Assets Management

Asset management refers to systematic approach to the governance and realization of value from the
things that a group or entity is responsible for, over their whole life cycles. It may apply both to
tangible assets (physical objects such as buildings or equipment) and to intangible assets (such as
human capital, intellectual property, goodwill and/or financial assets). Asset management is a
systematic process of developing, operating, maintaining, upgrading, and disposing of assets in the
most cost-effective manner (including all costs, risks and performance attributes).
The term is commonly used in the financial sector to describe people and companies who manage
investments on behalf of others. For example, investment managers that manage the assets of
a pension fund.
It is also increasingly used in both the business world and public infrastructure sectors to ensure a
coordinated approach to the optimization of costs, risks, service/performance and sustainability.
Asset management has two general definitions, one relating to advisory services and the other relating
to corporate finance.
In the first instance, an advisor or financial services company provides asset management by
coordinating and overseeing a client's financial portfolio -- e.g., investments, budgets, accounts,
insurance and taxes. In corporate finance, asset management is the process of ensuring that a
company's tangible and intangible assets are maintained, accounted for, and put to their highest and
best use.
Asset managers conduct research, interviews, and statistical analyses of companies, markets, and
trends in order to determine what investments to make or avoid on behalf of their clients. Asset
managers do not generally need "asset manager" licenses, though the firms that hire these managers
often require registration with one or more exchanges and/or the National Association of Securities
Dealers (NASD).
In corporate finance, asset management requires finding ways to maximize a company's value by
managing fixed and intangible assets to be more reliable, efficient, or cheaper -- including evaluating
asset financing options, asset accounting methods, productions operation management, and
maintenance discipline.
Why it matters:
Although most financial jobs don't carry an official "asset manager" title, the truth is that nearly everyone
in the finance world is an asset manager.

As a result, most financial professionals are judged on their ability to successfully manage assets --
either directly or indirectly. Proficiency in asset management makes the difference between a mediocre
and a stellar performance at both the individual and corporate levels.
What Is an Investment?
An investment is an asset or item acquired with the goal of generating income or appreciation. In an
economic sense, an investment is the purchase of goods that are not consumed today but are used in
the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that
the asset will provide income in the future or will later be sold at a higher price for a profit.
 The expectation of some positive rate of return.
 A sacrifice of current money or other resources for future benefits.
 Future income may be
 Interest
 Dividend
 Premiums
 Pension Benefits
 Insurance Policies
Characteristics of Investment
1. Risk Factor
Every investment contains certain portion of risk. It is a key feature of investment which refers to loss
of principal, delay in payment of interest and capital etc. Most investors prefer to invest in less riskier
securities. The higher the risk, the higher is the return.
Risk may be-
 Loss of capital
 Delay in Repayment
  Non-payment of Interest
 Variability in returns
Risk of an investment depends on some factors that are-
 Maturity period
 The lower credit worthiness
 Nature of the investment
Example- Equity shares carry higher risk as compare to debt instruments, bond or debenture.
2. Expectation Of Return
Return expectation is the main objective of investment. Investors expect regularity of high and
consistent income for their capital.
Returns depend upon-
 Nature of the investment:
a) Low Risk- Government Securities
b) Medium Risk- Debentures & Preference Shares
c) High Risk- Equity Share
3. Safety
Investors expect safety for their capital. They desire certainty of return and protection of their
investment or principal amount. Safety implies the certainty of return of capital without loss of money
or time.
4. Liquidity
Liquidity means easily sale or convert the capital or investment into cash without any loss. So, most
investors prefer liquid investments.
 Without loss of money
 Without loss of time

5. Marketability

It is another feature of investment that they are marketable. It means buying and selling or transferability
of securities in the market.

6. Stability Of Income

Investors invest their capital with high expectation of income. So, return on their investment should be
adequate and stable.
7. Tax Shelter
Tax shelters are any method of reducing taxable income resulting in a reduction of the payments to
tax collecting entities, including state and federal governments. The methodology can vary
depending on local and international tax laws.
Tax benefits are in the following three kinds
a) Initial Tax Benefit- The tax relief enjoyed at the time of making the investment.
b) Continuing Tax Benefit- A continuing tax benefit represents the tax shield associated with
the periodic returns from the investment.
c) Terminal Tax Benefit- Relief from taxation when an investment is realized or liquidate.
Objectives of Investment

 Maximisation of return-
With the shipping industry going through a tough time, it is more important than ever that
company receive a positive return on investment (ROI) across all parts of their business.
 Minimisation of risk-
Risk minimization is the process of doing everything possible to reduce the probability and/or
impact of a risk towards zero. This is reserved for risks that are viewed as unacceptable to a
society, organization or individual.
 Good Rate Of Return-
A rate of return (ROR) is the net gain or loss on an investment over a specified time period,
expressed as a percentage of the investment's initial cost. Gains on investments are defined as
income received plus any capital gains realized on the sale of the investment.
  Liquidity in time of emergency-
Liquidity might be your emergency savings account or the cash lying with you that you can
access in case of any unforeseen happening or any financial setback. Liquidity also plays an
important role as it allows you to seize opportunities.
 Safety of Funds-
The purpose of the fund is to improve financial security by creating a safety net of cash or
other highly liquid assets that can be used to meet emergency expenses, as well as
reduce the need to draw from high-interest debt options, such as credit
cards or unsecured loans—or undermine your future security by tapping retirement funds.
 Hedge against inflation-
To take steps to limit the reduction of the value of an investment due to
inflation. Inflation decreases the value of money such that an investment's
return is not worth as much as it might have been when the investment was
made originally. Hedging against inflation helps reduce this pressure.
Examples of hedging against inflation include buying commodities such as
gold or purchasing an inflation-protected
security, in which the return is linked to the inflation rate. .
 Money in future

What Are Long-Term Investments?

A long-term investment is an account on the asset side of a company's balance sheet that represents
the company's investments, including stocks, bonds, real estate, and cash. Long-term investments are
assets that a company intends to hold for more than a year.
The long-term investment account differs largely from the short-term investment account in that short-
term investments will most likely be sold, whereas the long-term investments will not be sold for years
and, in some cases, may never be sold.
Being a long-term investor means that you are willing to accept a certain amount of risk in pursuit of
potentially higher rewards and that you can afford to be patient for a longer period of time. It also
suggests that you have enough capital available to afford to tie up a set amount for a long period of
time.
Long term investment Management
Bank savings accounts currently offer paltry rates of interest. If you put leave all your money in banks it
should be safe but will not grow much. The stock market offers much more interesting returns but
because of the element of risk many people avoid it. Worse still they might enter the market at the top
and then sell out later at the bottom. Here are some simple rules to help you navigate the market and
build a large stock portfolio over a long period.
1. Diversify. Spread your risks by investing in a number of stocks in different markets and in mutual
funds, bonds and other instruments. A good rule is that no one stock or other investment should be
more than 10% of your total portfolio. Invest in different geographic areas such as US, Europe, Asia and
emerging markets. Diversify into property funds, commodity funds and hedge funds. This should give
you protection against a collapse in any one particular sector.
2. Do your research. Take advice from various sources. Invest in some companies whose products
and strategies you like. There are a multitude of comparison sites and other resources on the internet
to help you to analyse and understand investments. Past performance is no guarantee of future
performance but I would generally prefer to choose a mutual fund or unit trust that had been a strong
performer over the last two years and which offers low management fees.
3. Run the stars and sell the dogs. Monitor your investments and compare their performances against
the market index. If some of your holdings do well then the temptation is to cash in and take a profit. It
seems natural but if you are in this game for the long term then you want investments that grow over the
long term so when you find winners cherish and retain them. On the other hand you should ditch the
dogs that significantly underperform the market. The temptation is to hold onto them in the hope of a
rebound or worse still to increase your holding at the lower price. This is generally a poor strategy and it
is safer to take a small early loss rather than a large one later on. Do not cling onto stocks for emotional
reasons. Sell the dogs and run with the stars.
4. Reinvest dividends. A surprisingly large part of the overall growth in most portfolios comes from
reinvested dividends rather than in appreciation of the stock prices. A yield of 3% may appear small but
over a period it makes a big difference. Choose some investments with a solid history of dividends and
use them as the ballast in your ship.
5. Be contrarian. This advice is much easier to give than to observe. When the stock market is low buy
stocks. When the stock markets is high sell your worst performing stocks and buy other investments
such as property or bonds.
6. Take the long view. You are in this for the long terms so do not make frequent trades – the
commission will eat into your funds. Do not follow fads and fashions. Diversify in a sensible way. Do
not panic when markets occasionally crash – these are buying opportunities for the brave.
Finally be prepared to sell when you eventually need the money. You invested it to build financial
security for you and your family so it is better to use it when needed rather than to scrimp along in order
to become the richest man in the cemetery.
Selection of Investment Opportunities
1. Review your needs and goals
It’s well worth taking the time to think about what you really want from your investments. Knowing
yourself, your needs and goals and your appetite for risk is a good start, so start by filling in a Money
fact find.
2. Consider how long you can invest
Think about how soon you need to get your money back. Time frames vary for different goals and will
affect the type of risks you can take on.
For example:
 If you’re saving for a house deposit and hoping to buy in a couple of years, investments such as
shares or funds will not be suitable because their value goes up or down. Stick to cash savings
accounts like Cash ISAs.
 If you’re saving for your pension in 25 years’ time, you can ignore short-term falls in the value of
your investments and focus on the long term. Over the long term, investments other than cash
savings accounts tend to give you a better chance of beating inflation and reaching your pension
goal.
3. Make an investment plan
Once you’re clear on your needs and goals – and have assessed how much risk you can take – draw
up an investment plan. This will help you identify the types of product that could be suitable for you. A
good rule of thumb is to start with low risk investments such as Cash ISAs. Then, add medium-risk
investments like unit trusts if you’re happy to accept higher volatility. Only consider higher risk
investments once you’ve built up low and medium-risk investments. Even then, only do so if you are
willing to accept the risk of losing the money you put into them.
4. Diversify
It’s a basic rule of investing that to improve your chance of a better return you have to accept more risk.
But you can manage and improve the balance between risk and return by spreading your money across
different investment types and sectors whose prices don’t necessarily move in the same direction – this
is called diversifying. It can help you smooth out the returns while still achieving growth, and reduce the
overall risk in your portfolio.
5. Decide how hands-on to be
Investing can take up as much or as little of your time as you’d like:
 If you want to be hands-on and enjoy making investment decisions, you might want to consider
buying individual shares – but make sure you understand the risks.
 If you don’t have the time or inclination to be hands-on – or if you only have a small amount of
money to invest – then a popular choice is investment funds, such as unit trusts and Open Ended
Investment Companies (OEICs). With these, your money is pooled with that of lots of other
investors and used to buy a wide spread of investments.
 If you’re unsure about the types of investment you need, or which investment funds to
choose, get financial advice.
6. Check the charges
If you buy investments, like individual shares, direct, you will need to use a stock broking service and
pay dealing charges. If you decide on investment funds, there are charges, for example to pay the fund
manager. And, if you get financial advice, you will pay the adviser for this. Whether you’re looking at
stockbrokers, investment funds or advisers, the charges vary from one firm to another.
Ask any firm to explain all their charges so you know what you will pay, before committing your money.
While higher charges can sometimes mean better quality, always ask yourself if what you’re being
charged is reasonable and if you can get similar quality and pay less elsewhere.
7. Investments to avoid
Avoid high-risk products unless you fully understand their specific risks and are happy to take them on.
Only consider higher risk products once you’ve built up money in low and medium-risk investments. And
some investments are Usually best avoided altogether.
8. Review periodically – but don’t ‘stock-watch’
Regular reviews – say, once a year – will ensure that you keep track of how your investments are
performing and adjust your savings as necessary to reach your goal. You will get regular statements to
help you do this. However, don’t be tempted to act every time prices move in an unexpected direction.
Markets rise and fall all the time and, if you’re a long-term investor, you can just ride out these
fluctuations.
Evaluation Of Investment Opportunities
1. Payback Period Method:
The payback period is usually expressed in years, which it takes the cash inflows from a capital
investment project to equal the cash outflows. The method recognizes the recovery of original capital
invested in a project. At payback period the cash inflows from a project will be equal to the project’s
cash outflows.
This method specifies the recovery time, by accumulation of the cash inflows (inclusive of depreciation)
year by year until the cash inflows equal to the amount of the original investment. The length of time this
process takes gives the ‘payback period’ for the project. In simple terms it can be defined as the number
of years required to recover the cost of the investment.
In case of capital rationing situations, a company is compelled to invest in projects having shortest
payback period. When deciding between two or more competing projects the usual decision is to accept
the one with the shortest payback. Payback is commonly used as a first screening method. This method
recognizes the recovery of the original capital invested in a project.
Merits:
The merits of payback period method are as follows:
1. It is simple to apply, easy to understand and of particular importance to business which lack the
appropriate skills necessary for more sophisticated techniques.
2. In case of capital rationing, a company is compelled to invest in projects having shortest
payback period.
3. This method is most suitable when the future is very uncertain. The shorter the payback period,
the less risky is the project. Therefore, it can be considered as an indicator of risk.
4. This method gives an indication to the prospective investors specifying when their funds are
likely to be repaid.
5. Ranking projects according to their ability to repay quickly may be useful to firms when
experiencing liquidity constraints. They will need to exercise careful control over cash
requirements.
6. It does not involve assumptions about future interest rates.
Demerits:
The payback period method suffers from the following drawbacks:
1. It does not indicate whether an investment should be accepted or rejected, unless the payback
period is compared with an arbitrary managerial target.
2. The method ignores cash generation beyond the payback period and this can be seen more a
measure of liquidity than of profitability.
3. It fails to take into account the timing of returns and the cost of capital. It fails to consider the
whole life time of a project. It is based on a negative approach and gives reduced importance to
the going concern concept and stresses on the return of capital invested rather than on the
profits occurring from the venture.
4. The traditional payback approach does not consider the salvage value of an investment. It fails to
determine the payback period required in order to recover the initial outlay if things go wrong.
The bailout payback method concentrates on this abandonment alternative.
5. This method makes no attempt to measure a percentage return on the capital invested and is
often used in conjunction with other methods.
 6. The projects with long payback periods are characteristically those involved in long-term
planning, and which determine an enterprise’s future. However, they may not yield their highest
returns for a number of years and the result is payback method biased against the very
investments that are most important to long-term.
2. Accounting Rate of Return Method:
The accounting rate of return is also known as ‘return on investment’ or ‘return on capital employed’
method employing the normal accounting technique to measure the increase in profit expected to result
from an investment by expressing the net accounting profit arising from the investment as a percentage
of that capital investment. The method does not take into consideration all the years involved in the life
of the project.
In this method, most often the following formula is applied to arrive at the accounting rate of
return:

Sometimes, initial investment is used in place of average investment. Of the various accounting rates of
return on different alternative proposals, the one having highest rate of return is taken to be the best
investment proposal.
Merits:
The merits of accounting rate of return method are as follows:
1. It is easy to calculate because it makes use of readily available accounting information.
2. It is not concerned with cash flows but rather based upon profits which are reported in annual
accounts and sent to shareholders.
3. Unlike payback period method, this method does take into consideration all the years involved in the
life of a project.
4. Where a number of capital investment proposals are being considered, a quick decision can be taken
by use of ranking the investment proposals.
5. If high profits are required, this is certainly a way of achieving them.
Demerits:
The demerits of accounting rate of return method are summarized as follows:
1. It does not take into accounting time value of money.
2. It fails to measure properly the rates of return on a project even if the cash flows are even over the
project life.
3. It uses the straight line method of depreciation. Once a change in method of depreciation takes place,
the method will not be easy to use and will not work practically.
4. This method fails to distinguish the size of investment required for individual projects. Competing
investment proposals with the same accounting rate of return may require different amounts of
investment.
5. It is biased against short-term projects in the same way that payback is biased against longer-term
ones.
6. Several concepts of investment are used for working out accounting rates of return.
7. The accounting rates of return does not indicate whether an investment should be accepted or
rejected, unless the rates of return is compared with the arbitrary management target.
Example
A machine is available for purchase at a cost of Rs.80,000. We expect it to have a life of five years and
to have a scrap value of Rs.10,000 at the end of the five year period.
We have estimated that it will generate additional profits over its life as follows:

These estimates are of profits before depreciation. You are required to calculate the return on capital
employed.
Solution:
Total profit before depreciation over the life of the machine = Rs.1,10,000
... Average profit p.a. = Rs.1,10,000/5 years = Rs.22,000
Total depreciation over the life of the machine = Rs.80,000 – Rs.10,000 = Rs70,000
... Average depreciation p.a. = Rs.70,000/5 years = RS.14,000
... Average annual profit after depreciation = Rs.22,00 – Rs.14,000 = Rs.8,000
Original investment required
... Accounting rate of return = (Rs8,000/Rs.80,000) × 100 = 10%
Average investment = (Rs.80,000 + Rs.10,000)/2 = Rs.45,000
Accounting rate of return = (Rs.8,000/Rs.45,000) × 100 = 17.78%
3. Net Present Value Method:
The objective of the firm is to create wealth by using existing and future resources to produce goods
and services. To create wealth, inflows must exceed the present value of all anticipated cash outflows.
Net present value (NPV) is obtained by discounting all cash outflows and inflows attributable to a capital
investment project by a chosen percentage e.g., the entity’s weighted average cost of capital.
The method discounts the net cash flows from the investment by the minimum required rate of return,
and deducts the initial investment to give the yield from the funds invested. If yield is positive the project
is acceptable. If it is negative the project in unable to pay for itself and is thus unacceptable. The
exercise involved in calculating the present value is known as ‘discounting and the factors by which we
have multiplied the cash flows are known as the ‘discount factors’.
Discount factor = 1/(1+r)n
Where, r = Rate of interest p.a.
n = number of years over which we are discounting.
Discounted cash flow is an evaluation of the future net cash flows generated by a capital project, by
discounting them to their present day value. The method is considered better for evaluation of
investment proposal as this method takes into account the time value of money as well as, the stream of
cash flows over the whole life of the project. The discounting technique converts cash inflows and
outflows for different years into their respective values at the same point of time, allows for the time
value of money.
Merits:
Conceptually sound, the net present value criterion has considerable merits:
1. It explicitly recognises the time value of money.
2. It considers the cash flow stream in its entirety.
3. It squares neatly with the financial objective of maximization of the wealth of stockholders. The net
present value represents the contribution to the wealth of stockholders.
4. The net present value (NPV) of various projects, measured as they are in today’s rupees, can be
added.
For example, the NPV of a package consisting of two projects A and B, will simply be the sum of
NPV of these projects individually:
NPV(A + B) = NPV(A) + NPV(B)
The additivity property of NPV ensures that a poor project (one which has a negative NPV) will not be
accepted just because it is combined with a good project (which has a positive NPV).
5. A changing discount rate can be built into NPV calculations by altering the denominator. This feature
becomes important as this rate normally changes because the longer the time span, the lower is the
value of money and the higher is the discount rate.
6. This method is particularly useful for the selection of mutually exclusive projects.
Demerits:
The demerits of NPV method are as follows:
1. It is difficult to calculate as well as understand and use.
2. The ranking of projects on the NPV dimension is influenced by the discount rate – which is usually
the firm’s cost of capital. But cost of capital is quite a difficult concept to understand and measure in
practice.
3. It may not give satisfactory answer when the projects being compared involve different amounts of
investment. The project with higher NPV may not be desirable if it also requires a large investment.
4. It may mislead when dealing with alternative projects of limited funds under the condition of unequal
lives.
5. The NPV measures an absolute measure, does not appear very meaningful to businessmen who
think in terms of rate of return measures.
Example
A firm can invest Rs. 10,000 in a project with a life of three years.
The projected cash inflows are:
Year 1 – Rs.4,000,
Year 2 – Rs.5,000 and
Year 3 – Rs.4,000.
The cost of capital is 10% p.a. should the investment be made?
Solution:
Discount factors can be calculated based on Rs.1 received in with ‘r’ rate of interest in 3 years using
1/(1+r)n

In this article, the tables given at the end of the book are used wherever possible. Where a particular
year or rate of interest is not given in the tables, students are advised to use the basic discounting
formula as given above.

