Management of Cash and
Marketable Securities
Firms hold cash balances in checking
accounts. Why?
1. Transaction motive: Firms maintain cash
balances to conduct normal business
transactions. For example,
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Payroll must be met
Supplies and inventory purchases must be paid
Other day-to-day expenses of being in business
must be met
Management of Cash and
Marketable Securities
2. Precautionary motive: Firms maintain
cash balances to meet precautionary
liquidity needs.
a. To bridge the gaps between cash inflow and cash
outflow
b. To meet unexpected emergencies
Management of Cash and
Marketable Securities
3. Speculative motive: Firms maintain
cash balances in order to “speculate” –
that is, to take advantage of
unanticipated business opportunities that
may come along from time to time.
Management of Cash and
Marketable Securities
• Marketable securities: short-term, high-quality
debt instruments that can be easily converted
into cash.
• In order of priority, three primary criteria for
selecting appropriate marketable securities to
meet firm’s anticipated short-term cash needs
(particularly those arising from precautionary
and speculative motives):
1. Safety
2. Liquidity
3. Yield
Management of Cash and
Marketable Securities
1. Safety
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Implies that there is negligible risk of default
of securities purchases
Implies that marketable securities will not be
subject to excessive market fluctuations due
to fluctuations in interest rates
Management of Cash and
Marketable Securities
2. Liquidity
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Requires that marketable securities can be sold
quickly and easily with no loss in principal value due
to inability to readily locate purchaser for securities
3. Yield
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Requires that the highest possible yield be earned
and is consistent with safety and liquidity criteria
Least important of three in structuring marketable
securities portfolio
Management of Cash and
Marketable Securities
Actions firm may take to improve cash
flow pattern:
1. Attempt to synchronize cash inflows and
cash outflows
– Common among large corporations
– E.g. Firm bills customers on regular schedule
throughout month and also pays its own bills
according to a regular monthly schedule. This
enables firm to match cash receipts with cash
disbursements.
Management of Cash and
Marketable Securities
2. Expedite check-clearing process,
slow disbursements of cash, and
maximize use of “float” in corporate
checking accounts
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Three developments in financial services
industry have changed nature of cash
management process for corporate
treasurers
Management of Cash and
Marketable Securities
3. Impact of electronic funds transfer systems
(EFTS) and online banking
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Includes so-called “remote capture” technology for
quickly depositing checks without visiting a bank
branch
Radically reduced amount of time necessary to turn
customer’s check into available cash balance on
corporate books
Sharply reduced amount of float available, as
corporation’s own checks clear more rapidly
Management of Cash and
Marketable Securities
4. Expanded use of money market mutual
funds (as substitute for conventional checking
accounts)
Management of Cash and
Marketable Securities
5. Growth in cash management services
offered by commercial banks
These systems efficiently handle firm’s cash
management needs at very competitive price.
Accounts Receivable
Management
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Accounts receivable management
requires balance between cost of
extending credit and benefit received
from extending credit.
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No universal optimization model to
determine credit policy for all firms since
each firm has unique operating
characteristics that affect its credit policy.
Types Credit Policy
• Lenient/Liberal
• Stringent/Restrictive
Factors affecting the Credit
Policy
• Credit Terms
• Credit Standards
• Collection Policy
Credit Investigation
“Five Cs” of credit analysis” used to decide
whether or not to extend credit to particular customer:
1. Character: moral integrity of credit applicant and
whether borrower is likely to give his/her best efforts
to honoring credit obligation
2. Capacity: whether borrowing firm has financial
capacity to meet required account payments
3. Capital: general financial condition of firm as judged
by analysis of financial statements
4. Collateral: existence of assets (i.e. inventory,
accounts receivable) that may be pledged by
borrowing firm as security for credit extended
5. Conditions: operating and financial condition of
firm
Types of cost in maintaining
receivables:
✓ Collection costs
✓ Opportunity cost
✓ Bad-debt losses
✓ Carrying Costs
Supervising collection of accounts
receivable
➢ Requires close monitoring of average
collection period and aging schedule
➢ Analyze the receivable turn-over and the
receivable period.
➢ Aging schedule groups accounts by age and
then identified quantity of past due accounts
FINANCING OF
RECEIVABLES
Financing of Receivables
• Accounts receivable: used as collateral
for short-term loans
• Three methods of accounts receivable
financing:
1. Pledging
2. Assigning
3. Factoring
Pledge of Receivables
On January 1, 2020, ABC Corp. borrowed
money in the bank P1,000,000, 1-year term,
with an interest rate of 12% per annum.
ABC pledged it’s A/R which amounted to
P1,500,000. How much is the cash
proceeds of loan on January 1? How much
is the maturity value one year after? What is
the effective interest rate?
