
Where: ​D=the estimated value of next year’s dividend
k = is the investor's rate of return required
g = the expected dividend growth rate
BOND AND STOCK VALUATION CONCEPT (cont’d)

c. Discounted Cash Flow Models

Finally, the most common valuation method used in finding a
stock's fundamental value is the discounted cash flow
model analysis. In its simplest form, it resembles the DDM:

DCF = (CF/(1+r)ⁿ¹) + (CF/(1+r)ⁿ²) + (CF/(1+r)ⁿ³) + . . . . +

(CF/(1+r)^¹) ^ⁿ
Where: CF = Cash Flow in Period
R = interest rate or discount rate
N = number of period
D. WORKING CAPITAL MANAGEMENT
Working Capital – is current asset often called Working Capital because
these assets are used and replaced during the year.
Net Working Capital – is defined as current assets minus current liabilities
Net Operating Working Capital (NOWC) – represents the working capital
that is used for operating purposes. NOWC differs from Net working Capital
because interest bearing notes payable are deducted from current liabilities in
the calculation of NOWC. The reason for this distinction is that most
analysts view interest bearing notes payable as financing cost (similar to long
term debt) that is not part of the company’s operating free cash flows. In
contrast, the other current liabilities (accounts payable and accruals) are
treated as part of company’s operations, and therefore are included as part of
free cash flow.
NOWC = Current Assets – (Current Liabilities – Notes Payable)
WORKING CAPITAL MANAGEMENT (cont’d)

1. Current Assets Investment Policies – discuss how current assets held

affects profitability. When receivables are high, the firm has a liberal credit
policy, which results in a high level of receivable.
Relaxed Investment Policy – relatively large amounts of cash,
marketable securities, and inventories are carried, and a liberal credit policy
results in a high level of receivables
Restricted Investment Policy – Holdings of cash, marketable securities,
inventories, and receivables are constrained.
WORKING CAPITAL MANAGEMENT (cont’d)

Restricted Investment Policy – Holdings of cash, marketable securities,

inventories, and receivables are constrained.
Moderate Investment Policy – an investment policy that is between the
relaxed and restricted policies
We can use the DuPont equation to demonstrate how working capital
management affects ROE
 
ROE = Profit margin x Total Assets turnover x Equity multiplier
= Net Income x Sales x Asset
Sales Assets Equity
WORKING CAPITAL MANAGEMENT (cont’d)

2. Current Assets Financing Policy – the manner in which current assets are
financed which are categorized by the following approaches:
Maturity Matching or Self-Liquidating Approach – a financing policy
that matches the maturities of assets and liabilities. This is a moderate
policy. For example fixed assets and fixed current assets are financed by a
long term capital while temporary assets are financed by long term debt.
WORKING CAPITAL MANAGEMENT (cont’d)

a. Aggressive Approach – a financing policy approach wherein some fixed

assets being financed by a short-term debt. The policy would be highly
aggressive, extremely non-conservative position, and the firm would be
subject to dangers from loan renewal as well as problems with rising interest
rates. Firms usually take the opportunity of availing short-term financing debt
because of lower interest rates than long-term financing.
b. Conservative Approach – in this approach, the firm make use of long-
term financing to finance all permanent assets and uses small amount of
short-term credit to meet its peak requirements, but it also meets part of its
seasonal needs by storing liquidity in the form of marketable securities.
WORKING CAPITAL MANAGEMENT (cont’d)

Choosing Between the Approaches

All approaches can have both advantageous and disadvantageous to the
company depending on circumstances. The firm’s specific conditions will
affect the choice, as well the preferences of the managers. Optimistic or
aggressive managers would probably lean more toward short term credit to
gain an interest cost advantage, while more conservative managers will lean
towards long term financing to avoid potential loan renewal problems.
However, things depends on the manager’s personal preferences and
judgment.
WORKING CAPITAL MANAGEMENT (cont’d)
Managing Cash Cycle
 Cash Conversion Cycle (CCC)– the length of time funds are tied up in working capital or
the length of time between paying for working capital and collecting cash from the sales of
working capital.
 Inventory Conversion period (ICP) – the average time required to convert raw materials
into finished goods and then to sell them. Or the selling average time of merchandise
(Inventory days)
 Average Collection Period (ACP) – the average length of time required to convert the
firm’s receivable into cash, that is, to collect cash following a sale (Receivable days)
 Payables Deferral Period (PDP)– the average length of time between the purchase of
materials and labor and the payment of cash for them (Payable Days)
 If it takes 60 days the inventory to convert into sale; it takes 60 days to collect the sales on
account; and it takes 40 days for credit accounts payable to be paid; then the Cash
Conversion cycle is:
 CCC = ICP + ACP – PDP
CCC = 60 + 60 – 40 = 80 days
Does 80 days conform to the Industry Standards?
WORKING CAPITAL MANAGEMENT (cont’d)