Analysis:
Since the net present value is positive, investment in the project can be made.
4. Internal Rate of Return Method:
Internal rate of return (IRR) is a percentage discount rate used in capital investment appraisals which
brings the cost of a project and its future cash inflows into equality. It is the rate of return which equates
the present value of anticipated net cash inflows with the initial outlay. The IRR is also defined as the
rate at which the net present value is zero.
The rate for computing IRR depends on bank lending rate or opportunity cost of funds to invest which is
often called as ‘personal discounting rate’ or ‘accounting rate’. The test of profitability of a project is the
relationship between the IRR (%) of the project and the minimum acceptable rate of return (%).
The IRR can be stated in the form of a ratio as shown below:

P.V. of Cash Inflows – P.V. of Cash Outflows = Zero

The IRR is to be obtained by trial and error method to ascertain the discount rate at which the present
values of total cash inflows will be equal to the present values of total cash outflows.
If the cash inflow is not uniform, then IRR will have to be calculated by trial and error method. In order to
have an approximate idea about such discounting rate, it would be better to find out the ‘factor’. The
factor reflects the same relationship of investment and cash inflows as in case of payback calculations.
F = I/C
Where, F = Factor to be located
I = Original Investment
C = Average cash inflow per year
In appraising the investment proposals, IRR is compared with the desired rate of return or weighted
average cost of capital, to ascertain whether the project can be accepted or not. IRR is also called as
‘cut off rate’ for accepting the investment proposals.
Merits:
The merits of IRR method are as follows:
1. It considers the time value of money.
2. It takes into account the total cash inflows and cash outflows.
3. It is easier to understand. For example, if told that IRR of an investment is 20% as against the desired
return on an investment is Rs.15,396.
Demerits:
The demerits of IRR method are given below:
1. It does not use the concept of desired rate of return, whereas it provides the rate of return which is
indicative of the profitability of investment proposal.
2. It involves tedious calculations, based on trial and error method.
3. It produces multiple rates which can be confusing.
4. Projects selected based on higher IRR may not be profitable.
5. Unless the life of the project can be accurately estimated, assessment of cash flows cannot be
correctly made.
6. Single discount rate ignores the varying future interest rates.
5. Profitability Index Method:
It is a method of assessing capital expenditure opportunities in the profitability index. The profitability
index (PI) is the present value of an anticipated future cash inflows divided by the initial outlay The only
difference between the net present value method and profitability index method is that when using the
NPV technique the initial outlay is deducted from the present value of anticipated cash inflows, whereas
with the profitability index approach the initial outlay is used as a divisor.
In general terms, a project is acceptable if its profitability index value is greater than 1. Clearly, a project
offering a profitability index greater than 1 must also offer a net present value which is positive. When
more than one project proposals are evaluated, for selection of one among them, the project with higher
profitability index will be selected.
Mathematically, PI (profitability index) can be expressed as follows:

This method is also called ‘benefit-cost ratio’ or ‘desirability ratio’ method.

Limitations:
The limitations of profitability index method are as follows:
1. Profitability index cannot be used in capital rationing problems where projects are indivisible. Once a
single large project with high NPV is selected, the possibility of accepting several small projects which
together may have higher NPV than the single project, is excluded.
2. Sometimes the project with lower profitability index may have to be selected if it generates cash flows
in the earlier years, which can be used for setting up of another project to increase the overall NPV.
6. Discounted Payback Period Method:
In this method the cash flows involved in a project are discounted back to present value terms as
discussed above. The cash inflows are then directly compared to the original investment in order to
identify the period taken to payback the original investment in present values terms.
This method overcomes one of the main objections to the original payback method, in that it now fully
allows for the timing of the cash flows, but it still does not take into account those cash flows which
occur subsequent to the payback period and which may be substantial.
The method is a variation of payback period method, which can be used if DCF methods are employed.
This is calculated in much the same way as the payback, except that the cash flows accumulated are
the base year value cash flows which have been discounted at the discount rate used in the NPV
method (i.e., the required return on investment).
Thus, in addition to the recovery of cash investment, the cost of financing the investment during the time
that part of the investment remains unrecovered is also provided for. It thus, unlike the ordinary payback
method, ensures the achievement of at least the minimum required return, as long as nothing untoward
happens after the payback period.
7. Adjusted Present Value Method:
In the evaluation of capital budgeting proposals, the first step is to estimate the expected cash outflow
and inflow of the project. Such estimates are made over economic life of the project and present values
of future cash flows are reckoned. While calculation of present values of the future cash flows,
otherwise called discounted cash flows, weighted average cost of capital (WACC) is considered as a
rate for discounting the cash flows.
In NPV method, cash flows are discounted at WACC rate, and if the present value of cash inflow is
higher than the present value of cash outflow, the project can be accepted. The rate of discounted
return in the project with the initial outlay is calculated. Under IRR method this rate is the IRR of the
project and it is then compared with WACC figure. If WACC of the project is lower than IRR, the project
is accepted and vice versa.
Under adjusted present value (APV) approach, the project is splitted into various strategic components.
The cash flow estimates of the project are first discounted at the cost of equity, and a base-case present
value is arrived at as if the project is all-equity financed.
After that, the financial side effects are analyzed one by one and duly valued. For example, if the debt is
proposed to be used as a component of capital, then positive impact of tax shield is added to the base-
case present values. Likewise, different aspects in cost of financing like capital investment subsidy,
flotation costs of public issue/rights issue, administrative cost of equity/debt funds are analyzed
separately and a composite position arrived at.
The APV method is considered improvement over WACC method for the reason that by splitting the
overall decision into logical pieces and attributing financial values to it, aid the management in correct
valuation of the project’s viability. But this approach lays more emphasis on financial risk ignoring the
business risk.
Under WACC approach, all flows are post-tax and the discount rate is also post-tax. Thus the benefit of
tax shield will get discounted at the WACC. On the other hand, under APV approach, the tax shields are
discounted back at the cost of debt.
Risk analysis
Risk analysis is the process of identifying and analyzing potential issues that could negatively impact
key business initiatives or critical projects in order to help organizations avoid or mitigate those risks.
Performing a risk analysis includes considering the probability of adverse events caused by either
natural processes, like severe storms, earthquakes or floods, or adverse events caused by malicious or
inadvertent human activities; an important part of risk analysis is identifying the potential for harm from
these events, as well as the likelihood that they will occur.
Enterprises and other organizations use risk analysis to:
 Anticipate and reduce the effect of harmful results from adverse events;
 Evaluate whether the potential risks of a project are balanced by its benefits to aid in the decision
process when evaluating whether to move forward with the project;
 Plan responses for technology or equipment failure or loss from adverse events, both natural and
human-caused; and
 Identify the impact of and prepare for changes in the enterprise environment, including the likelihood
of new competitors entering the market or changes to government regulatory policy.
Benefits of risk analysis
Organizations must understand the risks associated with the use of their information systems to
effectively and efficiently protect their information assets.
Risk analysis can help an organization improve its security in a number of ways. Depending on the type
and extent of the risk analysis, organizations can use the results to help:
 Identify, rate and compare the overall impact of risks to the organization, in terms of both financial
and organizational impacts;
 Identify gaps in security and determine the next steps to eliminate the weaknesses and strengthen
security;
 Enhance communication and decision-making processes as they relate to information security;
 Improve security policies and procedures and develop cost-effective methods for implementing
these information security policies and procedures;
 Put security controls in place to mitigate the most important risks;
 Increase employee awareness about security measures and risks by highlighting best
practices during the risk analysis process; and
 Understand the financial impacts of potential security risks.
Done well, risk analysis is an important tool for managing costs associated with risks, as well as for
aiding an organization's decision-making process.
Steps in risk analysis process
The risk analysis process usually follows these basic steps:
1. Conduct a risk assessment survey: This first step, getting input from management and
department heads, is critical to the risk assessment process. The risk assessment survey is a way to
begin documenting specific risks or threats within each department.
2. Identify the risks: The reason for performing risk assessment is to evaluate an IT system or other
aspect of the organization and then ask: What are the risks to the software, hardware, data and IT
employees? What are the possible adverse events that could occur, such as human error, fire,
flooding or earthquakes? What is the potential that the integrity of the system will be compromised or
that it won't be available?
3. Analyze the risks: Once the risks are identified, the risk analysis process should determine the
likelihood that each risk will occur, as well as the consequences linked to each risk and how they
might affect the objectives of a project.
4. Develop a risk management plan: Based on an analysis of which assets are valuable and which
threats will probably affect those assets negatively, the risk analysis should produce control
recommendations that can be used to mitigate, transfer, accept or avoid the risk.
5. Implement the risk management plan: The ultimate goal of risk assessment is to implement
measures to remove or reduce the risks. Starting with the highest-priority risk, resolve or at least
mitigate each risk so it's no longer a threat.
6. Monitor the risks: The ongoing process of identifying, treating and managing risks should be an
important part of any risk analysis process.
The focus of the analysis, as well as the format of the results, will vary depending on the type of risk
analysis being carried out.
Qualitative vs. quantitative risk analysis
The two main approaches to risk analysis are qualitative and quantitative. Qualitative risk analysis
typically means assessing the likelihood that a risk will occur based on subjective qualities and the
impact it could have on an organization using predefined ranking scales. The impact of risks is often
categorized into three levels: low, medium or high. The probability that a risk will occur can also be
expressed the same way or categorized as the likelihood it will occur, ranging from 0% to 100%.
Quantitative risk analysis, on the other hand, attempts to assign a specific financial amount to adverse
events, representing the potential cost to an organization if that event actually occurs, as well as the
likelihood that the event will occur in a given year. In other words, if the anticipated cost of a significant
cyberattack is $10 million and the likelihood of the attack occurring during the current year is 10%, the
cost of that risk would be $1 million for the current year.
A qualitative risk analysis produces subjective results because it gathers data from participants in the
risk analysis process based on their perceptions of the probability of a risk and the risk's likely
consequences. Categorizing risks in this way helps organizations and/or project teams decide which
risks can be considered low priority and which have to be actively managed to reduce the effect on the
enterprise or the project.
A quantitative risk analysis, in contrast, examines the overall risk of a project and generally is conducted
after a qualitative risk analysis. The quantitative risk analysis numerically analyzes the probability of
each risk and its consequences.
The goal of a quantitative risk analysis is to associate a specific financial amount to each risk that has
been identified, representing the potential cost to an organization if that risk actually occurs. So, an
organization that has done a quantitative risk analysis and is then hit with a data breach should be able
to easily determine the financial impact of the incident on its operations.
A quantitative risk analysis provides an organization with more objective information and data than the
qualitative analysis process, thus aiding in its value to the decision-making process.
What Are Short-Term Investments?
Short-term investments, also known as marketable securities or temporary investments are those which
can easily be converted to cash, typically within 5 years. Many short-term investments are sold or
converted to cash after a period of only 3-12 months. Some common examples of short term
investments include CDs, money market accounts, high-yield savings accounts, government bonds and
Treasury bills. Usually, these investments are high-quality and highly liquid assets or investment
vehicles.
Short-term investments may also refer specifically to financial assets of a similar kind, but with a few
additional requirements that are owned by a company. Recorded in a separate account, and listed in
the current assets section of the corporate balance sheet, these are investments that a company has
made that are expected to be converted into cash within one year.
Nature of Cash:
For some persons, cash means only money in the form of currency (cash in hand). For other persons,
cash means both cash in hand and cash at bank. Some even include near cash assets in it. They take
marketable securities too as part of cash.
These are the securities which can easily be converted into cash. These viewpoints reflect the degree of
freedom of the persons using the cash. Whether a person’s wants to use it immediately or can wait for a
time to use it depends upon the needs of the concerned person.
Cash itself does not produce goods or services. It is used as a medium to acquire other assets. It is the
other assets which are used in manufacturing goods or providing services. The idle cash can be
deposited in bank to earn interest.
A business has to keep required cash for meeting various needs. The assets acquired by cash again
help the business in producing cash. The goods manufactured or services produced are sold to acquire
cash. A firm will have to maintain a critical level of cash. If at a time it does not have sufficient cash with
it, it will have to borrow from the market for reaching the required level.
There remains a gap between cash inflows and cash outflows. Sometimes cash receipts are more than
the payments or it may be vice-versa at another time. A financial manager tries to synchronize the cash
inflows and cash outflows. But this situation is seldom found in the real world. Perfect synchronization of
receipts and payments of cash is only an ideal situation.
Factors Determining Cash Needs
From the above, we can say that a firm has to decide the cash balance based on their needs, which is
determined after taking into consideration of the following factors:
1. Synchronisation of Cash Flows: Synchronisation of cash flows arises only when there is no
balance between the expected cash inflows and cash outflows. There is no need to manage cash
balance if there is the perfect match between cash inflows and cash outflows. Otherwise, there is a
need to manage cash balance for managing synchronisation. This synchronisation is forecasted through
the preparation of cash budget for a period of 12 months or the planning period. A well-prepared cash
budget will definitely point out the months or periods when the firm will have surplus or deficit cash.
[ Cash Management Aspects ]
2. Short Costs: This is another factor to be considered while determining the cash needs. Short costs
are those costs that arise with a shortfall of cash for the firm requirements. Shortage of cash can be
found through the preparation of cash budget. Cash shortage is not cost free; it involves cost whether it
is expected or unexpected shortage. The expenses incurred as a result of the shortfall are called short
costs. They include the following:
(a) The cost of Transaction: Whenever there is a shortage of cash it should be financed. Financing
may be done through the borrowings from banks or sale of marketable securities (if the firm has). If the
firm is planning to finance the deficit cash by the sale of marketable securities, then the firm is expected
to spend some expenses for brokerage.
(b) The cost of Borrowing: If the firm does not have marketable securities with it, then it prefers
borrowing as a source of financing, shortage of cash. It involves costs like interest on the loan,
commitment charges and other expenses relating to the loan.
(c) The cost of Deterioration of the Credit Rating: Generally credit rating is given by credit rating
agencies (CRISIL, ICRA and CARE). Low credit rating firms may have to go for bank loans with high-
interest charges since they cannot raise the required amount from the public. Low credit rating may also
lead to the stoppage of supplies, demands for cash payment refusal to sell, loss of image and the
attendant decline in sales and profits.
(d) The cost of Loss of Cash Discount: Sufficient cash helps to get cash discount benefits, but a
shortage of cash cannot help to obtain cash discounts.
(e) The cost of Penalty Rates: Whenever there is a shortage of cash firm may not be able to honour
currently returned obligations, which in turn demand penalty.
3. Surplus Cash Balance Costs: It is self-explanatory. It means that the cost associated with excess or
surplus cash balance. Cash is not an earning asset. Surplus cash funds are idle, an impact of idle cash
is that the firm losses opportunities to invest those funds and thereby lose interest, which would
otherwise have been earned.
4. Management Costs: Management costs are those costs involved with setting up and operating cash
management staff. This cost is generally fixed over a period and are mainly include staff, salary,
storage, handling the cost of security and so on. [ Cash Management Aspects ]
Motives for Holding Cash:
The firm’s needs for cash may be attributed to the following needs: Transactions motive, Precautionary
motive and Speculative motive. Some people are of the view that a business requires cash only for the
first two motives while others feel that speculative motive also remains.
These motives are discussed as follows:
1. Transaction Motive:
A firm needs cash for making transactions in the day to day operations. The cash is needed to make
purchases, pay expenses, taxes, dividend, etc. The cash needs arise due to the fact that there is no
complete synchronization between cash receipts and payments. Sometimes cash receipts exceed cash
payments or vice-versa.
The transaction needs of cash can be anticipated because the expected payments in near future can be
estimated. The receipts in future may also be anticipated but the things do not happen as desired. If
more cash is needed for payments than receipts, it may be raised through bank overdraft.
On the other hand if there are more cash receipts than payments, it may be spent on marketable
securities. The maturity of securities may be adjusted to the payments in future such as interest
payment, dividend payment, etc.
2. Precautionary Motive:
A firm is required to keep cash for meeting various contingencies. Though cash inflows and cash
outflows are anticipated but there may be variations in these estimates. For example, a debtor who was
to pay after 7 days may inform of his inability to pay; on the other hand a supplier who used to give
credit for 15 days may not have the stock to supply or he may not be in a position to give credit at
present.
In these situations cash receipts will be less than expected and cash payments will be more as
purchases may have to be made for cash instead of credit. Such contingencies often arise in a
business. A firm should keep some cash for such contingencies or it should be in a position to raise
finances at a short period.
The cash maintained for contingency needs is not productive or it remains ideal. However, such cash
may be invested in short-period or low-risk marketable securities which may provide cash as and when
necessary.
3. Speculative Motive:
The speculative motive relates to holding of cash for investing in profitable opportunities as and when
they arise. Such opportunities do not come in a regular manner. These opportunities cannot be
scientifically predicted but only conjectures can be made about their occurrence.
For example, the prices of shares and securities may be low at a time with an expectation that these will
go up shortly. The prices of raw materials may fall temporarily and a firm may like to make purchases at
these prices.
Such opportunities can be availed of if a firm has cash balance with it. These transactions are
speculative because prices may not move in a direction in which we suppose them to move. The
primary motive of a firm is not to indulge in speculative transactions but such investments may be made
at times.
4. Compensating Motive
 It is a motive for holding cash to compensate banks for providing certain services or loans
 Clients are supposed to maintain a minimum balance of cash at the bank which they cannot use
themselves

