Unit: C

Managing receivable means making decisions relating to the investment of funds in this assets as part of internal short-term operating process. S.C. Kuchchal Cost of maintaining Receivables: 1. Capital Cost 2. Collection Cost 3. Delinquency Cost 4. Default Cost

The objective of receivable management is to promote sales and profits until that point is reached where the return on investment in further funding of receivables is less than the cost of funds raised to finance that additional credit. S.E.Bolten

General Factors
1. 2. 3. 4. 5. 6. 7.

Specific Factors
Level of Credit Sales Terms of Trade Credit Policy Expansion Plans Credit Collection Efforts 6. Paying Habits of Customer
1. 2. 3. 4. 5.

Type and Nature of Business Anticipated Volume of Sales Price-level Variations Availability of Funds Interest Rate Pace of Technological Development Industry Norm

OPTIMUM LEVEL OF INVESTMENT IN TRADE RECEIVABLES

Profitability

Costs & Profitability

Optimum Level

Liquidity Stringent Liberal

Costs & Benefits Profitability

Costs & Return (%) Marginal cost of capital

Liquidity Tight Credit policy Loose Tight Credit policy

Marginal rate of return Loose

Formulation and Evaluation of Credit Policy Implementation of Credit Policy Formulation of Collection Procedure Analysis and Control of Receivable

Investment in receivable
volume of credit sales collection period

Elements of Credit policy

Credit standards Credit terms: credit period and cash discount Collection policies: regularity of collections, clarity of

collection procedures, responsibility for collection and follow-up, case-by-case approach, cash discount for prompt payment Credit analysis: collection period and default rate

A. Evaluation of Credit Applicants Obtaining Credit information pertaining to customer a. Bank Reference b. Credit Agency Report c. Published Information d. Trade References Analysis of Credit Information, business and financial performance a. Quantitative Aspect b. Qualitative Aspect: Character, Capacity, Collateral, Condition and Capital B. Financing the Investment in Receivable

Credit Policy Variables

Customer categories good accounts bad accounts marginal accounts Numerical credit scoring ad hoc approach simple discriminate approach multiple discriminate approach

A. Receivable Turnover Debtors Turnover Ratio= Net Credit Sales / Average Receivable B. Aging schedule Outstanding Period O/s Amount of Debtors % of Debtors 0 30 Days 31 40 Days 41 60 Days 61 90 Days Over 60 Days Total 5,00,000 1,00,000 2,00,000 1,00,000 1,00,000 10,00,000 50 10 20 10 10 100

C. Average Collection Period Avg.Collection Period= Average Receivable X Total Time / Net Credit Sales

Unit: C

Inventory: Stocks of manufactured products and

the material that make up the product. It includes raw materials, work-in-process, finished goods and stores and spares (supplies).

Need for Inventories:

Transaction motive Precautionary motive Speculative motive

Total Inventory Cost Cost of Material Ordering Cost Holding Cost

ORDERING COSTS Requisitioning Order Placing Transportation Receiving, Inspecting & Storing Clerical & Staff

CARRYING / Holding COSTS Warehousing Handling Clerical Staff Insurance Deflation, Deterioration & Obsolescence

Ensure a continuous supply of raw materials to facilitate uninterrupted production Maintain sufficient stock of raw materials in periods of short supply and anticipate price changes Maintain sufficient finished goods inventory for smooth sales operations and efficient customer service Minimise the inventory costs Control inventory investment by maintaining optimum inventory

 Lead Time Cost of Holding Inventory Material Costs Ordering Costs Carrying Costs Cost of tying-up of Funds Cost of Under stocking Cost of Overstocking

 Stock Levels

Reorder Level Maximum Level Minimum Level Safety Level / Danger Level Variety Reduction Materials Planning Service Levels Obsolete Inventory and Scrap Quantity Discounts

Economic order quantity (EOQ)

ordering costs: requisitioning, order placing,

transportation, receiving, inspecting and storing, administration carrying costs: warehousing, handling, clerical and staff, insurance, depreciation and obsolescence ordering and carrying costs trade-off:
EOQ = 2AO c

Minimum Total Costs

Ordering Cost EOQ Order Size Q

Reorder point under certainty

lead time average usage

Reorder point = Lead time x average usage

Reorder point under uncertainty

safety stock

Reorder point = (Lead time x average usage) safety stock

Estimation of incremental operating profit Estimation of incremental investment in inventory Estimation of the incremental rate of return (IRR) Comparison of the incremental rate of return with the required rate of return (RRR) Optimum inventory:
IRR = RRR