Cash Budget – a table that shows cash receipts, disbursements, and balances
over some period.
If firm needs additional cash, most likely it needs to forecast cash flows and
should line up funds well in advance. The monthly cash budget begins with
sales forecast for each month and a projection of when actual collections will
occur. Then it follows with forecasted purchases, followed by forecasted
payments. The difference between cash receipts and disbursements will be
either gain or loss. Management should take into account beginning cash
balance to arrive at the target cash balance. Usually, the target cash balance is
the desired cash balance that a firm plans to maintain in order to conduct a
business.
WORKING CAPITAL MANAGEMENT (cont’d)

Cash and Marketable Securities

Generally, cash in the balance sheet should include marketable securities
since the latter is also called cash equivalents and it can be converted to bank
deposits anytime within the period. Marketable Securities are highly liquid
that can be sold quickly at a predictable price. Operating short-term
securities are held primarily to provide liquidity and are bought and sold as
needed to provide funds for operations. While other short-term securities
are holdings in excess of the amount needed to support normal operations.
WORKING CAPITAL MANAGEMENT (cont’d)

Demand Deposits - are checking account deposits used for transactions such
as paying for raw materials, labor and other regular purchase transactions.
These earn no interest so firms minimize their holdings. Most common
nowadays are bank debit or transfer of funds to another bank of suppliers to
ensure prompt cash payments.
 
WORKING CAPITAL MANAGEMENT (cont’d)

Accounts Receivables – these are funds due from customers or clients

The firm’s credit policy is the primary determinant of accounts receivable,
and it is under the administrative control of the Chief Finance Officer (CFO).
Moreover, credit policy is a key determinant of sales and marketing
executives are concerned of this policy
Credit Policy – A set of rules that include the firm’s credit period, discounts,
credit standards, and collection procedures offered.
 
WORKING CAPITAL MANAGEMENT (cont’d)

Credit Period – the length of time customers have to pay for purchases.
A long credit period lengthen the cash conversion cycle and the higher the
probability of the customer to default and that will end up to bad debts. CFO
should also determine background of customers who avail of credit account
by creating credit standards.
 
Discounts – price reductions for early payments.
Offering discounts to customers may sometimes lower the price. The benefits
and cost of discounts must be balanced when credit policy is being
established.
 
WORKING CAPITAL MANAGEMENT (cont’d)
Credit standards – the financial strength customers must exhibit to qualify
for credit.
This includes verifying customer’s credit history thru credit rating agencies
with their credit score card. Tighter credit standards should be balanced
through its costs and benefits.
Collection Policy – degree of toughness in enforcing credit terms.
Sometimes excessive collection pressures to customers would lead to
strangling them. Valued customers may take their business elsewhere thus,
balance must be struck between costs and benefits of different collection
policies.
 
Credit Scores – numerical scores that indicate the likelihood that people or
business will pay on time.
WORKING CAPITAL MANAGEMENT (cont’d)

Monitoring accounts receivables

The total amount of accounts receivables outstanding at a given time is
determined by the volume of credit sales and the average length of time
between sales and collections. For example a sale distributor has sales of
P1,000 per day (all credit) and it requires payment after 10 days. The
distributor has no bad debts and not a slow paying customer. Under those
conditions, it must have a capital of P10,000 receivables.
Accounts Receivables = Sales per day x length of collection period =
P1,000 x 10 days =P10,000
 
WORKING CAPITAL MANAGEMENT (cont’d)

One easy use of monitoring techniques is to employ the DSO:

DSO = Days Sales Outstanding
= Receivables = Receivables Ave. sales per day
annual sales/365
= P375 = P375 P3,000/365
P8.2192
= 45.625 or 46 days
Compare it to industry standard of 36 days
To determine capital tied up in receivables:
 
Receivables = (ADS)(DSO)
= (8.2192)(45.625) = P375 million
 
WORKING CAPITAL MANAGEMENT (cont’d)

Trade Credit - Debt arising from credit sales and recorded as an account
receivable by the seller and as accounts payable to the buyer.
 
