THE IMPLICATION OF INSUFFICIENCY AND EXCESSIVE

CASH TO ENTITY’S CASH MANAGEMENT AND EFFECTS TO

THE FINANCIAL PERFORMANCE

Requirement for Accounting Research Method (ARM)

BY

GROUP 7 – AT1 (7:00-8:00 MWF)

Walan, Jan Mark

Aguilar, Maria Elena
Escabarte, Michelle Jane
Mamaton, Shaiiyrah
Garpia, Marienel
 TABLE OF CONTENTS

SCOPE AND DISCUSSION OF THE PROBLEM

ADVANTAGE AND DISADVANTAGE

ILLUSTRTATION AND FINDINGS

CONCLUSION AND RECOMMENDATIONS

REFERENCES
 SCOPE AND DISCUSSION OF THE PROBLEM

This research aims to address the problem regarding the impact and implication

of keeping excessive and having insufficient amount of cash in the following:

1. CASH MANAGEMENT

a. Definition

Cash is the most liquid asset used primarily by companies to pay

their obligations and other purposes. Cash management is the process of

collecting and managing cash flows (Kenton, 2020).

It includes, Cash budget, Cash planning, Cash collection, Cash

control and Managing cash flow.

b. Poor Financial and Cash Planning

Unable to manage cash properly is just a reflection of the

company’s poor financial management and planning. Some are the

identified and common causes on why there is an excessive or

insufficiency of company’s cash:

Cash Mismanagement

In business operation, entity acquired multitude of cash inflows and

outflows that must be carefully managed in order to meet payment

obligations, plan for future payments and maintain business stability.

Thus, cash mismanagement may be the cause of different cash flow

problems like excessive amount of cash reported or insufficiency.

 The following are few examples of cash mismanagement that leads

entity to have shortage and excessive cash (Hiiemaa, 2021):

a. Cashier giving customers less or too much change.

b. Entering incorrect payment methods (cash, credit, debit cards).

c. Not handling returns properly (cash back, exchanging item,

taking store credit)

d. Fraud and theft.

Over Investment/ Under Investment

Investments can serve as catalysts for continued growth of a

business; thus, it needs to be planned and managed wisely or it may

result to different problems.

 Over-investing may be the cause of having insufficiency or

shortage in the amount of cash. It is the practice of investing

more into an asset than what that asset is worth on the open

market (Egba, 2021).

Sometimes, entity lose out on an investment completely

while chasing gains that may not be feasible, which will result to

a greater loss and may lead to shortage in the cash while

recording many defective investments.

  Under-investing is clearly one of the reasons why a company

is recording excessive amount of cash. Holding onto cash at

the expense of the investments, not just in stocks but also in

new product development and business expansion, may be

missing many significant market opportunities (Kokemuller,

2021).

Unnecessary Borrowings

Borrowing large amount of money may prevent company from

running out of funds, but in fact it only delays a potential future financial

obligation (Jacob, 2018).

Unnecessary borrowings will continuously add cash to the company

that results to excessive amount of cash, for a meantime. Loans involve

interest that may cause additional future burden to the entity.

2. FINANCIAL PERFORMANCE

a. Definition

Financial performance is a subjective measure of how well a firm

can use assets from its primary mode of business and generate revenues.

The term is also used as a general measure of a firm's overall financial

health over a given period.

 It can be measured using Key performance indicator such as

Return on assets, Return on sales, Earnings before interest and tax and

Liquidity ratio.

b. Relationship of cash management to the financial performance

Businesses are required to maintain a balance between liquidity—

ability to meet short-term obligations, and profitability while conducting

day to day operations. Cash management directly affects liquidity and

profitability (Raheman & Nasr, 2007).

The objective of the cash management is to ensure the financial

health of a business entity to improve the profitability for the shareholders.

This can be achieved by ensuring that finances are available when

needed, since liquidity is the lifeblood of any business entity.

c. Effect of keeping excessive cash to the financial performance

Poor cash management can harm the company’s performance in

both subtle ways and obvious ones. Problems do not just arise from a lack

of cash; having too much cash can also negatively affect a business.

Excessive cash will simply remain idle, without contributing

anything towards the firm’s profitability. It may be a big help on the

company's financial performance, but it will also cause threat to the

company if not manage properly.

d. Effect of having inadequate cash to the financial performance

 According to Said (2011), the firm should keep sufficient cash,

neither more or less. Inadequate cash will disrupt the firm’s operations.

Inadequacy of cash affects financial performance of an entity. It

affects company’s ability to grow. Negative cash flow forces you to

exhaust your cash reserves on payables instead of growing your

business. (Rivero,2018).
 ADVANTAGES AND DISADVANTAGES

1. EXCESS CASH

ADVANTAGES OF EXCESS CASH

 It helps an organization manage its cash flow efficiently.

