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Working Capital Management > The Importance of Cash
The Importance of Cash
• Reasons for Maintaining Cash on Hand
• Defining the Cash Flow Cycle
• Calculating the Cash Flow Cycle
• Components of the Cash Budget
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Working Capital Management > The Importance of Cash
Reasons for Maintaining Cash on Hand
• Liquidity is the ability to meet obligations when they come due without incurring
unacceptable losses.
• Banks can generally maintain as much liquidity as desired, because bank
deposits are insured by governments in most developed countries.
• Banks can attract significant liquid funds to generate stronger profits, more
stability, and more confidence among depositors, investors, and regulators.
• Cash is the most liquid asset and can be used immediately to perform economic
actions like buying, selling, or paying debt, and meeting immediate wants and
needs.
Cash
• Bank can attract significant liquid funds to generate stronger profits, more stability,
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and more confidence among depositors, investors, and regulators.
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Working Capital Management > The Importance of Cash
Defining the Cash Flow Cycle
• In management accounting, the cash conversion cycle (CCC) measures how long
a firm will be deprived of cash if it increases its investment in resources in order to
expand customer sales.
• It is thus a measure of the liquidity risk entailed by growth. However, shortening
the CCC creates its own risks. While a firm could even achieve a negative CCC
by collecting from customers before paying suppliers, a policy of strict collections
and lax payments is not always sustainable.
• The term "cash conversion cycle" refers to the timespan between a firm's
disbursing and collecting cash.
• Since a retailer's operations consist of buying and selling inventory, the equation
Cash flow cycle
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models the time between (1) disbursing cash to satisfy the accounts payable
created by purchase of inventory, and (2) collecting cash to satisfy the accounts
receivable generated by that sale.
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Working Capital Management > The Importance of Cash
Calculating the Cash Flow Cycle
• Cash flow cycle = Inventory conversion period + Receivables conversion period –
Payables conversion period.
• Inventory conversion period = Avg. Inventory / (COGS / 365); Receivables
conversion period = Avg. Accounts Receivable / (Credit Sales / 365); Payables
conversion period = Avg. Accounts Payable / (Purchases / 365).
• There are five important intervals, referred to as conversion cycles (or conversion
periods).
• Our aim of studying cash conversion cycle and its calculation is to change the
policies relating to credit purchase and credit sales.
Cash cycle
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Working Capital Management > The Importance of Cash
Components of the Cash Budget
• The cash flow budget helps the business determine when its income will be
sufficient to cover its expenses and when the company will need to seek outside
financing.
• Components - major classes include cash receipts and payments.
• Cash receipts include cash generated from operations, cash receipts from
customers, proceeds from the sale of equipment, dividends received, and other
income.
• Cash payments include cash paid to suppliers, cash paid to employees, purchase
of assets, payments related to mergers and acquisitions, interest paid, income
Budgeting Example
taxes paid, dividends paid, and other payments.
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Appendix
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Working Capital Management
Key terms
• balance sheet A summary of a person's or organization's assets, liabilities and equity as of a specific date.
• cash flow The sum of cash revenues and expenditures over a period of time.
• Credit Sales Credit Sales are all sales made on credit.
• liquidity Availability of cash over short term: ability to service short-term debt.
• mergers and acquisitions Mergers and acquisitions (abbreviated M&A) is an aspect of corporate strategy, corporate finance,
and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can
help an enterprise grow rapidly, whether in its sector or location of origin, or a new field or new location, without creating a
subsidiary, other child entity, or using a joint venture.
• money market A market for trading short-term debt instruments, such as treasury bills, commercial paper, bankers'
acceptances, and certificates of deposit
• retail The sale of goods directly to the consumer; encompassing the storefronts, mail-order, websites, etc., and the corporate
mechanisms, branding, advertising, etc. that support them, which are involved in the business of selling and point-of-sale
marketing retail goods to the public.
• stockholders A shareholder or stockholder is an individual or institution (including a corporation) that legally owns a share of
stock in a public or private corporation.
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Working Capital Management
Cash flow cycle
Cash conversion cycle (CCC) measures how long a firm will be deprived of cash if it increases its investment in resources in order to expand customer
sales.