Line of credit – an arrangement in which a bank agrees to lend up to a
specified maximum amount of funds during a designated period. It is an
agreement between a bank and a borrower indicating the maximum amount of
credit the bank will extend to the borrower.
 
WORKING CAPITAL MANAGEMENT (cont’d)

Revolving Credit Agreement – a formal committed line of credit extended

by a bank or other lending institution.
 
Prime Rate – A published interest rate charged by commercial banks to large,
strong borrowers.
 
Regular or Simple Interest Rates – the situation when interest only is paid
monthly.
 
Add-on Interest – interest that is calculated and added to funds received to
determine the face amount an instalment loan.
 
WORKING CAPITAL MANAGEMENT (cont’d)

Commercial Paper – unsecured short-term promissory notes of large firms

(most often a financial institution), usually issued in denominations of
$100,000 or more with an interest rate somewhat below the prime rate.
Commercial paper is primarily sold to other business firms, insurance
companies, pension funds, money market mutual funds, and banks, in
denominations of at least $100,000 . It is generally unsecured but “asset-
backed paper” secured by credit card debt and other small, short-term loans
has been issued.
 
WORKING CAPITAL MANAGEMENT (cont’d)

Accruals – continually recurring short-term liabilities especially accrue

wages, accrued taxes rent, etc.
 
Spontaneous Funds – funds that are generated spontaneously as the firm
expands.
 
Secured Loans – a loan backed by collateral, often inventories or accounts
receivables.
E. LIQUIDITY AND CASH MANAGEMENT

What is Cash and Liquidity Management?

Cash and liquidity management is a sub-function of treasury management that
aims to convert sales to available cash as soon as possible and at the lowest
processing cost.
It’s a crucial component in treasury operations; operations which are
concerned with maximising the benefits of surplus funds and minimising the
cost of shortfalls through careful investment and considered borrowing.
Cash management plays an important role in these operations by maximising
the amount of liquid funds available at any time to ensure cash shortfalls are
minimised and more cash is available for investment purposes.
E. LIQUIDITY AND CASH MANAGEMENT (cont’d)

Cash management deals with all aspects of working capital management and
involves many different tasks. The roles and responsibilities of this
department include:
•Forecasting the cash requirements of the business and preparing budgets.
•Establishing necessary banking relationships and providing working capital
finance security.
•Managing the credit collection.
•Ensuring that shortfalls are avoided or minimised and that the business can
always meet its financial obligations.
•Releasing trapped cash
•Extracting liquidity from working capital
•Releasing working capital
F. MANAGEMENT OF SHORT-TERM INVESTMENTS

Setting and Implementing Investment Strategies

The Strategy-Setting Process
The first stage will be to agree an overarching short-term investment
strategy. This will reflect the organization’s risk appetite and will provide
the guidelines for the treasury to develop the investment policy. It is
preferable that the strategy and, ideally, the policy also, is approved at
board level.
MANAGEMENT OF SHORT-TERM INVESTMENTS
(cont’d)

The short-term investment strategy

The short-term investment strategy and policy are key parts of the
organization’s approach to working capital management. In terms of
documentation, the short- term investment strategy need be little more than a
board minute. This should simply state the degree to which the treasury
should focus on each of the three investment objectives, and should reflect
the wider risk appetite within the organization. The real detail will be
incorporated into the investment policy and day-to-day operating procedures.
MANAGEMENT OF SHORT-TERM INVESTMENTS
(cont’d)