Explicitly state the inventory policy Create an inventory monitoring cell Management group for controlling purchases Periodic meetings between purchase, materials planning and production executives Monthly reviews of total inventory at plant/corporate level Dovetail inventory control to the total budgeting system Identify critical inventory items for closer scrutiny

Classification ABC [Always Better Control ]

VED [ Vital, Essential, Desirable] FSN [ Fast-moving, Slowmoving, Non-moving ] HML [ High, Medium, Low ] SDE [ Scarce, Difficult, Easy ] XYZ

Basis Value of items consumed The importance or criticality The pace at which the material moves
Unit price of materials Procurement Difficulties Value of items in storage

Unit: c

Cash management is concerned with the managing of cash flows into and out of the firm, cash flows within the firm, and cash balances held by the firm at a point of time by financing deficit or investing surplus cash. Motives for Holding Cash : Transactions motive Precautionary motive Speculative motive

Cash planning Managing the cash flows Optimum cash level Investing surplus cash

Cash planning is a technique to plan and control the use of cash. It includes Cash Forecasting and Budgeting. Cash Forecasting may be short-term cash forecasting as well as long-term cash forecasting . Short-term Cash Forecasts: It is primarily used: To determine operating cash requirements To anticipate short-term financing To manage investment of surplus cash.

Long-term Cash Forecasting: It is primarily used :

To depict companys future financial needs, especially for its working capital requirements. To evaluate proposed capital projects. To improve corporate planning.

 The receipt and disbursements method The adjusted net income method.
Receipt and Disbursements Method: Virtues: It gives a complete picture of all the items of expected cash flows. It is a sound tool of managing daily cash operations. limitations: Its reliability is reduced because of the uncertainty of cash forecasts. It fails to highlight the significant movements in the working capital items.

The benefits of the adjusted net income method are:

It highlights the movements in the working capital items, and thus helps to keep a control on a firms working capital. It helps in anticipating a firms financial requirements.

The major limitation of this method is:

It fails to trace cash flows, and therefore, its utility in controlling daily cash operations is limited.

Cash Management will be successful only if cash collections are accelerated and cash payments (disbursements), as far as possible, are delayed. Accelerating Cash Collections
Decentralised Collections Lock-box System

Controlling Disbursements
Disbursement or Payment Float

Continued

Methods of ACCELERATING CASH INFLOWS

Prompt payment from customers (Debtors) Quick conversion of payment into cash Decentralized collections Lock Box System (collecting centers at different locations)
Paying on the last date Payment through Cheques and Drafts Adjusting Payroll Funds (Reducing frequency of payments) Centralization of Payments Inter-bank transfers Making use of Float (Difference between balance in Bank Pass Book and Bank Column of Cash Book)

Methods of DECELERATING CASH OUTFLOWS

Optimum Cash Balance under Certainty: Baumols Model Optimum Cash Balance under Uncertainty: The MillerOrr Model

The firm is able to forecast its cash needs with certainty. The firms cash payments occur uniformly over a period of time. The opportunity cost of holding cash is known and it does not change over time. The firm will incur the same transaction cost whenever it converts securities to cash.

Optimum Balance of Cash is: Optimum Cash Balance = (2cT/k) The total annual cost of the demand for cash is: Total Cost = Holding Cost + Transaction Cost Where, Holding Cost (Opportunity Cost) = k (C/2) and Transaction Cost (Cost in converting marketable securities to cash)= c (T/C) T= Total number of transactions during the year K= Opportunity Cost C = Average required balance of Cash c = Per Transaction Cost

The MO model provides for two control limitsthe upper control limit and the lower control limit as well as a return point. If the firms cash flows fluctuate randomly and hit the upper limit, then it buys sufficient marketable securities to come back to a normal level of cash balance (the return point). Similarly, when the firms cash flows wander and hit the lower limit, it sells sufficient marketable securities to bring the cash balance back to the normal level (the return point). The difference between the upper limit and the lower limit depends upon the transaction cost (c), the interest rate, (i) and the standard deviation (s) of net cash flows.

The formula for determining the distance between upper and lower control limits (called Z) is as follows: (Upper Limit-Lower Limit)=((3/4)x Transaction Cost)x Cash Flow Variance/Interest Rate)) Upper Limit=Lower Limit +3Z Return Point=Lower Limit +Z The Net Effect is that the firms hold the average the cash balance equal to: Average Cash=Lower Limit+4/3Z

Selecting Investment Opportunities:

safety, Maturity, and Marketability

Short-term Investment Opportunities:

Treasury bills Commercial papers Certificates of deposits Bank deposits Inter-corporate deposits Money market mutual funds