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'. MOTIVES OF HOLDING CASH
Transaction- For carrying out the day to day
transactions. 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 OBJECTIVES OF CASH MANAGEMENT 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 need. 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 requirements. Short costs - The costs the compnay has to bear because of shortage of cash should be ascertained in order to reduce such costs. CASH MANAGEMENT STRATEGIES cash cycle and cash turnover minimum cash balance 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 MANAGEMENT TECHNIQUES Cash collection/inclows Concentration banking Lock box system Payments Float Surplus cash Cash shortages OPTIMUM CASH BALANCE MODELS 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 balance. c=2ut/i 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 advance The cash payment are steady It assumes the transaction costs but not cost of precaution Limitations of Baumol model Measurement of trasaction cost is difficult as every security has different rate and different maturity. Baumol assumes that cash uses at constant rate. 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 liquidity 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 cost. 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 5Cs Character means willingness to pay Capacity means ability to pay Capital is financial position of customer Collateral means security offered by customer for extension 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 customer 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 customer. 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 period (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 receivables 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 not. (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 production. 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. EOQ=2RCp/Ch 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. MAXIMUM level Rorder level + re-order qtty-(Minimum consumption X minimum re-order period) MINIMUM level 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) OR Min level +1/2(ReOrder qtty)