The Policy-Setting Process

Once the company has established and documented its risk appetite, the treasurer
can work to develop a short-term investment policy. In terms of process, the best way
to do this is for the treasurer, together with appropriate other colleagues (who might
include the CFO or a treasury committee of the board), to develop a policy. The
policy should then be put forward for board level approval. Again, the precise
process will depend on the structure and culture of the company. Some companies
require treasury policies to be formally approved by the full board; others are happy
to devolve decision-making to a board-level committee. The investment policy
should seek to address the risks outlined below. Once the policy has been approved
at senior level, it is usually appropriate to devolve the approval of detailed operating
procedures to the CFO and the treasurer (depending on the size of the organization)
MANAGEMENT OF SHORT-TERM INVESTMENTS
(cont’d)

Setting Objectives
The first step in setting any investment strategy is to understand the three core
objectives and the interrelationships between them. The three core objectives
are to preserve the invested principal (also known as security or safety), to
maintain access to the invested funds (liquidity), and to maximize the return
on the invested funds (yield).
G. ACCOUNTS RECEIVABLE MANAGEMENT

These key areas will now be explored in more detail.

Assessing creditworthiness
a bank reference – while a bank reference can be fairly easily obtained, it
must be remembered that the other company is the bank’s customer and so a
bank reference will stick to the facts. It is most unlikely to raise any fears the
bank may have about the company
a trade reference – this is obtained from another company who has dealings
with your potential customer/customer. Due to the litigious nature of society
these days, it may not be so easy to obtain a written reference. However, you
may be able to call contacts you have in the trade and obtain an informal oral
reference
ACCOUNTS RECEIVABLE MANAGEMENT (cont’d)

Information from the financial media – information in the national and

local press, and in suitable trade journals and on the internet, may give an
indication of the current situation of a company. For example, if it has been
reported that a large contract has been lost or that one or more directors has
left recently, then this may indicate that the company has problems
Visit – visiting a potential new customer to discuss their exact needs is likely
to impress the customer with regard to your desire to provide a good service.
At the same time, it gives you the opportunity to get a feel for whether or not
the business is one which you are happy to give credit to. While it is not a
very scientific approach, it can often work quite well, as anyone who runs
their own successful business is likely to know what a good business looks,
feels and smells like!
ACCOUNTS RECEIVABLE MANAGEMENT (cont’d)

Setting credit terms and monitoring accounts receivable

As soon as a customer is given credit, the credit terms of the company should
be explained to them. For instance, the normal credit period granted and any
discount for prompt payment, or interest charged on late payment, should be
explicitly detailed to the customer. Very often, the credit terms a company
adopts are the terms that are most common in its trade.
ACCOUNTS RECEIVABLE MANAGEMENT (cont’d)

Accounts receivable aged analysis – this shows the amounts outstanding

from each customer and for how long they have been outstanding. This will
indicate any breaches of the credit terms.
A credit utilisation report – this shows the proportion of each customers
credit limit that is currently being utilised. Therefore, it will indicate where
credit limits may need to be reviewed upwards or downwards and whether
any credit limit breaches have occurred.
 
ACCOUNTS RECEIVABLE MANAGEMENT (cont’d)

Collecting cash
Obviously, if cash is to be collected, then the customer must be invoiced. It is
essential that the invoice is sent out quickly and accurately. The receipt of
your invoice is the first indication a company gets of the efficiency of your
debt collection system. If the invoice takes a long time to arrive and is not
accurate, then your accounts receivable department will be viewed as
inefficient and customers may seek to exploit this perceived weakness and
delay payment.

 
ACCOUNTS RECEIVABLE MANAGEMENT (cont’d)

Having sent out the invoice quickly and accurately, the methods a
company could use to ensure customers pay in a timely fashion include:
1. monthly statements – these can be produced quickly and easily by any
computerised sales ledger system and sent to customers. Exactly how much
impact they have is however debatable
2. chasing letters – these should be directed to a specific person preferably at
a reasonably senior level. However, preparing and sending these letters has a
cost and, like the monthly statements, their impact is often limited

 
ACCOUNTS RECEIVABLE MANAGEMENT (cont’d)

3. chasing phone calls – these can often have a great impact as all businesses
have to answer the telephone and, hence, they have a nuisance value which
can generate results. A credit controller who regularly contacts a suitably
senior person at their customers with overdue amounts and politely, but
firmly, demands payment can often achieve good results
4. personal approach – a personal approach from a senior person in the
company to a senior person at the customer can often yield results. This is
quite common in trades where the personal relationship with clients is
important. For instance, this often occurs in professional accountancy and
legal firms
ACCOUNTS RECEIVABLE MANAGEMENT (cont’d)