Simple Interest
Cash proceeds:
P 1,000,000
Discounted Interest
P 880,000
Maturity value:
P 1,120,000
P 1,000,000
Effective interest rate:
12%
13.64%
Financing of Receivables
2. Assigning
– Borrowing firm assigns over its right to collect
account to lender
– Lender advances money to borrower up to
some predetermined percentage (75%-90%) of
accounts receivable and then collects directly
from customer account
– Payments received in excess of amount
loaned are property of borrower (treated as
part of “circulating pot” of money from which
borrower may draw funds as needed)
Assignment of Receivables
Suppose that XYZ Company obtains
P800,000 cash on December 31, 2019, by
assigning P 1,000,000 of its trade
receivables. It agrees to place the
collections in a special restricted checking
account from which it will repay the original
P 800,000 plus a P 36,000 finance charge
on April 1, 2020. What is the interest rate?
36,000/800,000= 4.5% for 3months.
Financing of Receivables
• Pledging/Assigning (continued)
– Lender has recourse to borrower if account
fails to pay
– Lender only acts as supplier of funds so if
borrower defaults, borrower suffers bad-debt
loss, not lender
– Cost of pledging and assigning are about
equal
Financing of Receivables
3. Factoring
– Lender buys accounts receivable outright
from borrower at discount from face value
and assumes burden of collecting
receivables
• Burden includes assumption of bad-debt
losses
• If account does not pay, lender has no
recourse on borrowing firm
Financing of Receivables
3. Factoring (continued)
• Lenders provides three services
1. Provide financing of accounts receivable for
borrowing firms
2. Act as borrowing firm’s credit department
3. Assumes risk of bad-debt losses
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Transfers risk from borrowing firms to factor
Most expensive form of accounts receivable
financing
Factoring without recourse
ABC Company transfers P 500 million of
receivables without recourse for proceeds of
P495 million.
Factoring with recourse
ABC Company transfers
receivables with recourse
P445 million less a P50
Later on, the factor is
receivables of P490 million.
P500 million of
for proceeds of
million holdback.
able to collect
INVENTORY MANAGEMENT
GOAL: To provide the inventories
required to sustain operations at
the lowest possible cost.
Meaning, adequate stock in units at
minimum inventory cost.
Inventory Management
Cost of maintaining inventory:
1. Carrying costs: all costs associated with carrying
inventory
• Storage, handling, loss in value due to
obsolescence and physical deterioration, taxes,
insurance, financing
2. Ordering costs:
• Cost of placing orders for new inventory (fixed
cost: same peso amount regardless of quantity
ordered)
• Cost of shipping and receiving new inventory
(variable cost: increase with increases in quantity
ordered)
Inventory Management
Cost of maintaining inventory:
3. Stockout costs: the costs of running short
on inventory, including foregone income on lost
sales, cost of downtime, loss of customer
goodwill.
Inventory Management
Total inventory maintenance costs (carrying
costs plus ordering costs) vary inversely.
– Carrying costs increase with increases in average
inventory levels and therefore argue in favor of
low levels of inventory in order to hold these costs
down.
– Ordering costs decrease with increases in
average inventory levels and therefore firm wants
to carry high levels of inventory so that it does not
have to reorder inventory as often as it would if it
carried low levels of inventory.
Inventory Management
• Economic order quantity (EOQ) model:
mathematical model designed to
determine optimal level of average
inventory that firm should maintain to
minimize sum of carrying costs and
ordering costs (total cost inventory
maintenance cost)
– Explains inventory control problem
– EOQ = √2DO/C
Assumption of EOQ Model
1. Annual demand requirements (sales) can
be forecasted perfectly.
2. Demand is evenly distributed throughout
the year.
3. No quantity discounts.
4. Instantaneous delivery.
EOQ Model Extension
• Basic EOQ model assumes that inventory is used up
uniformly and that there are no delivery lags
(inventory is delivered instantaneously). Thus, two
modifications:
1. Establish reorder point that allows for delivery
lead times.
• Ex. If 2,700 units are ordered every 3 months
and normal delivery time is one month after order
is placed, then EOQ should be ordered when onhand amount drops to 900 units.
Inventory Management
2. Add quantity of safety stock to base average
inventory that allows for uncertainty of estimates used
in model and possibility of non-uniform usage.
• This added quantity is dependent on degree of
uncertainty of demand, cost of stockouts, level of
carrying costs, and probability of shipping delays
• Ex. Adequate level of safety stock is 500 units.
Reorder point would be increased to 1,400 units
(900+500) and new order would be placed each
time on-hand quantity reached 1,400.
Inventory Management
Example: Widget Wholesalers, Inc.
• Widgets sold per year: 240,000 units
• Cost price per unit: 2
• Inventory carrying costs: 20% of average
inventory level
• Fixed cost of ordering: 30 per order
Inventory Management
Solve EOQ = √(2DO/C)
– EOQ = √(2)(30)(240,000)/(0.20)(2)
– Widget should order 6,000 units per order.
– If Widget allows ten-day supply as safety
stock, then reorder point would be at 6,575
units (10 days divided by 365 days times
240,000)
– At 6,000 units per order, Widget would place
forty orders per year (240,000/6,000)