 Excess cash on hand is a way to meet day-to-day

obligations in case the on boarding of new clients takes

time.

 Ensures that the organization isn't forced to borrow

money. Since borrowing costs are high, organizations

should maintain some excess cash on hand to avoid

taking short-term loans.

 It ensures that the organization is able to meet its

obligations, such as payroll, rent, administration expenses

and loan payments, even if it doesn't generate any revenue

for a specified period.

 It helps the entity to take advantage of speculative

investment opportunities such as to exploit discounts for

prompt payments and to improve credit ratings.

DISADVANTAGES OF EXCESS CASH

 It lowers your return on assets

  The business loses an opportunity to generate additional

returns.

 It increases your cost of capital

 It increases overall risk by destroying business value and

can create an overly confident management team.

2. INSUFFICIENCY OF CASH

DISADVANTAGES OF INADEQUATE CASH

 Damage Morale

 Prevent Business Growth

 Discourages Investors

 This could slow down production and prevent a business

from fulfilling orders that have already been accepted.

 Insufficient capital can prevent the purchase of inventory to

fill new orders resulting in lost business, which makes it

difficult to increase cash flow.

 Can jeopardize future business and the company’s

reputation.
 ILLUSTRATION AND FINDINGS

ILLUSTRATION 1: EFFECT OF EXCESS CASH TO THE RETURN ON ASSET

(PROFITABILITY RATIO)

SITUATION 1: For this example, we’ll use a business with total assets of P1,000,000
and cash making up 15% of that total, or P150,000. The business has an annual after-
tax net income of P100,000.

Requirement: Compute the rate of Return on Asset and provide interpretation.

Computation:
ROA = Net income after tax/Total Assets
= P100,000 / P1,000,000
= 10%

Interpretation:
This concludes that for every peso invested in the asset of the business, it results
in a profit worth 10 cents.
Also, to create 1 unit of profit, 10 units need to be invested in the asset of the
company (100%/10%).

SITUATION 2: Same data as SITUATION 1 with additional assumptions:

 It is assumed that all of the cash are excess (in other words, not earmarked for
other projects, improvements, etc).

Let us try to eliminate the excess cash, resulting to a total asset of P850,000
(P1,000,000 – 150,000). Still, the total net income after tax is P100,000.
Requirement: Compute the rate of Return on Asset and provide interpretation.

Computation:
ROA = Net income after tax/Total Assets
= P100,000 / P850,000
= 11.8%

Interpretation:
This concludes that for every peso invested in the asset of the business, it results
in a profit worth 11.8 cents.

FINDINGS: By eliminating the excess cash and put it into investment, the ROA is
now 1.8% higher than previous situation, an increase of 18%. Therefore, holding
excess cash reduces overall return on assets (ROA). If there is excess cash
balance and an increasing cash generation, it needs to be eliminated by investing
it wisely or to be distributed.

ILLUSTRATION 2: EFFECT OF EXCESS AND INSUFFICIENCY OF CASH TO THE

CASH RATIO (LIQUIDITY RATIO)

SITUATION 1 – CASH RATIO IS LESS THAN 1

On December 31, 2020, Walan Company’s Statement of Financial Position indicates
the following:

 Cash and Cash equivalent totaling P75,000.

 Total Asset of P675,000
 Current liabilities of P110,000
 Long-term liabilities P65,000
 Share Capital of P350,000 and reserves of P150,000.
Requirement: Compute for the Cash Ratio and provide interpretation.

Computation:
Cash Ratio = Cash and Cash Equivalent / Current Liabilities
= P75,000 / P110,000
= 68% or .68

Interpretation:
It is shown above that for every peso of the current liabilities, the company
only has P0.68 of cash to pay for it. Which implies that the cash in the system is
insufficient to pay for its short-term liabilities. A low cash ratio may indicate that the
company is not keeping enough cash to fund its operations. Nonetheless, the
company has other assets that can be liquidate to be able to settle its current
obligations.

SITUATION 2 – CASH RATIO IS EQUAL TO 1

Same data as SITUATION 1, except:

 Cash and Cash equivalent is increased from P75,000 to P110,000.

Requirement: Compute for the Cash Ratio and provide interpretation.

Computation:
Cash Ratio = Cash and Cash Equivalent / Current Liabilities
= P110,000 / P110,000
= 100% or 1

Interpretation:
It means that cash and cash equivalents are equal to the short-term liabilities
which is enough to pay it when it falls due. It is a good indicator for the company
since it implies a good cash management by not keeping to much cash that becomes
idle and unprofitable, as well as not having insufficient cash that may lead creditors
to assume risk while extending credit to the company.
SITUATION 3 – CASH RATIO IS MORE THAN 1
Same problem as SITUATION 1, except for the following changes:

 Cash and Cash equivalent is increased from P75,000 to P125,000.

