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BCA II Sem. Financial Management UNIT-VI Cash Management Cash is considered as vital asset and its proper management support company development and financial strength. An effective cash management program designed by companies can help to realize this growth and strength. Cash is vital element of any company needed to acquire supply resources, equipment and other assets used in generating the products and services. Marketable securities also come under near cash, serve as back pool of liquidity which provides quick cash when needed.
Cash management is the stewardship or proper use of an entity's cash resources. It assists to keep an organization functioning by making the best use of cash or liquid resources of the organization. Cash management is associated with management of cash in such a way as to realize the generally accepted objectives of the firm, maximum productivity with maximum liquidity.
The term cash management denotes to the management of cash resource in such a way that generally accepted business objectives could be accomplished. In this perspective, the objectives of a firm can be combined as bringing about consistency between maximum possible effectiveness and liquidity of a firm. Cash management may be defined as the ability of a management to identify the problems related with cash which may come across in future course of action, finding appropriate solution to curb such problems if they arise, and lastly delegating these solutions to the competent authority for carrying them out. Cash management maintains sufficient quantity of cash in such a way that the quantity denotes the lowest adequate cash figure to meet business obligations. Cash management involves managing cash flows (into and out of the firm), within the firm and the cash balances held by a concern at a point of time.
Objectives of Cash Management
- To make Payment According to Payment Schedule: Firm needs cash to meet its routine expenses including wages, salary, taxes etc.
- To minimize Cash Balance: The second objective of cash management is to reduce cash balance. Excessive amount of cash balance helps in quicker payments, but excessive cash may remain unused & reduces profitability of business. Contrarily, when cash available with firm is less, firm is unable to pay its liabilities in time. Therefore optimum level of cash should be maintained.
Importance of Cash Management
An effective management is considered to be important for the following reasons:
- Cash management guarantees that the firm has sufficient cash during peak times for purchase and for other purposes.
- (^) Cash management supports to meet obligatory cash out flows when they fall due.
- Cash management helps in planning capital expenditure projects.
- Cash management helps to organize for outside financing at favorable terms and conditions, if necessary.
- Cash management helps to allow the firm to take advantage of discount, special purchases and business opportunities.
- Cash management helps to invest surplus cash for short or long-term periods to keep the idle funds fully employed.
General Principles of Cash Management Harry Gross has recommended certain general principles of cash management.
- (^) Determinable Variations of Cash Needs: A reasonable amount of funds, in the form of cash is required to be kept aside to overcome the period expected as the period of cash shortage. This period may either be short and temporary or last for a longer duration of time. Normal and regular payment of cash leads to small cutbacks in the cash balance at periodic intervals. Making this payment to different workers on different days of a week can balance these reductions. Another practice for balancing the level of cash is to schedule cash disbursements to creditors during the period when accounts receivables collected amounts to a large sum but without putting the helpfulness at stake.
- Contingency Cash Requirement: There may arise certain cases, which fall beyond the forecast of the management. These establish unexpected calamities, which are too difficult to be provided in the normal course of the business. Such contingencies always demand for special cash requirements that was not assessed and provided for in the cash budget. Denials of wholesale product, huge amount of bad debts, strikes, and lockouts are some of these contingencies. Only a prior experience and investigation of other similar companies prove supportive as a customary practice. A useful procedure is to shield the business from such calamities like bad-debt losses, fire by way of insurance coverage.
- Availability of External Cash: This factor also has immense significance in the cash management which refer to the availability of funds from outside sources. There resources help in providing credit facility to the firm, which materialized the firm's objectives of holding minimum cash balance. As such if a firm succeeds in obtaining sufficient funds from external sources such as banks or private financers, shareholders, government agencies, the need to maintain cash reserves lessens.
- Maximizing Cash Receipts: Nearly, all financial managers have objective to make the best possible use of cash receipts. Cash receipts if tackled carefully results in minimizing cash requirements of a concern. For this purpose, the comparative cost of granting cash discount to customer and the policy of charging interest expense for borrowing must be appraised continually to determine the ineffectiveness of either of the alternative or both of them during that particular period for maximizing cash receipts. Some techniques proved helpful in this context are mentioned below:
4.i. Concentration Banking: In this system, a company launches banking centers for collection of cash in different areas. Thus, the company instructs its customers of neighboring areas to send their payments to those centers. The collection amount is then deposited with the local bank by these
cash controlling becomes indispensable as it increases the availability of usable cash from within the enterprise. It is understandable that greater the speed of cash flow cycle, greater would be the number of times a firm can convert its goods and services into cash and so lesser will be the cash requirement to finance the desired volume of business during that period. Additionally, every business is in possession of some concealed cash, which if traced out significantly decreases the cash requirement of the enterprise.
- Optimizing the Cash Level: It is important that a financial manager must focus to maintain sound liquidity position i.e. cash level. All his efforts relating to planning, managing and controlling cash should be diverted towards maintaining an optimum level of cash. The prime need of maintaining optimum level of cash is to meet all requirements and to settle the obligations well in time. Optimization of cash level may be related to establishing equilibrium between risk and the related profit expected to be earned by the company.
- Investing Idle Cash: Idle cash or surplus cash is described as the extra cash inflows over cash outflows, which do not have any specific operations or any other purpose to solve currently. Usually, a firm is required to hold cash for meeting working needs facing contingencies and to maintain as well as develop friendliness of bankers. Benefits of Cash Management System
In the period of technology progression, the Cash Management System provides following Benefits to its customers:
- Funds availability as per need on day zero, day one, day two, day three etc. i.e. Corporate can plan their cash flows.
