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Quick Quiz
What is another term for receivables management?
a) Inventory management
b) Cash management
c) Trade credit management
d) Debt management
Answer: c) Trade credit management
2. Which of the following is not a factor that influences total sales, and is generally outside of a financial manager's direct
control?
a) Market share
b) Credit standards
c) Economic conditions
d) Product quality
Answer: b) Credit standards
What does the collection period (Days Sales Outstanding) measure?
a) The total amount of sales on credit
b) The average number of days it takes for a company to receive payment after making a credit sale
c) The percentage of credit sales to total sales
d) The costs associated with overdue payments
Answer: b) The average number of days it takes for a company to receive payment after making a credit sale
4. Which of the following is a key component of a firm's credit policy?
a) Inventory turnover ratio
b) Credit terms
c) Market share
d) Economic conditions
Answer: b) Credit terms
Cash
Management
Learning Outcome

• Analyze the concept of cash management with short-term and long-

term techniques.
Near
Cash
Characteristics of Near-Cash Assets:
•Readily sold

Assets •Easily converted into cash

•Serve as a reserve pool of liquidity
•Provide cash quickly when needed
Purposes of Near-Cash Assets:
•Short-term investment outlet for excess cash
•Useful for meeting planned outflows of funds

Examples of near-cash assets include:

• Marketable securities

• Time deposits in banks

Scope of Cash Management:

• Employed in the broader sense, including near-cash

assets.
Cash
Management
Cycle
Motives for Holding Cash Balances:
•Transaction Motive: Holding cash to meet routine cash requirements for day-to-day transactions.
• Cash is needed to pay for purchases, wages, operating expenses, interest, taxes, and dividends.
• Cash inflows come from sales and returns on investments.
• Inflows and outflows don't always coincide, necessitating a cash balance.
• Some transaction balances may be held in marketable securities with maturities that align with anticipated
payments.
•Precautionary Motive: Holding cash/near-cash as a buffer to meet unexpected needs.
• Unexpected cash needs may arise from events like floods, strikes, customer failures, early settlement of bills,
slow collections, order cancellations, and sudden increases in raw material costs.
• Precautionary balances provide a cushion for unforeseen fluctuations in cash flows.
• The unpredictability of cash flows increases the need for these balances.
• Availability of short-term credit can reduce the need for large precautionary balances.
• These balances are often held in marketable securities to earn a return.
•Speculative Motive: Holding cash/near-cash to take advantage of unexpected opportunities.
•This is an aggressive approach to exploit profitable opportunities outside the normal course of business.
•Examples include purchasing raw materials at reduced prices, speculating on interest rate movements,
delaying purchases in anticipation of price declines, and making purchases at favorable prices.
•Compensating Motive: Holding cash/near-cash to compensate banks for services and loans.
•Banks provide services like check clearance, credit information, and fund transfers.
•Some services are compensated through direct fees, others through compensating balances.
•Borrowers may be required to maintain minimum balances as a condition of loan agreements, especially
when credit is restricted and interest rates are rising.
•Compensating balances can be:
•An absolute minimum below which the bank balance cannot fall.
•A minimum average balance over a period (e.g., a month).
Objectives of Cash Management:
•Meeting the Payment Schedule: Ensuring the firm has sufficient cash to meet its disbursement needs.
• Advantages of adequate cash:
• Prevents insolvency/bankruptcy.
• Maintains good relationship with banks.
• Fosters good relations with suppliers (prompt payment can help their cash management).
• Enables the firm to take advantage of cash discounts.
• Leads to a strong credit rating.
• Allows the firm to capitalize on favorable business opportunities.
• Enables the firm to handle unexpected cash expenditures during emergencies.
• However, large cash balances involve a high cost as cash is a non-earning asset.
•Minimizing Funds Committed to Cash Balances: Striking a balance between the advantages of holding sufficient cash
and the cost of foregoing profits by not investing excess cash.
• A high level of cash balances ensures prompt payment but results in large idle funds and lost profits.
• A low level of cash balances may lead to a failure to meet the payment schedule.
• The goal of cash management is to determine the optimal cash balance.
Factors Determining the Need for Cash Balances:

•Synchronization of Cash Flows: The extent of non-synchronization between cash inflows and outflows.

• Greater non-synchronization necessitates larger cash balances.

• Cash inflows and outflows should be forecast over a period (e.g., a year) using a cash budget.

• A cash budget helps identify periods of excess or shortage.

•Short Costs: Costs associated with a shortfall in cash.

• Include transaction costs (e.g., brokerage for selling near-cash assets).

• Borrowing costs (e.g., interest, commitment charges).

• Loss of cash discounts.

• Costs associated with deterioration of credit rating (e.g., higher bank charges, stoppage of supplies).

• Penalty rates imposed by banks for shortfalls in compensating balances.