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Google. "Google Image Result for http://www.commbank.com.au/business/images/cashflow_cycle.gif." CC BY
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Working Capital Management
Cash cycle
Cash cycle measures how long a firm will be deprived of cash if it increases its investment in resources in order to expand customer sales
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Google. "Google Image Result for http://www.cfosystemsllc.com/cfo/wp-content/uploads/2010/01/cash-flow-300x297.jpg." CC BY
http://www.google.com/imgres?um=1&hl=en&sa=N&biw=1275&bih=595&authuser=0&tbm=isch&tbnid=_UFKoR4ztGcctM:&imgrefurl=http://www.cfosystemsllc.com
Working Capital Management
Cash
A business's cash account is how much currency it has on hand at a given time.
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Working Capital Management
Budgeting Example
A budget is essential to tracking and controlling money that is coming in to and being spent on a project.
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Working Capital Management
Which of the following is a reason to always have cash on hand?
A) All of these answers.
B) It increases a company's liquidity.
C) It allows the company to meet its obligations without incurring
avoidable losses.
D) It can be used immediately to perform economic actions, such as
paying outstanding debts.
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Working Capital Management
Which of the following is a reason to always have cash on hand?
A) All of these answers.
B) It increases a company's liquidity.
C) It allows the company to meet its obligations without incurring
avoidable losses.
D) It can be used immediately to perform economic actions, such as
paying outstanding debts.
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Working Capital Management
The sum of cash revenues and expenditures over a period of
time.
A) Cash
B) Assets
C) Cash Flow
D) Account Receivables
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Working Capital Management
The sum of cash revenues and expenditures over a period of
time.
A) Cash
B) Assets
C) Cash Flow
D) Account Receivables
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Working Capital Management
Which of the following statements regarding the cash flow cycle is
correct?
A) The cash flow cycle is also called the "cash conversion cycle" (CCC).
B) The cash conversion cycle is directly observed from a business's cash
flows.
C) The cash conversion cycle is written to analyze firms that conducts its
business solely using cash.
D) All of these answers.
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Working Capital Management
Which of the following statements regarding the cash flow cycle is
correct?
A) The cash flow cycle is also called the "cash conversion cycle" (CCC).
B) The cash conversion cycle is directly observed from a business's cash
flows.
C) The cash conversion cycle is written to analyze firms that conducts its
business solely using cash.
D) All of these answers.
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Working Capital Management
A company has average inventory of $10 million and COGS of
$15 million. Its average accounts receivable is $1 million and it
had $3 million in credit sales. Its average accounts payable is
$1.5 million and it had $10 million in purchases. What is its CCC?
A) 419.75 days
B) 188.58 days
C) 310.25
D) 365 days
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Working Capital Management
A company has average inventory of $10 million and COGS of
$15 million. Its average accounts receivable is $1 million and it
had $3 million in credit sales. Its average accounts payable is
$1.5 million and it had $10 million in purchases. What is its CCC?
A) 419.75 days
B) 188.58 days
C) 310.25
D) 365 days
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Working Capital Management
Which of the following is not a component included in a cash
budget?
A) Depreciation expense.
B) Payments for mergers and acquisitions.
C) Purchases of assets.
D) Income taxes paid.
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Working Capital Management
Which of the following is not a component included in a cash
budget?
A) Depreciation expense.
B) Payments for mergers and acquisitions.
C) Purchases of assets.
D) Income taxes paid.
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Working Capital Management
Attribution
• Wikipedia. "Cash conversion cycle." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Cash_conversion_cycle
• Wiktionary. "retail." CC BY-SA 3.0 http://en.wiktionary.org/wiki/retail
• Wiktionary. "balance sheet." CC BY-SA 3.0 http://en.wiktionary.org/wiki/balance+sheet
• Wiktionary. "cash flow." CC BY-SA 3.0 http://en.wiktionary.org/wiki/cash+flow
• Wikipedia. "Cash conversion cycle." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Cash_conversion_cycle
• Wikipedia. "Credit Sales." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Credit%20Sales
• Wikipedia. "Cash." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Cash
• Wikipedia. "Liquidity." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Liquidity
• Wiktionary. "liquidity." CC BY-SA 3.0 http://en.wiktionary.org/wiki/liquidity
• Wiktionary. "money market." CC BY-SA 3.0 http://en.wiktionary.org/wiki/money+market
• Wikipedia. "Dividend." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Dividend
• Wikipedia. "Budget." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Budget
• Wikipedia. "Cash flow statement." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Cash_flow_statement
• Wikipedia. "Accounts receivable." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Accounts_receivable
• Wikipedia. "stockholders." CC BY-SA 3.0 http://en.wikipedia.org/wiki/stockholders
• Wikipedia. "mergers and acquisitions." CC BY-SA 3.0 http://en.wikipedia.org/wiki/mergers%20and%20acquisitions
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