 Current Liabilities is reduced by P10,000.

Requirement: Compute for the Cash Ratio and provide interpretation.

Computation:
Cash Ratio = Cash and Cash Equivalent / Current Liabilities
= P125,000 / P110,000 – 10,000
= P125,000 / P100,000
= 125% or 1.25

Interpretation:
In the example, the company has a cash of 1.25 to pay off a peso of its
current liabilities. It concludes that there are adequate cash in the system that is
more than enough to pay the existing short-term liabilities of the company. Creditors
are more willing to extend credit seeing the company’s ability to pay obligations.
However, having high cash ratio may indicate that the company is missing out on
more opportunities.

FINDINGS:
It is better to have enough cash (amount which is not to low and not too
high) in the company to maintain harmony in its daily operation. It is essential in
cash management to utilize well the cash as well as maintaining its function (as
highly liquid asset) in the company.
Furthermore, having low cash ratio doesn’t literally mean that the company
is in total distress or at risk, sometimes it is the company’s strategy to maintain
low cash reserves – because cash are used for investment. Also, aside from
cash, there are current assets to be use as payment for any existing debts.
Another one is when the computation results to a high cash ratio which is
somehow good in the company as well as to the creditors, but it also implies
poor cash utilization and a limited growth opportunity present in the company.
Excess cash that sometimes become idle does not return anything and will only
result to opportunity loss.
 CONCLUSION AND RECOMMENDATIONS

The result of the study showed a strong relationship between the cash

management and entity's financial performance. It also revealed that holding both

excessive and insufficient amount of cash will literally affect the decision of the

management on how to effectively manage cash as will as its overall financial

performance. Following the outcome of the study, it proposes that the entity should

have a special look to its cash flow management.

Therefore, we recommend an emphasis on:

1. Maintaining an optimum balance of cash and such cash balance needs to

be maintained at the right place, at the right time and at the right cost off its

existing debts.

A. One of the ways to handle excess cash is to pay off existing debts of

the entity and some of the payment methods are:

 Snowball Method - Pay your smallest debt first then move on to

the immediately bigger one.

 Avalanche Method - Pay off your highest-interest debt first.

Once sorted, you’ll end up paying less interest than you would

otherwise.
 B. Meanwhile, there are a number of immediate ways to fund unexpected

cash shortages, including:

 Collecting outstanding debts

 Increasing prices (reasonable)

 Negotiating better payment terms with suppliers – for example,

delaying payment in exchange for regular or bigger orders

 Negotiating better payment terms with customers – for example, by

offering discounts for prompt payment, encouraging automated

payments or insisting on deposits first

2. Save contingency fund.

3. Savings – having savings now will prove quite useful in times when you

suddenly find your entity distressed for cash.

4. Invest the sum against future requirements.

5. Planning for cash flows in advance such as preparing a projected cash flow

statement. Projected cash flow statement is best defined as a listing of expected

cash inflows and outflows. By monitoring and forecasting your cash inflows and

outflows, you can better predict cash flow shortfalls and organize debt finance

ahead of time if necessary.

 Train cashiers the habit of counting back change to the customer.

 Established policies and procedures in handling transactions related to

cash short and over. They should include before and after count
 verification, accountability of employee assigned on cash drawer,

manager authorizations for voids, refunds, and closing the cash drawer

after every transaction.

 Managers should remove excess cash and large bills from the cash

register and place it safe.

 REFERENCES

Egba, L. 2021. There Is Such A Thing as Over-Investing.

https://yochaa.com/there-is-such-a-thing-as-overinvesting

Hiiemaa, K. 2021. How to Explain Money Missing from Cash Register

https://erply.com/why-your-end-of-shift-or-end-of-day-reports-arent-matching-
yourdrawer/#:~:text=One%20of%20the%20main%20reasons,few%20cents
%20to%20a%20dollar.

Jacob, A., 2018. The Top 10 Causes of Poor Cash Flow & How to Fix Them.

https://www.ordermentum.com/blog/the-top-causes-of-poor-cash-flow-and-how-
to-fix-them

Kenton, W., 2020. Cash Management. Corporate Finance & Accounting.

https://www.investopedia.com/terms/c/cashmanagement.asp#:~:text=Cash
%20management%20is%20the%20process,of%20a%20company's%20financial
%20stability.

Kokemuller, N. 2021. Why Is It a Financial Risk for Businesses to Have Too Much

Cash on Hand. https://smallbusiness.chron.com/financial-risk-businesses-much-

cash-hand-81214.html

https://corporatefinanceinstitute.com/resources/knowledge/finance/cash-
management/

https://www.bizfilings.com/toolkit/research-topics/finance/managing-cash-
flow/using-cash-flow-surpluses-for-investment-or-to-pay-down-debt