CASH MANAGEMENT
Definition: Cash management is the efficient collection, disbursement, and investment of cash in an
organization while maintaining the company’s liquidity. In other words, it is the way in which a particular
organization manages its financial operations such as investing cash in different short-term projects,
collection of revenues, payment of expenses, and liabilities while ensuring it has sufficient cash
available for future use.
In the real world, organizations have strict cash management controls to monitor its inflows and outflows
while retaining a sufficient amount in order to take advantage of attractive investments or handle
unforeseen liabilities. Efficient management of cash prevents loss of money due to theft or error in
processing transactions. Numerous best practices are adopted to enhance management of company’s
funds.
This involves shortening of cash collection periods, regular follow ups for collections, negotiation of
favourable terms with suppliers allowing delay in payment periods, and preparation of cash flow
forecasts. Businesses also use of technology to speed up cash collection process. They must do all of
this while maintaining adequate amount of funds to meet daily operations.
Cash management means a company’s ability to allocate its funds efficiently in an effort to cover
operating expenses, make investments, repay shareholders, and maintain adequate reserves. The cash
management aspects can be examined under three heads, such as:
1. Cash inflows and outflows,
2 Cash flow within the firm, and
3. Cash balance sheet the point of time.
Cash inflows (receipts) and outflows (payments) may not match, they may be excess or less over cash
outflows. Surplus cash arises when the cash inflows are excess over cash outflows and the deficit will
arise when the cash inflows are less than the cash outflows. The balance known as synchronisation firm
should develop appropriate strategies for resolving the uncertainty involved in cash flow prediction and
in the balance of cash receipts and payments.
Cash Management refers to the collection, handling, control and investment of the organizational cash
and cash equivalents, to ensure optimum utilization of the firm’s liquid resources. Money is the lifeline of
the business, and therefore it is essential to maintain a sound cash flow position in the organization.
Receivables Cash Management
Any amount which the company has earned however not yet received, i.e. its outstanding and is
expected to be received in future, is known as receivables.
An organization must manage its receivables to maintain the surplus cash inflow. It helps the firm to fulfil
its immediate cash requirements.
The cash receivables must be planned in such a way that the organization can realise its debts quickly
and should allow a short credit period to the debtors.
Payables Cash Management
The payables refer to the payment which is unpaid by the organization and is to be paid off shortly.
The organization should plan its cash outflow in such a manner that it can acquire an extended credit
period from the creditors.
This helps the firm to retain its cash resources for a longer duration to meet the short term requirements
and sudden expenses. Even the organization can invest this cash in a profitable opportunity for that
particular credit period to generate additional income.
Objectives of Cash Management
Following purposes of cash management will resolve the above queries:
 Fulfil Working Capital Requirement: The organization needs to maintain ample liquid cash to
meet its routine expenses which possible only through effective cash management.
 Planning Capital Expenditure: It helps in planning the capital expenditure and determining the
ratio of debt and equity to acquire finance for this purpose.
 Handling Unorganized Costs: There are times when the company encounters unexpected
circumstances like the breakdown of machinery. These are unforeseen expenses to cope up with;
cash surplus is a lifesaver in such conditions.
 Initiates Investment: The other aim of cash management is to invest the idle funds in the right
opportunity and the correct proportion.
 Better Utilization of Funds: It ensures the optimum utilization of the available funds by creating
a proper balance between the cash in hand and investment.
 Avoiding Insolvency: If the business does not plan for efficient cash management, the situation
of insolvency may arise. It is either due to lack of liquid cash or not making a profit out of the
money available.
Functions of Cash Management
Cash management is required by all kinds of organizations irrespective of their size, type and location.
Following are the multiple managerial functions related to cash management:
 Investing Idle Cash: The company needs to look for various short term investment alternatives to
utilize surplus funds.
  Controlling Cash Flows: Restricting the cash outflow and accelerating the cash inflow is an
essential function of the business.
 Planning of Cash: Cash management is all about planning and decision making in terms of
maintaining sufficient cash in hand and making wise investments.
 Managing Cash Flows: Maintaining the proper flow of cash in the organization through cost-
cutting and profit generation from investments is necessary to attain a positive cash flow.
 Optimizing Cash Level: The organization should continuously function to maintain the required
level of liquidity and cash for business operations.
Aspects of Cash Management
The firm has to come up with some cash management Aspects strategies regarding the following four
facts of cash management.
1. Cash Planning: Cash planning is required to estimate the cash surplus or deficit for each planning
period. Estimation of cash surplus or deficit can be arrived by preparation of cash budget.
2. Cash Flows Management: Cash flows means cash inflows and cash outflows. The cash flows
should be properly managed that the cash inflows should be accelerated (collected as early as possible)
and cash outflows should be decelerated (cash payments should be delayed without affecting firm
name).
3. Determination of Optimum Cash Balance: Optimum cash balance is that balance at which the cost
of excess cash and danger of cash deficiency will match. In other words, it is the cash balance at that
the total cost (total cost equals to transaction cost and opportunity cost) is minimum. The firm has to
determine optimum cash balance.
4. Investment of Surplus Cash: Whenever there is surplus cash it should be properly invested in
marketable securities, to earn profits. Firms should not invest in long-term securities; they cannot be
converted into cash within a short period. [Cash Management Aspects]
Cash Management Models
Cash management requires a practical approach and a strong base to determine the requirement of
cash by the organization to meet its daily expenses. For this purpose, some models were designed to
determine the level of money on different parameters.
The two most important models are discussed in detail below:
1. The Baumol’s EOQ Model
Based on the Economic Order Quantity (EOQ), in the year 1952, William J. Baumol gave the Baumol’s
EOQ model, which influences the cash management of the company.
This model emphasizes on maintaining the optimum cash balance in a year to meet the business
expenses on the one hand and grab the profitable investment opportunities on the other side.
The following formula of the Baumol’s EOQ Model determines the level of cash which is to be
maintained by the organization:

Where,
‘C’ is the optimum cash balance;
‘F’ is the fixed transaction cost;
‘T’ is the total cash requirement for that period;
‘i’ is the rate of interest during the period
2. The Miller – Orr’ Model
According to Merton H. Miller and Daniel Orr, Baumol’s model only determines the cash withdrawal;
however, cash is the most uncertain element of the business.
There may be times when the organization will have surplus cash, thus discouraging withdrawals;
instead, it may require to make investments. Therefore, the company needs to decide the return point or
the level of money to be maintained, instead of determining the withdrawal amount.
This model emphasizes on withdrawing the cash only if the available fund is below the return point of
money whereas investing the surplus amount exceeding this level.
Given below is the graphical representation of this model:
 Where,
‘Z’ is the spread of cash;
‘UL’ is the upper limit or maximum level
‘LL’ is the lower limit or the minimum level
‘RP’ is the Return Point of cash
We can see that the above graph indicates a lower limit which is the minimum cash a business requires
to function. Adding up the spread of cash (Z) to this lower limit gives us the return point or the average
cash requirement.
However, the company should not invest the sum until it reaches the upper limit to ensure maximum
return on investment. This upper limit is derived by adding the lower limit to the three times of spread
(Z). The movement of cash is generally seen across the lower limit and the upper limit.
Let us now discuss the formula of the Miller – Orr’ model to find out the return point of cash and the
spread across the minimum level and the maximum level:

Where,
‘Return Point’ is the point at which money is to be invested or withdrawn;
‘Minimum Level’ is the minimum cash required for business sustainability;
‘Z’ is the spread across the minimum level and the maximum level;
‘T’ is the transaction cost per transfer;
‘V’ is the variance of daily cash flow per annum;
‘i’ is the daily interest rate
Cash Management Strategies
Cash management involves decision making at every step. It is not an immediate solution but a
strategical approach to financial problems. Following are the strategies of cash management:

Business Line of Credit: The organization should opt for a business line of credit at an initial stage to
meet the urgent cash requirements and unexpected expenses.
Money Market Fund: While carrying on a business, the surplus fund should be invested in the money
market funds. These are readily convertible into cash whenever required and yield a considerable profit
over the period.
Lockbox Account: This facility provided by the banks enable the companies to get their payments
mailed to its post office box. This lockbox is managed by the banks to avoid manual deposit of cash
regularly.
Sweep Account: The organizations should avail the facility of sweep accounts which is a mix of
savings and fixed deposit account. Thus, the minimum balance of the savings account is automatically
maintained, and the excess sum is transferred to the fixed deposit account.
Cash Deposits (CDs): If the company has a sound financial position and can predict the expenses well
along with availing of a lengthy period, it can invest the surplus cash in the cash deposits. These CDs
yield good interest, but early withdrawals are liable to penalties.
Cash Flow Management Techniques
Managing cash flow is a contemplative process and requires a lot of analytical thinking. The various
techniques or tools used by the managers to practice cash flow management are as follows:
 Accelerating Collection of Accounts Receivable: One of the best ways to improve cash inflow
and increase liquid cash by collecting the debts and dues from the debtors readily.
 Stretching of Accounts Payable: On the other hand, the company should try to extend the
payment of dues by acquiring an extended credit period from the creditors.
 Cost Cutting: The company must look for the ways of reducing its operating cost to main a good
cash flow in the business and improve profitability.
 Regular Cash Flow Monitoring: Keeping an eye on the cash inflow and outflow, prioritizing the
expenses and reducing the debts to be recovered, makes the organization’s financial position
sound.
 Wisely Using Banking Services: The services such as a business line of credit, cash deposits,
lockbox account and sweep account should be used efficiently and intelligently.
 Upgrading with Technology: Digitalization makes it convenient for the organizations to maintain
the financial database and spreadsheets to be assessed from anywhere anytime.
Limitations of Cash Management
Cash management is an inevitable part of business organizations. However, it has a few shortcomings
which make it unsuitable for small organizations; these are as follows:
1. Cash management is a very time consuming and skilful activity which is required to be
performed regularly.
2. As it requires financial expertise, the company may need to hire consultants or other experts to
perform the task by paying administrative and consultation charges.
3. Small business entities which are managed solely, face problems such as lack of skills,
knowledge, time and risk-taking ability to practice cash management.
Inventory Management
It refers to the process of ordering, storing, and using a company's inventory. These include the
management of raw materials, components, and finished products, as well as warehousing and
processing such items.
For companies with complex supply chains and manufacturing processes, balancing the risks of
inventory gluts and shortages is especially difficult. To achieve these balances, firms have developed
two major methods for inventory management: just-in-time and materials requirement planning: just-in-
time (JIT) and materials requirement planning (MRP).
Concept of Inventory:
Inventory refers to those goods which are held for eventual sale by the business enterprise. In other
words, inventories are stocks of the product a firm is manufacturing for sale and components that make
up the product. Thus, inventories form a link between the production and sale of the product.
The forms of inventories existing in a manufacturing enterprise can be classified into three
categories:
(i) Raw Materials:
These are those goods which have been purchased and stored for future productions. These are the
goods which have not yet been committed to production at all.
(ii) Work-in-Progress:
These are the goods which have been committed to production but the finished goods have not yet
been produced. In other words, work-in-progress inventories refer to ‘semi-manufactured products.’
(iii) Finished Goods:
These are the goods after production process is complete. Say, these are final products of the
production process ready for sale. In case of a wholesaler or retailer, inventories are generally referred
to as ‘merchandise inventory’.
Some firms also maintain a fourth kind of inventory, namely, supplies. Examples of supplies are office
and plant cleaning materials, oil, fuel, light bulbs and the like. These items are necessary for production
process. In practice, these supplies form a small part of total inventory involving small investment.
Therefore, a highly sophisticated technique of inventory management is not needed for these.

The size of above mentioned three types of inventories to be maintained will vary from one business
firm to another depending upon the varying nature of their businesses. For example, while a
manufacturing firm will have all three types of inventories, a retailer or a wholesaler business, due to its
distinct nature of business, will have only finished goods as its inventories. In case of them, there will
be, therefore, no inventories of raw materials as well as work-in- progress.
Motives for Holding Inventories:
A simple but meaningful question arises:
Why do firms hold inventories while it is expensive to hold inventories? The reply to this question is the
motives behind holding inventories in an enterprise.
Researchers report that there are three major motives behind holding inventories in an
enterprise:
1. Transaction Motive
2. Precautionary Motive
3. Speculative Motive
A brief description about each of these motives follows in seriatim:
1. Transaction Motive:
According to this motive, an enterprise maintains inventories to avoid bottlenecks in its production
and sales. By maintaining inventories; the business ensures that production is not interrupted for
want of raw material, on the one hand, and sales also are not affected on account of non-availability
of finished goods, on the other.
2. Precautionary Motive:
Inventories are also held with a motive to have a cushion against unpredicted business. There may
be a sudden and unexpected spurt in demand for finished goods at times. Similarly, there may be
unforeseen slump in the supply of raw materials at some time. In both the cases, a prudent business
would surely like to have some cushion to guard against the risk of such unpredictable changes.
3. Speculative Motive:
An enterprise may also hold inventories to take the advantages of price fluctuations. Suppose, if the
prices of raw materials are to increase rather steeply, the enterprise would like to hold more
inventories than required at lower prices.
Benefits and Costs of Holding Inventories:
Holding inventories bears certain advantages for the enterprise.
The important advantages but not confined to the following only are as follows:
1. Avoiding Losses of Sales:
By holding inventories, a firm can avoid sales losses on account of non-supply of goods at times
demanded by its customers.
2. Reducing Ordering Costs:
Ordering costs, i.e., the costs associated with individual orders such as typing, approving, mailing, etc.
can be reduced, to a great extent, if the firm places large orders rather than several small orders.
3. Achieving Efficient Production Run:
Holding sufficient inventories also ensures efficient production run. In other words, supply of sufficient
inventories protects against shortage of raw materials that may at times interrupt production operation.
Costs of Holding Inventories:
However, holding inventories is not an unmixed blessing. In other words, it is not that everything is good
with holding inventories. It is said that every noble acquisition is attended with risks; he who fears to
encounter the one must not expect to obtain the other. This is true of inventories also. There are certain
costs also associated with holding inventories. Hence, it is necessary for a firm to take these costs into
consideration while planning for inventories.
These are broadly classified into three categories:
1. Material Costs:
These include costs which are associated with placing of orders to purchase raw materials and
components. Clerical and administrative salaries, rent for the space occupied, postage, telegrams, bills,
stationery, etc. are the examples of ordering costs. The more the orders, the more will be the ordering
costs and vice versa.
2. Carrying Costs:
These include costs involved in holding or carrying inventories like insurance charges for covering risks,
rent for the floor space occupied, wages to laborers, wastages, obsolescence or deterioration, thefts,
pilferages, etc. These also include opportunity costs. This means had the money blocked in inventories
been invested elsewhere in the business, it would have earned a certain return. Hence, the loss of such
return may be considered as an ‘opportunity cost’.
The above facts underline the need for inventory management, i.e., to decide the optimum volume of
inventories in the firm/enterprise during the period.
Objectives of Inventory Management:
There are two main objectives of inventory management:
1. Making Adequate Availability of Inventories:
The main objective of inventory management is to ensure the availability of inventories as per
requirements all the times. This is because both shortage and surplus of inventories prove costly to the
organization. In case of shortage of availability in inventories, the manufacturing wheel comes to a
grinding halt. The consequence is either less production or no production.
The either case results in less sale to less revenue to less profit or more loss. On the other hand,
surplus in inventories means lying inventories idle for some time implying cash blocked in inventories.
Speaking alternatively, this also means that had the organization invested money blocked in inventories
invested elsewhere in the business, it would have earned a certain return to the organization. Not only
that, it would have also reduced the carrying cost of inventories and, in turn, increased profits to that
extent.
2. Minimising Costs and Investments in Inventories:
Closely related to the above objective is to minimize both costs as well as volume of investment in
inventories in the organization. This is achieved mainly by ensuring required volume of inventories in the
organization all the times.
This benefits organization mainly in two ways. One, cash is not blocked in idle inventories which can be
invested elsewhere to earn some return. Second, it will reduce the carrying costs which, in turn, will
increase profits. In lump sum, inventory management, if done properly, can bring down costs and
increase the revenue of a firm.
The main objective of inventory management is to maintain inventory at appropriate level to avoid
excessive or shortage of inventory because both the cases are undesirable for business. Thus,
management is faced with the following conflicting objectives:

1. To keep inventory at sufficiently high level to perform production and sales activities smoothly.

2. To minimize investment in inventory at minimum level to maximize profitability.

Other objectives of inventory management are explained as under:-

1. To ensure that the supply of raw material & finished goods will remain continuous so that production
process is not halted and demands of customers are duly met.

2. To minimize carrying cost of inventory.

3. To keep investment in inventory at optimum level.

4. To reduce the losses of theft, obsolescence & wastage etc.

5. To make arrangement for sale of slow moving items.

6. To minimize inventory ordering costs.

The inventory management process

Inventory management is a complex process, particularly for larger organizations, but the basics are
essentially the same regardless of the organization's size or type. In inventory management, goods are
delivered into the receiving area of a warehouse in the form of raw materials or components and are put
into stock areas or shelves.
Compared to larger organizations with more physical space, in smaller companies, the goods may go
directly to the stock area instead of a receiving location, and if the business is a wholesale distributor,
the goods may be finished products rather than raw materials or components. The goods are then
pulled from the stock areas and moved to production facilities where they are made into finished goods.
The finished goods may be returned to stock areas where they are held prior to shipment, or they may
be shipped directly to customers.
Inventory management uses a variety of data to keep track of the goods as they move through the
process, including lot numbers, serial numbers, cost of goods, quantity of goods and the dates when
they move through the process.
Some inventory management software systems are designed for large enterprises, and they may be
heavily customized for the particular requirements of those organizations. Large systems were
traditionally run on premises, but are now also deployed in public cloud, private cloud and hybrid
cloud environments. Small and midsize companies typically don't need such complex and costly
systems, and they often rely on stand-alone inventory management products, generally
through SaaS applications.
Inventory Accounting
Inventory represents a current asset since a company typically intends to sell its finished goods within a
short amount of time, typically a year. Inventory has to be physically counted or measured before it can
be put on a balance sheet. Companies typically maintain sophisticated inventory management systems
capable of tracking real-time inventory levels. Inventory is accounted for using one of three methods:
first-in-first-out (FIFO) costing; last-in-first-out (LIFO) costing; or weighted-average costing.
An inventory account typically consists of four separate categories:
1. Raw materials
2. Work in process
3. Finished goods
4. Merchandise
Raw materials represent various materials a company purchases for its production process. These
materials must undergo significant work before a company can transform them into a finished good
ready for sale.
Works-in-process represent raw materials in the process of being transformed into a finished product.
Finished goods are completed products readily available for sale to a company's customers.
Merchandise represents finished goods a company buys from a supplier for future resale.
Inventory Management Methods/Technique
Depending on the type of business or product being analyzed, a company will use various inventory
management methods. Some of these management methods include just-in-time (JIT) manufacturing,
materials requirement planning (MRP), economic order quantity (EOQ), and days sales of inventory
(DSI).
Just-in-Time Management
Just-in-time (JIT) manufacturing originated in Japan in the 1960s and 1970s; Toyota Motor Corp. (TM)
contributed the most to its development. The method allows companies to save significant amounts of
money and reduce waste by keeping only the inventory they need to produce and sell products. This
approach reduces storage and insurance costs, as well as the cost of liquidating or discarding excess
inventory.
JIT inventory management can be risky. If demand unexpectedly spikes, the manufacturer may not be
able to source the inventory it needs to meet that demand, damaging its reputation with customers and
driving business toward competitors. Even the smallest delays can be problematic; if a key input does
not arrive "just in time," a bottleneck can result.
Materials Requirement Planning
The materials requirement planning (MRP) inventory management method is sales-forecast
dependent, meaning that manufacturers must have accurate sales records to enable accurate planning
of inventory needs and to communicate those needs with materials suppliers in a timely manner. For
example, a ski manufacturer using an MRP inventory system might ensure that materials such as
plastic, fiberglass, wood, and aluminum are in stock based on forecasted orders. Inability to accurately
forecast sales and plan inventory acquisitions results in a manufacturer's inability to fulfill orders.
Economic Order Quantity
The economic order quantity (EOQ) model is used in inventory management by calculating the number
of units a company should add to its inventory with each batch order to reduce the total costs of its
inventory while assuming constant consumer demand. The costs of inventory in the model
include holding and setup costs.
The EOQ model seeks to ensure that the right amount of inventory is ordered per batch so a company
does not have to make orders too frequently and there is not an excess of inventory sitting on hand. It
assumes that there is a trade-off between inventory holding costs and inventory setup costs, and total
inventory costs are minimized when both setup costs and holding costs are minimized.
Days Sales of Inventory
Days sales of inventory (DSI) is a financial ratio that indicates the average time in days that a company
takes to turn its inventory, including goods that are a work in progress, into sales.
DSI is also known as the average age of inventory, days inventory outstanding (DIO), days in inventory
(DII), days sales in inventory or days inventory and is interpreted in multiple ways. Indicating the liquidity
of the inventory, the figure represents how many days a company’s current stock of inventory will last.
Generally, a lower DSI is preferred as it indicates a shorter duration to clear off the inventory, though the
average DSI varies from one industry to another.
ABC analysis methodology, which classifies inventory into three categories that represent the inventory
values and cost significance of the goods. Category A represents high-value and low-quantity goods,
category B represents moderate-value and moderate-quantity goods, and category C represents low-
value and high-quantity goods. Each category can be managed separately by an inventory
management system, and it's important to know which items are the best sellers in order to keep
quantities of buffer stock on hand. For example, more expensive category A items may take longer to
sell, but they may not need to be kept in large quantities. One of the advantages of ABC analysis is that
it provides better control over high-value goods, but a disadvantage is that it can require a considerable
amount of resources to continually analyze the inventory levels of all the categories.
Inventory control is the area of inventory management that is concerned with minimizing the total cost of
inventory, while maximizing the ability to provide customers with products in a timely manner. In some
countries, the two terms are used as synonyms.
Qualitative Analysis of Inventory
There are other methods used to analyze a company's inventory. If a company frequently switches its
method of inventory accounting without reasonable justification, it is likely its management is trying to
paint a brighter picture of its business than what is true. The SEC requires public companies to
disclose LIFO reserve that can make inventories under LIFO costing comparable to FIFO costing.
Frequent inventory write-offs can indicate a company's issues with selling its finished goods or inventory
obsolescence. This can also raise red flags with a company's ability to stay competitive and
manufacture products that appeal to consumers going forward.
What are the consequences of over investment & under investment in inventory?

Both over investment and under investment in inventory is undesirable as both have consequences.

Following are the consequences of over investment:

- Unnecessary blockage of funds in inventory

- Excessive storage is required to store the inventory.

- Excessive insurance cost.

- Risk of liquidity: Value of the inventory reduces due to the long holding period as the inventories once
purchased are difficult to dispose off at the same value.

Following are the consequences of under investment:

- Under investment in the inventory may cause frequent interruptions in production process.

