Basic Issues in Finance & Investment
Management of Cash
Cash is the most liquid current asset.
Cash management is concerned primarily with the optimization of the amount of cash available while maximizing the interest earned by spare funds not required immediately. Available cash includes:
- Coins and notes
- Money in current accounts and short-term deposits
- Unused bank overdraft facility
- Foreign currency; and
- Deposits that can quickly be converted into the local currency
- We should note that cash does not include stock; money owed by customers; and long-term deposits (if they cannot be withdrawn)
The need for cash
There are three motives why an organization chooses to hold cash:
- Transaction motive: Organizations need cash reserves to be able to purchase goods and services. They need the cash to balance the short term cash inflows and outflows. It should be noted that cash inflows and outflows are not usually perfectly matched. The optimum size of the cash reserve can be estimated by forecasting cash inflows and outflows, and having prepared a cash budget.
- Precautionary motive: Organizations keep some cash reserves to avoid unexpected demands for cash in the short term. They just take precaution. Reserves for precautionary motives maybe in the form of easily realized short term investments (e.g. near cash items, treasury bills).
- Speculative motive: This is the motive of holding cash reserves so that you can take advantage of any attractive investment opportunities that may arise.
Cash Budget
Cash budget incorporates estimates of future inflows and outflows of cash over a short term period of time projected (The period may usually be a year, half a year, or quarter year). Effective cash management requires that the cash budget be further broken down into month, week, or even on a daily basis. These are two components of the cash budget:
Main sources of these inflows and outflows
Cash Inflows
- Cash sales
- Cash received from debtors
- Receipt of a bank loan
- Cash received from loans, deposits
- Interest on saving and investments
- Cash receipts of other revenue income
- Cash received from sales of investments or asset
- Shareholder investments
- Increased bank overdrafts or loans
Cash Outflows
- Purchase of stock, raw materials or tools
- Cash purchases
- Cash payment to creditors
- Cash payment for other revenue expenditure (wages, rent, daily opening expenses)
- Cash payments for asset acquisition (e.g. a building, machinery, office furniture, etc.)
- Cash payments for withdrawals, taxes (Income tax, corporation tax, VAT, etc.)
- Repayment of loan
- Reduced over draft facilities divided payments
Cash budget M/S Moode Enterprises Ltd
Particulars
Estimated Cash inflows
……………………………….
……………………………….
- Total Cash inflows
Estimate cash outflows
……………………………….
………………………………..
- Total cash outflows
- Opening cash balance
- Add/ Deduct surplus/Deficit during the month( I-II)
- Closing cash balance(III-IV)
- Minimum level of cash balance
VII. Estimated excesses or shortfall of cash (V-VI)
Month
January February March
What is Cash flow?
Cash flow is the measure of an organization’s ability to pay the bills on a regular basis. It depends on the amounts and timing of money flowing into (cash inflow) and out (cash out flows) of the business each week, month, quarter, or year. Good cash flow allows a business to pay its bills on time.
Determining optimum cash levels:
- The forecast of future cash inflows and outflows
- The efficient management of the cash flows
- The availability of liquid assets to the organization
- The availability and borrowing capability of the organization. The organization’s risk appetite.
Cash flow problems:
- Poor credit controls
- Failure to fulfill your orders
- Poor management accounting
- Inadequate supplier management
- Ineffective ordering services
- Poor marketing
- Poor control of overheads
Remedies for cash flow problems
- Postpone expenditures on non-essential capital.
- Start to accelerate the rate at which cash flows into the business by say offering discounts for early payments to customers, an aggressive credit recovery policy (by closing overdue accounts), or even having a grand sale to clear unwanted inventory.
- Sell and convert into cash the investments that were probably bought with the surplus cash from previous period. This will also generate cash reserves.
- Postpone or reduce cash outflows by delaying to pay suppliers, and by rescheduling loan payments.
- This last one is the hard one. An organization may decide to reduce (or even pass) a dividend repayment. This is not good. It is usually seen as a sign of financial weakness by the capital market.
