cash management Flashcards
motives for holding cash
to maintain cushion - precautionary motive
to make payment - transaction motive
to seize opportunity - speculative
Disadvantages of High Cash Levels
The “negative arbitrage” effect (i.e., interest obligations exceed interest income from cash reserves).
Increased attractiveness as a takeover target.
Investor dissatisfaction with allocation of assets (i.e., failure to pay dividends)
Primary Methods of Increasing Cash Levels
Either speeding up cash inflows or slowing down cash outflows increases cash balances. Improved rates of cash collection are generally achieved through faster accounts receivable collections, which improves a company’s operating cycle. Reduced cash outflows are often achieved through delayed (or deferred) disbursements. The combination of current cash inflows and current cash outflows related to a business is called the cash conversion cycle. The objective of financial managers is to shorten the cash conversion cycle
Credit Policy
Credit policy is one of the major determinants of demand for a firm’s products or services, along with price, product quality, and advertising. The credit policy of a company is typically established by a committee of senior company executives. Credit policy variables include:
- Credit Period: Credit period is the length of time buyers are given to pay for their purchases. A commonly used credit period is 30 days. If the credit period is too long, the company may experience cash shortages. A credit period that is too short may damage relationships with customers and negatively affect future sales.
- Credit Standards: Credit standards refer to the required financial strength of credit customers. Extending credit to only financially strong customers minimizes uncollectible receivables, but also limits potential sales. Extending credit to a broader base of customers increases sales, but adds risk in that a greater percentage of receivables are likely to be written off.
- Collection Policy: Collection policy is measured by a company’s stringency or laxity in collecting delinquent accounts. This is also a balancing act between wanting to collect cash owed quickly versus maintaining positive relationships with customers.
- Discounts: Discounts include the discount percentage and period. Offering discounts to customers who pay early may result in faster receivables collection, depending on the terms of the discount and the customer’s own cash needs and capacity to pay early.
Methods to speed Collections
Customer Screening and Credit Policy: A company can choose to extend credit to more responsible customers, who are more likely to pay bills promptly.
Prompt Billing: Timely billing of charges to credit customers ultimately serves to speed collections.
Payment Discounts: Offering payment discounts may influence customers to pay faster and can result in improved cash collections. Discounts foregone represent a higher cost to the customer than a bank loan for similar financing
Expedite Deposits: Financial managers not only must collect credit sales in a timely manner, but also must ensure that funds are deposited and credited to their account quickly. The following techniques reduce the time during which payments received by a firm remain uncollected.
Concentration Banking: Concentration banking is characterized by the designation of a single bank as a central depository. Advantages of concentration banking include:
-Improved controls over inflows and outflows of cash
-Reduced idle balances
-Improved effectiveness for investments
Factoring
Factoring accounts receivable entails turning over the collection of accounts receivable to a third-party factor in exchange for a discounted short-term loan. Cash is collected from the factor immediately rather than from the customer according to the credit terms.
Types of Inventory
Raw Materials: Inventory held for use in the production process.
Work-in-Process: Inventory in production but incomplete.
Finished Goods: Production inventory that is complete and ready for sale.
Factors Influencing Inventory Levels
Inventory depends on the accuracy of sales forecasts. Lack of inventory can result in lost sales, and excessive inventory can result in burdensome carrying costs, including:
-Storage costs
-Insurance costs
-Opportunity costs of inventory investment
-Lost inventory due to obsolescence or spoilage
Safety Stock
Many companies maintain safety stock to ensure that manufacturing or customer supply requirements are met. The determination of safety stock depends on the following factors:
Reliability of sales forecasts
Possibility of customer dissatisfaction resulting from back orders
Stockout costs (the cost of running out of inventory), including loss of income, the cost of restoring goodwill with customers, and the cost of expedited shipping to meet customer demand
Lead time (the time that elapses from the placement to the receipt of an order)
Seasonal demands on inventory
Reorder Point
The reorder point is the inventory level at which a company should order or manufacture additional inventory to meet demand and to avoid incurring stockout costs. The reorder point can be calculated using the following formula:
reorder point = Safety stock + (lead time * sales during lead time)
EOQ
Economic order quantity
Two types of cost involved in EOQ
* Ordering cost: The costs of placing order, receiving and checking in goods
* Carrying cost: The cost of inventory storage, handling, and insurance, and opportunity cost over the period.
Purpose of EOQ
Minimize total ordering and carrying costs
Determination of EOQ
EOQ = (2OS/C)^(1/2)
Supply chain management
Integrated supply chain management (ISCM) exists when a firm and the entire supply chain (suppliers, producers, distributors, retailers, customers, and service providers) are able to reasonably predict the expected demand of consumers for a product and then plan accordingly to meet that demand. Integrated supply chain management is a collaborative effort between buyers andsellers.
Four key management processes or core activities pertaining to SCOR
plan, source, make, and deliver