- Insufficient stock of finished goods may create problems in meeting customers’ demands and they
may shift to the competitors.
Effective of inventory management
 Maintain sufficient finished goods inventory for smooth sales operation and efficient customer
service
 Minimize the carrying cost and time
 Control investment in inventories and keep it at an optimum level
Essential Tips for effective Inventory Management
Inventory management is a crucial piece of a business's profitability, but a lot of SMBs don't practice
good management practices when it comes to the items they sell.
It makes sense that having too little inventory is a detriment to a business. Customers become
frustrated when the items they're looking for aren't available on the shelf or through your website. At
least some of those customers will go elsewhere for the missing item. This runs the risk that those
frustrated consumers may never return.
Some businesses go the other way, though, and overstock items "just in case." While you're sure to
always have the items your customers are looking for, the risk with this strategy is bleeding money from
your business. Not only does excess inventory tie up valuable cash flow, but it also costs more to store
and track.
The answer to effective inventory management lies somewhere between these two extremes. While it
requires more work and planning to achieve an efficient management process, your profits will reflect
your effort.
1. Prioritize your inventory.
Categorizing your inventory into priority groups can help you understand which you need to order more
of and more frequently, and which are important to your business but may be costly and move more
slowly. Experts typically suggest segregating your inventory into A, B and C groups. Items in the A
group are higher-ticket items that you need fewer of. Items in the C category are lower-cost items
whose inventory turns over quickly. The B group is what's left – those items that are moderately
priced and move out the door more slowly than C items but more quickly than A items.
2. Track all product information.
Make sure that you keep a record of the product information you have for items in your inventory.
Information should include SKUs, barcode data, suppliers, countries of origin and lot numbers. You may
also consider tracking the cost of each item over time so you're aware of factors that may change the
cost, like scarcity and seasonality.
3. Audit your inventory.
Some businesses do a comprehensive count once a year. Others do monthly, weekly or even daily spot
checks of their hottest items. Many do all of the above. Regardless of how you do it, make it a point to
physically count your inventory regularly to ensure it matches up with what you think you have.
4. Analyze supplier performance.
An unreliable supplier can cause problems for your inventory. If you have a supplier that is habitually
late with deliveries or frequently shorts an order, it's time to take action. Have a discussion with your
supplier about the issues and find out what the problem is. Be prepared to switch partners, or deal with
uncertain stock levels and the possibility of running out of inventory as a result.
5. Practice the 80/20 inventory rule.
As a general rule, 80 percent of your profits come from 20 percent of your stock. Make inventory
management of these items a priority. Understand completely the sales lifecycle of these items,
including how many you sell in a week or a month, and closely monitor them. These are the items that
make you the most money; don't fall short in managing them.
6. Be consistent in how you receive stock.
It may seem like common sense to make sure incoming inventory is processed, but do you have a
standard process that everyone follows? Or does each employee receiving and processing incoming
stock do it differently? Small discrepancies in how new stock is taken in could have you scratching your
head at the end of the month or year, wondering why your numbers don't align with your POs. Make
sure all staff that receives stock does so the same way, that all boxes are verified received and
unpacked together, accurately counted, and checked for accuracy.
7. Track sales.
Again, this seems like a no-brainer, but it goes beyond simply adding up sales at the end of the day.
You should understand, on a daily basis, what items sold and how many, and update inventory totals.
But more than that, you'll need to analyze this data. Do you know when certain items sell faster or drop
off? Is it seasonal? Is there a specific day of the week when you sell certain items? Do some items
almost always sell together? Understanding not just your sales totals but the broader picture of how
things look is important to keeping inventory under control.
8. Order restocks you.
Some vendors offer to do inventory and reorders for you. On the surface, this seems like a good thing.
You save on staff and time by letting someone else manages the process for at least a few of your
items. But remember that your vendors don't have the same priorities you do. They are looking to move
their items, while you're looking to stock the items that are most profitable for your business. Take the
time to check inventory and order restocks of all your items yourself.
9. Invest in inventory management technology.
If you're a small enough business, managing the first eight things on this list manually, with
spreadsheets and notebooks, is doable. But as your business grows, you'll spend more time on
inventory than you do on your business, or risk your stock getting out of control. Good inventory
management software makes all these tasks easier. Before you choose a software solution, make sure
you understand what you need, that it provides you with the analytics important to your business, and
that it's easy to use.
10. Use technology that integrates well.
Inventory management software isn't the only technology that can help you manage stock. Things like
mobile scanners and POS systems can help you stay on track. When investing in technology,
prioritize systems that work together. Having a POS system that won't talk to your inventory
management software isn't the end of the world, but it might cost you extra time to transfer the data from
one system to another, making it easy to end up with inaccurate inventory counts.
Receivable
Accounting term for amount due from a customer, employee, supplier (as a rebate or refund), or any
other party. Receivables are classified as accounts receivable, notes receivable, etc., and represent an
asset of the firm.
Receivable Management
Receivables are amounts owed to the company by the customers to who company sell goods or
services in the normal course of business. The main purpose of managing receivables is to meet
competition and to increase sales and profits.

Objective of Receivable Management

1. To optimize the amount of sales

2. To minimize cost of credit
3. To optimize investment in receivables.
4. To increase credit sales.

Therefore, the main objective of receivable management is to create a balance between profitability and
cost.

What are the areas covered by receivables management?

Following are the areas covered by receivables management:

- Credit Analysis
- Credit Terms
- Financing of Receivables
- Credit Collection
- Monitoring of Receivables
Cash flow is the blood line for any business. Business can survive lack of profits, but cannot survive lack
of Cash flow. Managing receivables is one of the most important parts of any Small or large businesses.
Hence it is important to know about receivable management solutions.
When we start the business, the thing that looks most difficult is Sales. But once we have done Sales,
then we are revealed to more difficult part – Receivables. Yes, collecting the due payment from our
Buyers is a bigger task, sometimes than the Sales itself.
What does Receivable Management Mean?
Put simply, Receivable Management or Managing Accounts Receivables means collecting the
payments due for Sales in a timely manner. When we sell any services, products or solutions to our
clients or customers, they owe us the money. Collecting that money is called Receivables Management.
In Accounting terms Our Customers who owe us money are called as “Sundry Debtors”. Yes, they are
called Debtors, because they owe us money.
In India, Management of Receivables is also known as:
1. Payment Collection.
2. Collection Management.
3. Accounts Receivables.
What is receivable management?
There are very few businesses, which have the luxury of receiving money before selling, i.e. Selling for
advance payments. Most of the Companies sell their offerings on a credit. This means that they will
collect the money after selling
Although it looks very simple on the face of it, Managing receivables from Debtors can be a very
complex task depending on the nature of our business. As our business grows and as our offering gets
complex the process of collecting the payments needs to be designed accordingly.
So the entire process of defining the Credit Policy, Setting Payment Terms, Payment Follow ups and
finally timely collection of the due payments can be defined as Receivables Management.
Objectives of Receivable Management
In order to keep business running, we need cash. The whole purpose or objective of Receivables
Management is to keep inflow of cash healthy.
In other words, these are the objectives of Payment Collection.
 Collect receivables from our sundry debtors.
 Maintain a healthy cash flow for the company, so that it can pay our creditors.
 Have proper Policy for Credit management.
 A working process and mechanism for managing payment follow ups and timely collection.
Importance
1. Cash flow is always considered as bloodline of any business organisation. Badly managed
Receivables can break the company.
2. Most of the companies that go bankrupt have Cash flow problems. Companies with lack of profit
can survive, but lack of cash flow is fatal.
3. Working Capital is one the most costliest form of capital. One of the ways of calculating working
capital requirement can be defined as the difference between Sales and Receivables. Bad
collections can mean higher working capital requirements. Which means higher interest costs for
the company.
4. A reliable and predictable Receivables will ensure steady cash flow management of the
organisation. Amounts receivables with no due dates are useless.

Benefits of Accounts Receivable Management

1. Better Cash Flow.
All our Budgets and projections depends on how much we can spend. Predictable cash flow enables us
to manage our operations and expansion plans.
2. Lower Working Capital Requirements.
Effective receivables management ensures that our Working Capital requirements are kept at minimum.
3. Lowered Interest costs.
Working capital is also fixed capital, which attracts interest. Lower Debtors will reduce our Interest
burden.
4. Better Bargaining with Sellers.
When we are buying any goods or services, we can bargain mainly on quantity or Payment terms.
Having a good receivable management provides us with enough cash flow to bargain effectively with
our Suppliers.
5. Stop profit leakages
In case of thin margins, just imagine how much more sales we have to do to recover and adjust just one
small bad-debt. Non receipt or delayed receipt is the biggest profit leakage any company can have.
Types of receivable management
 Collection cost
 Capital cost
 Delinquency cost
 Default cost
Accounts Payable
Definition: When a company purchases goods on credit which needs to be paid back in a short period
of time, it is known as Accounts Payable. It is treated as a liability and comes under the head ‘current
liabilities’. Accounts Payable is a short-term debt payment which needs to be paid to avoid default.

Description: Accounts Payable is a liability due to a particular creditor when it order goods or services
without paying in cash up front, which means that you bought goods on credit. Accounts Payable as a
term is not limited to companies. Even individuals like you and me have Accounts Payable.

We consume electricity, telephone, broadband and cable TV network. The bills get generated towards
the end of the month or a particular billing period. It means that the service provider gave you some
service and sends the bill which needs to be paid by a certain date or else you will default. This
becomes Accounts Payable.

Let’s also understand from a company’s point of view. You are a company A who purchases goods from
company B on credit. The amount raised needs to be paid back in 30 days.

Company B will record the same sale as accounts receivable and company A will record the purchase
as accounts payable. This is because company A has to pay company B.

Under the accounting (Accrual) methodology, this will be treated as a sale even though money has not
exchanged hands yet. The accounts department needs to be extremely careful while processing
transactions relating to Accounts Payable.

Here, time is the essence considering it is a short term debt which needs to be paid within a specific
period of time. Along with that accuracy is the key, which involves the amount that needs to be paid
along with the name of the supplier. Accuracy is important because it will impact the company’s cash
position.
Why are Accounts Payable and its management important?
Accounts payable and its management is vital for the smooth functioning process of any business entity.
It is important for any business because:
 It primarily takes charge of paying the entity’s bills on a timely basis. This is important so that
strong credit and long-term relationship with the vendors can be maintained.
 Only when invoices are paid on time, vendors will ensure an uninterrupted flow of supplies and
services; which in turn will help in the systematic flow of business.
 A good accounts payable process ensures there are no overdue charges, penalty or late fees to
be paid for the dues.
 The organized accounts payable process ensures all that the invoices due are tracked and paid
properly. This will help avoid missing payments and making a payment twice.
 It also enables business entities to manage better cash flows (i.e. making payments only when
due, using the credit facility provided by the vendor, etc.)
  Frauds and thefts can be avoided to a greater extent by following a stringent accounts payable
process.
For a company’s financial statements to be complete and accurate, the accounts payable balances
should be recorded with accuracy. These payables must be dealt with efficiently and accurately. If there
is a double-entry of an expense or omission of a particular invoice, the financial statements will not
report the correct amounts and the loss will be huge when the numbers involved are big. Hence, proper
recording of the expense and tracking of the payment is necessary.
Accounts Payable Process
Every entity will have an accounts payable department and its structure depends upon the size of the
business. Accounts payable section is set up based on the probable number of vendors & service
providers, the volume of the payments that would be processed for a period of time and the nature of
reports that would be required by the management.
For example, a small entity with less number of purchase transactions would require a basic accounts
payable process.