5. stopping supplies – this is a cash collection tool that must be used with
care. If the product being sold is built specifically to the customers design,
and you are the only supplier who currently makes the product, then it is a
powerful tool as, in the short term, you are the only supplier and, hence,
payment is likely to be forthcoming. However, in the longer term it is always
possible for the customer to train up an alternative supplier to make the
product. If the product is a generic product that could be purchased from
many suppliers, then quite obviously this is a weak tool that is simply likely
to lead to the loss of the customer
6. legal action – this is costly and is likely to lead to the customer being lost
ACCOUNTS RECEIVABLE MANAGEMENT (cont’d)

. external debt collection agency – as with legal action this is costly and is
likely to lead to the loss of the customer.

Invoice discounting
Invoice discounting is another method a company can use to speed up the
receipt of cash from its receivables. If a company is short of cash, it can
approach an invoice discounter who will lend cash against the security of one
or a few invoices that customers have still to pay.
H. INVENTORY MANAGEMENT

What is inventory management?

Inventory management is a systematic approach to sourcing, storing, and
selling inventory—both raw materials (components) and finished goods
(products).
 
As a part of your supply chain, inventory management includes aspects such as
controlling and overseeing purchases — from suppliers as well as customers —
maintaining the storage of stock, controlling the amount of product for sale, and
order fulfilment.
Naturally, your company’s precise inventory management meaning will vary
based on the types of products you sell and the channels you sell them through.
But as long as those basic ingredients are present, you’ll have a solid foundation
to build upon.
INVENTORY MANAGEMENT (cont’d)
Retail inventory management
Retail is the broadest catch-all term to describe business-to-consumer (B2C)
selling. There are essentially two types of retail separated by how and where a sale
takes place.
First, online retail (eCommerce) where the purchase takes place digitally.
Second, offline retail where the purchase is physical through a brick-and-mortar
storefront
t or a salesperson.
Wholesale, on the other hand, refers to business-to-business (B2B) selling.
Knowing the differences and best practices of retail and wholesale is critical to
success.
Most businesses maintain stock across multiple channels as well as in multiple
locations. The diversity of retail inventory management adds to its complexity and
drives home its importance to your brand.
INVENTORY MANAGEMENT (cont’d)

Importance of inventory management

For any goods-based businesses, the value inventory cannot be overstated,
which is why inventory management benefits your operational efficiency and
longevity.
From SMBs to companies already using enterprise resource planning (ERP),
without a smart approach, you’ll face an army of challenges, including
blown-out costs, loss of profits, poor customer service, and even outright
failure.
From a product perspective, the importance of inventory management lies in
understanding what stock you have on hand, where it is in your warehouse(s),
and how it’s coming in and out.
INVENTORY MANAGEMENT (cont’d)

Clear visibility helps you:

Reduce costs
Optimize fulfilment
Provide better customer service
Prevent loss from theft, spoilage, and returns
INVENTORY MANAGEMENT (cont’d)

Inventory management terms

Barcode scanner -Physical devices used to check-in and check-out stock
items at in-house fulfillment centers and third-party warehouses.
Bundles - Groups of products that are sold as a single product: selling a
camera, lens, and bag as one SKU.
Cost of goods sold (COGS) - Direct costs associated with production along
with the costs of storing those goods.
INVENTORY MANAGEMENT (cont’d)

Deadstock - Items that have never been sold to or used by a customer

(typically because it’s outdated in some way). Also known as safety stock or
decoupling stock; refers to inventory that’s set aside as a safety net to mitigate
the risk of a complete halt in production if one or more components are
unavailable.
OQ refers to how much you should reorder, taking into account demand and
your inventory holding costs.
Holding costs - Also known as carrying costs; the costs your business incurs
to store and hold stock in a warehouse until it’s sold to the customer.
INVENTORY MANAGEMENT (cont’d)