- Bank interest saved as instruments are collected faster.
- Affordable and competitive rates.
- Single point enquiry for all queries.
- Pooling of funds at desired locations.
Management of Receivable
Accounts receivable typically comprise more than 25 percent of a firm's assets. The term receivables are described as debt owed to the firm by the customers resulting from the sale of goods or services in the ordinary course of business. There are the funds blocked due to credit sales. Receivables management denotes to the decision a business makes regarding to the overall credit, collection policies and the evaluation of individual credit applicants. Receivables Management is also known as trade credit management. Robert N. Anthony, explained it as "Accounts receivables are amounts owed to the business enterprise, usually by its customers. Sometimes it is broken down into trade accounts receivables; the former refers to amounts owed by customers, and the latter refers to amounts owed by employees and others".
Receivables are forms of investment in any enterprise manufacturing and selling goods on credit basis, large sums of funds are tied up in trade debtors. When company sells its products, services on credit, and it does not receive cash for it immediately, but would be collected in near future, it is termed as receivables. However, no receivables are created when a firm conducts cash sales as payments are received immediately. Accounts Receivables Management denotes to make decisions relating to the investment in the current assets as vital part of operating process, the objective being maximization of return on investment in receivables. It can be established that accounts receivables management involves maintenance of receivables of optimal level, the degree of credit sales to be made, and the debtors' collection.
Receivables are useful for clients as it increases their resources. Thus, not only the present customers but also the Potential creditors are attracted to buy the firm's product at terms and conditions favorable to them.
Maintenance of receivable
Objectives of receivables management: The objective of Receivables Management is to promote sales and profits until that point is reached where the return on investment in further funding receivables is less than the cost of funds raised to finance that additional credit i.e. cost of capita. Management of Accounts Receivables is quite expensive. The following are the main costs related with accounts receivables management:
Cost of Management of Accounts Receivables
Advantages of accounts receivable management: Accounts Receivables Management has numerous benefits. These include:
- Increased Sales: Offering goods or services on credit enhances sales, by holding old customers and attraction potential customers.
- Increased Market Share: When the firm is able to maintain old customers and attract new customers automatically market share will be bigger to the extent new sales.
- Increase in profits: Increase sales, leads to increase in profits, because it need to produce more products with a given fixed cost and sales of products with a given sales network in both cost per unit comes down and the profit will be better.
Management of Inventory
Component of inventory
The process of Inventory management consists of determining, how to order products and how much to order as well as identifying the most effective source of supply for each item in each stocking location. Inventory management contains all activities of planning, forecasting and replenishment. The main purpose of inventory management is minimize differences between customers demand and availability of items. These differences have caused by three factors that include customers demand fluctuations, supplier's delivery time fluctuations and inventory control accuracy.
Motives of inventory management: Managing inventories involve lack of funds and inventory holding costs. Maintenance of inventories is luxurious. Still there is motive to retain inventories. There are three general motives:
- The transaction motive: Firm may hold the inventories in order to facilitate the smooth and continuous production and sales operations. It may not be possible for the company to obtain raw material whenever necessary. There may be a time lag between the demand for the material and its supply. Therefore, it is needed to hold the raw material inventory. Similarly, it may not be possible to produce the goods instantly after they are demanded by the customers. Hence, it is needed to hold the finished goods inventory. The need to hold work-in-progress may arise due to production cycle.
- The precautionary motive: Firms also prefer to hold them to protect against the risk of unpredictable changes in demand and supply forces. For example, the supply of raw material may get delayed due to the factors like strike, transport disruption, short supply, lengthy processes involved in import of the raw materials.
- The speculative motive: Firms may like to buy and stock the inventory in the quantity which is more than needed for production and sales purposes. It is done to get the advantages in terms of quantity discounts connected with bulk purchasing or expected price rise.
Merits of Inventory Management
There are several advantages of managing inventory in proper way.
- Inventory management guarantees adequate supply of materials and stores to minimize stock outs and shortages and avoid costly interruption in operations.
- (^) It keeps down investment in inventories, inventory carrying costs, and obsolescence losses to the minimum.
- It eases purchasing economies throughout the measurement of requirements on the basis of recorded experience.
- It removes duplication in ordering stock by centralizing the source from which purchase requisition emanate.
- It allows better utilization of available stock by enabling inter-department transfers within a firm.
- It offers a check against the loss of materials through carelessness or pilferage.
- Perpetual inventory values provide a stable and reliable basis for preparing financial statements a better utilization.
Demerits of Holding Inventory
Besides several benefits, there are some drawbacks of holding inventory.
- Price decline: It is a major disadvantage of inventory holding. Price decline is the result of more supply and less demand. It can be said that it may be due to introduction of competitive product. Generally, prices are not controllable in the short term by the individual firm. Controlling inventory is the only way that a firm can counter act with these risks. On the demand side, a decrease in the general market demand when supply remains the same may also cause price to increase. This is also long-lasting management problem, because reduction in demand may be due to change in customer buying habits, tastes and incomes.
- Product deterioration: It is also serious demerits of inventory holding. Holding of finished completed goods for a long period or shortage under inappropriate conditions of light, heat, humidity and pressures lead to product worsening.
- Product obsolescence: If items are hold for long time, it may become outdated. Product may become outmoded due to improved products, changes in customer choices, particularly in high style merchandise, changes in requirements. Then this is a major risk and it may affect in terms of huge revenue loss. It is costly for the firms whose resources are limited and tied up in slow moving inventories.