Whereas, accounts payable department of a medium/large enterprise will have a set of procedures to
be followed before making the vendor payments. Set guidelines here are essential because of the value
and volume of transactions during any period of time. The process involves:
 Receiving the bill:
In the case of goods, the bill/invoice helps in tracing the number/quantity of goods received. The time for
which the bill is valid can also be known when the bill is received on time.
 Scrutinizing the bill for details:
The vendor’s name, authorizations, date, and requirements raised with the vendor based on the
purchase order can be verified too.
 Updating the records for the bills received:
Ledger accounts connected to the bills received need to be updated. Here, an expense entry is usually
required to be made in the books of accounts. In cases when an accounting software is used, recording
some expenses may require managerial approval. The approval will be based on the bill value. As a
precautionary step, large companies usually follow the ‘maker and checker’ concept for posting.
  Making timely payment:
As and when the due dates arrive (based on a mutual understanding with the vendor/supplier/creditor),
the payments need to be processed. Here, the required documents need to be prepared and verified.
Details entered on the cheque, vendors bank account details, payment vouchers, the original bill,
purchase order/agreement, etc., need to be scrutinized. Often the signature of the authorized person
may be required.
Once the payments are made, the vendors/suppliers/creditors ledger account has to be closed in the
books of accounts. This will reduce the liability earlier created. In simpler words, the amount showed as
payable, will no longer be seen as a liability.
The procedures mentioned above are organization specific. They can be stricter for large companies
with more approvals required. However, the basic steps are needed to be considered before payments
are made in order to avoid errors and frauds.
As the accounts payable process is vital for every organization, a lot of time needs to be invested for its
successful implementation. In order to have efficient accounts, payable process automation becomes
necessary. This will minimize the time and cost of invoice processing, employee headcount and much
more. Automation will also help reduce human errors and increase efficiency.
Accounting software available in the market which can streamline the accounts payable process. These
eliminate most of the paperwork involved in accounting. Using electronic invoices, scanned copies of
reports, email approvals, etc., will not only reduce the time involved in managing the payables but will
also improve the day to day performance of the businesses. To add, they usually integrate with the
organizations ERP.
There are many other value added services which can be availed from this accounting software. They
ultimately improve business efficiency.
Accounts Payable Management
Account Payables Management refers to the set of policies, procedures, and practices employed by a
company with respect to managing its trade credit purchases.
In summary, they consist of seeking trade credit lines, acquiring favorable terms of purchase, and
managing the flow and timing of purchases so as to efficiently control the company’s working capital.
The account payables of a company can be found in the short-term liabilities section of its balance
sheet, and they mostly consist of the short-term financings of inventory purchases, accrued expenses,
and other critical short-term operations.
EVALUATING THE PERFORMANCE OF PAYABLES MANAGEMENT
Accounts payable are one of 3 main components of working capital, along with receivables and
inventory.
Understanding how these 3 accounts interact among each other and the resulting effects on working
capital levels, cash flow, and the operating cycle can help in managing and evaluating payables
management.
An appropriate balance must be struck, whereby the advantage of deferring cash outlays using trade
credit is weighted against the risk of excessive short-term credit.
It is therefore important to maintain optimal utilization of credit lines and timing of payments, and create
a balance between the need for cash, working capital, and liquidity.
A number of metrics and short-term financial ratios can be used to evaluate the performance payables
management.
Payables Turnover Ratio
Management can use this ratio to measure the average number of times a company pays its suppliers
in a particular period.
A higher number than the industry average indicates the company pays its suppliers at a faster rate
than its competitors, and is generally conducive to short-term liquidity.
Days in Payables Outstanding (DPO)
Measuring the average length of time it takes a company to pay for its short-term purchases in a period,
the DPO can be used by management to determine an optimal timing of payments for its payables.
Cash Conversion Cycle
An important measure of the length of time required to turn inventory purchases into sales, and
subsequently into cash receipts.
Using the CCC, management can assess the interaction of payables with the 2 other working capital
accounts: receivables and inventory, and the resulting effects on cash flow.
 A low CCC is highly desirable. A company can shorten the CCC by for example, lengthening its terms of
purchases.
Net Working Capital (NWC)
NWC is the difference between current assets and current liabilities. High levels are desirable for short-
term liquidity.
A decreasing pattern or trend in NWC can be attributed to increasing levels of payables, and thus can
serve as a warning sign of excessive short-term credit.
A negative NWC (particularly when persistent) is a red flag for a lack of liquidity or potential insolvency.
Current and Quick Ratio
Two other liquidity measures, the current ratio expresses the NWC equation above as a ratio between
current assets and current liabilities. Holding all else equal, rising A/P levels will reduce both the current
and quick ratio. These ratios can be used to assess the impact of increasing payables on short-term
liquidity.
Accounts payable management is one of the important business processes that help in managing
payable obligations of the entity in the most effective manner. Accounts payable is the amount that the
entity has to pay to its suppliers or vendors on the account of goods and services received. It means
that after giving orders of goods and services by the entity, the firm should record a liability in its books
of accounts on the basis of the invoice amount before making the payment. So this liability of the entity
over its supplier or vendor is known as accounts payable. After the payment has been made to the
vendor or the supplier, the amount is deducted from the accounts payable balance.
Important of Accounts Payable management
Accounts payable management is an essential tool for the proper functioning of the business entity. Let
us take note of some common supporting reasons
 It undertakes the responsibility of paying the entity’s bills on time. As this will help in maintaining
the so-called strong credit and long-term relationship with the vendors.
 If the payment is made to the vendor on time, the vendor will provide the continuous flow of goods
and services for the proper functioning of the entity and also probable trade discounts.
 Accounts Payable management has the responsibility that the payment must be done on time to
avoid overdue charges, penalty or late fees.
 It has to make sure that all the invoices can be easily tracked and paid before the due date. The
same helps in avoiding the non-payment or payment for the same bill multiple times.
 The process helps in maintaining the proper cash flows such as making payments only when due,
by making effective and appropriate use of vendor’s credit facility etc.
 It also helps in refraining from any kind of fraud and theft in the business entity.
It is important for an entity to make sure that all its financial statements must be completed with high
accuracy and the unpaid balances must be recorded with high accuracy and efficiency. In case if
expense entry is done twice or unpaid transactions are not recorded, it will lead to the incorrect financial
statements recorded in the book. Because as a result of these incorrect amounts huge losses might be
caused when the big figures are involved. Hence, it is very important to record the various expenses in
the proper manner and also track their payment details.
Objective of Accounts Payable Management
Irrespective of the size of the company, the objective of accounts payable management is to make
payment only to all those company’s bills as well as invoices that are accurate and legitimate. This
means that before making the entry of the vendor’s invoice into the accounting records and proceed for
the payment, the invoice must show these details:
 Details of the order made by the company.
 Details of the company receivable.
 And many more such as calculations, totals, the proper unit costs, terms, etc.
To protect the cash and other assets of a company, internal controls are taken care of by the accounts
payable process due to the following few reasons:
 To prevent making a payment to the fraudulent invoice
 Prevent making a payment to the inaccurate invoice
 And, to prevent making a payment to the vendor invoice twice.
 What is a Purchase order?
A purchase order or PO is the document made by a company to convey its requirements and document
precisely to the vendor. The paper format of a PO is a multi-copy form with copies distributed to many
people. Those people or departments who recieve a PO copy are:
 Receiving department of a company.
 Person who prepares the purchase order.
 Accounts payable department of a company.
 Vendor.
 Person who made a request for a PO to be issued for the goods or services.
Components of a Purchase Order
The purchase order has a
 Company name,
 Preparation Date
 Vendor name,
 PO number
 Mobile number
 Goods description,
 The quantity,
 Shipping method,
 Unit prices,
 Payment Date, etc.
In the three-way match, one copy of the purchase order will be used.
What is receiving report?
A receiving report is a document that shows the details of the goods received by the company. It may
be in paper format or it may be a computer entry. The description and quantity of the goods mentioned
on the receiving report are compared with the details specified on the company’s purchase order.
After the purchase order and receiving report details are matched , it is compared with the vendor
invoice. Hence, the receiving report is one of the documents used in the three-way match.
What is Vendor Invoice?
It is the invoice sent by the supplier or vendor to the company that had received the goods or services
on credit basis. After receiving the invoice, the customer will refer to it as a vendor invoice. Every vendor
invoice is directed to accounts payable for further processing. After the verification and approval, the
specific amount will be credited to the company’s Accounts Payable account simultaneously another
account is debited with the same amount.

Three-way match concept

The accounts payable management, many times uses a technique known as the three-way match
concept that is used to make sure that only the accurate and valid vendor invoices are recorded in the
book of accounts. ALso, it ensures that the payment is made for these accounts only. The three-way
match involves the following:
 A : Will prepare Purchase Order of the Company (POs)
 B : Will prepare Receiving Reports of the Company
 C : Will compare PO, Receiving Reports and Invoice of the Company
 D : Will make payments to the vendors of the Company
The Process of Accounts Payable Management
Every organisation have the accounts payable department and its composition depends upon how big is
the organisation. Accounts payable section structure depends upon the approximate number of vendors
and service providers. The no of payments transaction that would take place in the particular interval of
time and the kind of the report demanded by the organisation like a small organisation having small no
of number of purchase transactions would have been required only a basic accounts payable process.
On the other hand, accounts payable department of a medium or big organisation has some of the
official’s guidelines. These set of rules needs to be followed before making payments to the vendor
because of the value and no of payment transaction during any period of time. The process involves:
 Bill receivable:
In the case of trading of goods, the number or quantity of goods received can easily be traced by the bill
or the invoice. The validity of the bill time can easily be known if the bill is received on time.
 Inspecting the details of the bill :
Now the details such as the vendor’s name, date, authorizations and all other requirements raised with
the vendor depend upon the purchase order will be verified.
 Revising the records for the bills received:
Updating is done in the ledger accounts that are linked with the bills received. In this expense, entry is
generally required to be made in the books of accounts. If accounting software is used in the
organisation, managerial approval is required to record some of the expenses transaction. The manager
gives the approval depends upon the on the value of the bill. Generally, big companies usually follow
the ‘maker and checker’ concept for posting as the precaution step.
 Payment made timely:
The due dates are set between the company and the supplier or vendor by their mutual understanding.
So the necessary documents are being prepared and all of them are verified. Details such as
 The original bill,
 Details as per cheque,
 Vendors bank account details,
 purchase order/agreement,
 Payment vouchers etc.
Are inspected. Sometimes, for further processing signature of the authorized person is the must.
After completing the payment to the vendors or suppliers or creditors, ledger account has to be closed
in the books of accounts. It further helps in reducing the liability of the company. In other words, the
overall payable amount will be reduced which will result in an overall reduction in the liability of the firm.

Automated Accounting Management Process

As the accounts payable process is very important in every organization. For its smooth functioning and
implementation normally, a lot of time is required to be invested. In order to have efficient accounts,
automation in the payable process reduces the time significantly. It will also reduce
 The cost of invoice processing,
 No of employees required and many more.
 It helps in reduce human errors and increase the overall efficiency.
Many accounting software is available in the market which can smoothen the accounts payable
process. This also reduces the use of paper in the accounting process. Normally, electronic invoices,
email approvals, scanned copies of reports, etc., reduce the time required in managing the payables as
well as improve the operational efficiency of the businesses. Now a days integrated management is
usually integrated with the organizations ERP.