Landed costs - These are the costs of shipping, storing, import fees, duties,
taxes and other expenses associated with transporting and buying inventory.
The time it takes a supplier to deliver goods after an order is placed along
with the timeframe for a business’ reordering needs.
The complete lifecycle of an order from the point of sale to pick-and-pack to
shipping to customer delivery.
a supplier and a buyer that outlines types, quantities, and agreed prices for
products or services.
INVENTORY MANAGEMENT (cont’d)

Order management - Backend or “back office” mechanisms that govern

receiving orders, processing payments, as well as fulfillment, tracking and
communicating with customers.
Purchase order (PO)- Commercial document (B2B) between
Pipeline inventory - Any inventory that is in the “pipeline” of a business’
supply chain — e.g., in production or shipping — but hasn’t yet reached its
final destination.
Reorder point - Set inventory quotas that determine when reordering should
occur, taking into account current and future demand as well as lead time(s).
 Safety stock- Also known as buffer stock; inventory held in a reserve to
guard against shortages.
INVENTORY MANAGEMENT (cont’d)

Sales order - The transactional document sent to customers after a purchase

is made but before an order is fulfilled.
 Stock keeping unit (SKU) - Unique tracking code (alphanumeric) assigned
to each of your products, indicating style, size, color, and other attributes.
 Third-party logistics (3PL) - Third-party logistics refers to the use of an
external provider to handle part or all of your warehousing, fulfillment,
shipping, or any other inventory-related operation. 
Fourth-party logistics (4PL) takes this a step further by managing resources,
technology, infrastructure, and full-scale supply chain solutions for
businesses.
  Variant - Unique version of a product, such as a specific color or size.
 
INVENTORY MANAGEMENT (cont’d)

Inventory Management Formulas:

1. Economic order quantity (EOQ) formula
EOQ = √(2DK/H), or the square root of (2 x D x K / H)
Where:
D = Setup or order costs (per order, generally includes shipping and handling)
K = Demand rate (quantity sold per year)
H = Holding or carrying costs (per year, per unit)
 
INVENTORY MANAGEMENT (cont’d)

2. Days inventory outstanding (DIO) formula

also known as days sales of inventory (DSI), refers to the number of days it
takes for inventory to turn into sales. The average inventory days outstanding
varies from industry to industry, but generally a lower DIO is preferred.
DIO = Cost of Inventory x 365
Cost of Goods Sold
Determining whether your DIO is high or low depends on the average for
your industry, your business model, the types of products you sell, etc.
INVENTORY MANAGEMENT (cont’d)
3. Reorder point formula
The reorder point formula answers the age-old question: When is the right
time to order more stock?
Calculating your reorder point takes three steps:
a. Determine your lead time demand in days
b. Calculate your safety stock in days
c. Sum your lead time demand and your safety stock

Calculate your product's reorder point using the calculator below:

Lead time in days × Average daily usage + Safety stock
INVENTORY MANAGEMENT (cont’d)

4. Safety stock formula

As we touched upon earlier, safety stocks acts as an emergency buffer you
can break out when it looks like you’re on the verge of selling out. You want
to have enough safety stock to meet demand, but not so much that increased
carrying costs end up straining your finances.
Multiply your maximum daily usage by your maximum lead time in days

Safety maximum daily usage average daily usage

= X - X
Stocks maximum lead time in days average lead time in days
SHORT-TERM FINANCING SOURCES

Source # 1. Trade Credit:

Trade credit refers to the credit extended by the supplier of goods or
services to his/her customer in the normal course of business. It occupies a
very important position in short-term financing due to the competition. Almost
all the traders and manufacturers are required to extend credit facility (a
portion), without which there is no business. Trade credit is a spontaneous
source of finance that arises in the normal business transactions without
specific negotiation, (automatic source of finance).
SHORT-TERM FINANCING SOURCES (cont’d)

Source # 2. Commercial Papers (CPs):

Commercial paper represents a short-term unsecured promissory
note issued by firms that have a fairly high credit (standing) rating.
It was first introduced in the USA and it is an important money
market instrument. In India, Reserve Bank of India introduced CP
on the recommendations of the Vaghul Working Group on Money
Market. CP is a source of short-term finance to only large firms
with sound financial position.
SHORT-TERM FINANCING SOURCES (cont’d)

Forms of Bank Finance:

Banks provide different types of tailor- made loans that are suitable
for specific needs of a firm.
The different types or forms of loans are:
(i) Loans - Loan is an advance lump sum given to the borrower
against some security. Loan is given to the applicant in the form of
cash or by credit to his/her account. Borrower can repay the loan
either in lump sum or in installments depending on conditions. If
the loan is repayable in installment basis interest will be calculated
on quarterly and on reduced balances. Short-term loans are payable
within one year
SHORT-TERM FINANCING SOURCES (cont’d)

(ii) Overdrafts - Overdraft facility is an agreement between the

borrower and the banker, where the borrower is allowed to
withdraw funds in excess of the balance in the firm’s current
account up to a certain limit during a specified period. Interest is
charged on daily over drawn balances and not on the overdraft limit
given by the bank.
(iii) Cash credits - It is the most popular source of working capital
finance. A cash credit facility is an arrangement where a bank
permits a borrower to withdraw money up to a sanctioned credit
limit against tangible security or guarantees.
SHORT-TERM FINANCING SOURCES (cont’d)

(iv) Purchase or discounting of bills - Bills receivable arise out of credit sales
transaction, where the seller of goods draws the bill on the buyer. The bill may be
documentary or clean bill. Once the bill is accepted by the buyer, then the drawer
(seller) of the bill can go to the bank for bill discounting or sale.
(v) Letter of Credit - There are two non-fund based sources of working capital, viz.,
letter of credit (L/Cs) and Bank Guarantees (B/Gs). These are also known as quasi-
document issued by the Buyer’s Banker (BB) at the request of the Buyer’s, in favour
of the seller, where the Buyer’s Banker gives an undertaking to the seller, that the bank
pay the obligations of its customer up to a specified amount, if the customer fails to
pay the value of goods purchased. Letter of credit facility is available from banks only
for the companies that are financially sound and bank charges the customer for
providing this facility.
SHORT-TERM FINANCING SOURCES (cont’d)

Source # 3. Public Deposits:

Public deposits or term deposits are in the nature of unsecured deposits, are solicited
by the firms (both large and small) from general public primarily for the purpose of
financing their working capital requirements.
Source # 4. Inter-Corporate Deposits (ICDs):
A deposit made by one firm with another firm is known as Inter-Corporate Deposit
(ICD). Generally, these deposits are made for a period up to six months.
Such deposits may be of three types:
(a) Call Deposits:
These deposits are those expected to be payable on call/on just one day notice. But, in
actual practice, the lender has to wait for at least 2 or 3 days to get back the amount.
Inter-corporate deposits generally have 12 per cent interest per annum.
SHORT-TERM FINANCING SOURCES (cont’d)

(b) Three Months Deposits:

These deposits are more popular among companies for investing the surplus
funds. The borrower takes this type of deposits for meeting short-term cash
inadequacy. The interest rate on these types of deposits is around 14 per cent
per annum.
(c) Six months Deposits:
Inter-corporate deposits are made for a maximum period of six months. These
types of deposits are usually given to ‘A’ category borrowers only and they
carry an interest rate of around 16 per cent per annum.
 
SHORT-TERM FINANCING SOURCES (cont’d)

Source # 5. Commercial Banks:

Commercto ial banks are the major source of working capital finance
industries and commerce. Granting loan to business is one of their primary
functions. Getting bank loan is not an easy task since the lending bank may ask
a number of questions about the prospective borrower’s financial position and
its plans for the future.
At the same time the bank will want to monitor borrower’s business progress.
But there is a good side to this, and that is borrower’s share price tends to rise,
because investor knows that convincing banks is very difficult.
Forms of Bank Finance:
Banks provide different types of tailor- made loans that are suitable for specific
needs of a firm.
SHORT-TERM FINANCING SOURCES (cont’d)

Source # 6. Factoring:

Factoring is one of the sources of working capital. Banks have been given
more freedom of borrowing and lending both internally and externally and
facilitated the free functioning in lending and investment operations. In other
words, banks are free to enter or exit in any field depending on their
profitability, but subject to guidelines.
Banks provide working capital finance through financing receivables, which is
known as “factoring”. A “Factor” is a financial institution, which renders
services relating to the management and financing of sundry debtors that arises
from credit sales.