•Excess Cash Balance Costs: The opportunity cost of holding too much cash.
•Refers to the lost interest that could have been earned by investing the excess cash.
•Procurement and Management Costs: Costs associated with managing cash operations.
•Generally fixed costs, including salaries, storage, and handling of securities.
•Uncertainty: The impact of unpredictable cash flows on cash management.
•Requires a precautionary cushion to handle irregularities, delays, defaults, and unexpected
needs.
•Can be mitigated by:
•Improved forecasting of payments like taxes, capital expenditures, and dividends.
•Increased ability to borrow through overdraft facilities.
Components of Cash Management
1) Cash planning: Cash planning involves forecasting cash inflows and outflows to
ensure that the business can meet its obligations and avoid liquidity shortages
or surpluses. Techniques like cash budgets and cash flow forecasts are
commonly used.

2) Managing the cash flows: Efficient cash management requires monitoring

accounts receivable, accounts payable, and inventory to optimize cash
conversion cycles.
• Receivables Management: Reducing the time taken to collect payments.
• Payables Management: Taking full advantage of credit terms without damaging
creditworthiness.
• Inventory Management: Avoiding excess inventory that locks up cash.
3. Optimum Cash Level Determination
It is essential to determine the optimum
levels of cash to be maintained.
• Too Much Cash: Opportunity cost (loss of
potential investment returns).
• Too Little Cash: Risk of liquidity crisis and
penalties for late payments.
4. Short-Term Investment of Surplus Cash
• Surplus cash should not be left idle. It can be invested in short-term,
liquid, and low-risk instruments like:
• Treasury bills
• Commercial paper
• Certificates of deposit
5. Cash Collection and Disbursement Management
• Strategies to accelerate collections and delay payments without
harming business relations, such as:
• Lockbox Systems: Customers send payments directly to a bank-
operated post office box.
• Concentration Banking: Funds are collected at regional banks and
transferred to a central account.
What is Cash Planning?

•Definition: Cash planning is the process of estimating the timing and amount of cash

inflows (money coming into the business) and cash outflows (money leaving the

business) over a defined period.

•Goal: The primary goal is to ensure that a business always has sufficient cash on hand

to cover its operational expenses, meet unexpected needs, and take advantage of

potential opportunities.

•Distinction from Budgeting: While budgeting is a broader financial plan covering

revenues and expenses (often on an accrual basis), cash planning specifically focuses

on the movement of actual cash.

Cash Planning
• Cash planning is the process of estimating a company's short-term
and long-term cash requirements to ensure that it has adequate
liquidity to meet its obligations when they fall due. It helps an
organization avoid cash shortages (leading to insolvency) or excessive
idle cash (which leads to opportunity costs).

• In essence, cash planning ensures effective cash management and

financial stability by forecasting cash inflows and cash outflows over a
certain period.
Objectives of Cash Planning

•Ensure Liquidity: Ensuring that sufficient cash is available to meet

routine business needs like paying suppliers, salaries, and taxes.
•Minimize Idle Cash: Excess cash does not earn returns; thus, surplus
cash can be invested in short-term marketable securities.
•Forecast Future Needs: Advance knowledge of future cash needs
helps in arranging finance in time.
•Aid Budgeting: Supports effective preparation of financial budgets.
•Optimize Working Capital: Helps maintain an efficient balance
between cash and other current assets.
Process of Cash Planning
1. Estimate Cash Inflows:

•Sales revenues (cash sales + expected collections from credit sales)

•Other incomes (interest, dividends, asset sales)

2. Estimate Cash Outflows:

•Operating expenses (raw materials, salaries, overheads)

•Capital expenditures (new equipment, renovations)

•Financial expenses (loan repayments, dividends)

3. Prepare Cash Budget:
•Set the time period (monthly, quarterly)
•Prepare forecasts for each cash inflow and outflow
4. Analyze Cash Surpluses and Deficits:
•Identify periods of expected cash deficits
•Plan financing (short-term borrowing, overdrafts)
•Identify periods of surplus
•Plan short-term investments
5. Review and Update Regularly:
• Cash planning is dynamic and
must be reviewed periodically as
actual results vary from
projections.
•Net Cash Flow: The difference between total cash inflows and total cash

outflows for the period. (Net Cash Flow = Total Cash Inflows - Total Cash

Outflows)

•Ending Cash Balance: The resulting cash balance after considering the

net cash flow. (Ending Cash Balance = Beginning Cash Balance + Net

Cash Flow)
Receipt and Disbursements Method
• Virtues of the receipt and payment methods:

• It gives a complete picture of all the items of expected cash flows.

• It is a sound tool of managing daily cash operations.

• Limitations:

• Its reliability is reduced because of the uncertainty of cash forecasts. For example,
collections may be delayed, or unanticipated demands may cause large disbursements.

• It fails to highlight the significant movements in the working capital items.

Adjusted Net Income Method
• Benefits of the adjusted net income method:

• It highlights the movements in the working capital items, and thus helps to keep a
control on a firm’s working capital.

• It helps in anticipating a firm’s financial requirements.

• Limitation

• It fails to trace cash flows, and therefore, its utility in controlling daily cash
operations is limited.
Long-term cash forecast

• It indicates as company’s future financial needs.

• It helps to evaluate proposed capital projects.

• It pinpoints the cash required to finance these projects as well as the cash to

be generated by the company to support them.

• It helps to improve corporate planning.

• Long-term cash forecasts compel each division to plan for future and to

formulate projects carefully.

Thank you