B.B.A. L.L.B. (HONS.

)
SEM – 1
MINOR - I

FINANCIAL MANAGEMENT
Margie Acharya
Assistant Professor
Faculty of Law
 UNIT - 2 CURRENT ASSET MANAGEMENT

FLOW OF TOPIC:
 Motives for holding cash
 Objectives of Cash Management
 Concept of Cash budget
 Nature & Planning of Working Capital
 Meaning & Definition of Inventory management
 Objectives and Components of Inventory
 Cost of Holding Inventory
 Concept of EOQ
 Basic Sums & Problems of Inventory EOQ, and Working Capital

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 CASH MANAGEMENT –MOTIVES
 Cash – Ready currency to which all liquid assets can be reduced.
 Broad view of cash - Near cash assets – marketable securities and time deposits in banks –
Readily sold and converted to cash
 Marketable securities are short term interest earning money market instruments used by firms to
obtain return on idle funds
 Cash as an asset has no earning power. Reasons to hold cash:
 Transaction Motive - The requirement of cash balances to meet routine cash needs
 Precautionary motive - To meet unexpected contingencies/demand for cash
 Speculative motive – To quickly take advantage of opportunities outside the normal course of
business
 Compensative motive – To compensate banks for providing certain services /loans

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 CASH MANAGEMENT – OBJECTIVES &
FACTORS DETERMINING NEED
 Meet payments schedule
 Minimising funds committed to cash balances

 Factors Determining Cash need:

 synchronisation of cash flows
 short costs,
 excess cash balance
 procurement and management
 uncertainty

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 Tools to Manage Cash
 Conversion Models like Baumol Model, Miller Orr Model , Orgler’s Model
 Cash Budget – Statement of inflows and outflows of cash that is used to estimate its short term
requirements
 Purpose of Cash Budget :
1. To coordinate the timings of cash needs
2. Pinpoints the period(s) when there is likely to be excess cash
3. Pnables a firm which has sufficient cash to take advantage of cash discounts, to pay
obligations when due, to formulate dividend policy, to plan financing of capital expansion
and for production related decisions
4. Arrange needed funds on the most favorable terms and prevents the accumulation of excess
funds

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

CASH Management Terminology

 Cash Cycle: Amount of time cash is tied up between payment for

production inputs and receipts from sale of products

 Cash Turnover: number of times cash is used during each year

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

STRATEGIES OF EFFECTIVE CASH
MANAGEMENT
 Speedy cash collections

 Concentration banking – Collection procedure in which payments are made in

regionally dispersed collection centres and then deposited in local banks for quick
clearing

 Lock Box System – payers send their payments/cheques to nearby post box that is
emptied by firms banks several times and bank deposits the cheque in firms
account.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 WORKING CAPITAL MANAGEMENT -
NEED
 The goal of working capital management is to manage the firm’s current assets and liabilities in such a
way that a satisfactory level of working capital is maintained.
 If the firm cannot maintain a satisfactory level of working capital, it is likely to become insolvent and
may even be forced into bankruptcy.
 The current assets should be large enough to cover its current liabilities in order to ensure a reasonable
margin of safety
 Gross Working Capital - total current assets which represent the proportion of investment that circulates
from one form to another in the ordinary conduct of business
 Net Working Capital - difference between current assets and current liabilities; or portion of current
assets which is financed with long-term funds.
 Zero Working Capital - The zero working capital (ZWC) concept of net working capital differs from the
commonly used concept of working capital (CA – CL). The ZWC = Inventories (+) Receivables (-)
Payables. The rationale is that inventories and receivables are the major constituents of current assets
which affect sales.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 BENEFITS OF LOW WORKING CAPITAL
 Results in a one-time release of cash flow
 Release of cash flow enhances the firm’s earnings
 Permanent reduction in working capital funds results in less financial costs
 Zero working capital concept forces the corporates to produce and deliver faster
 With low inventories, storage cost as well as loss due to obsolete inventories are also minimised,
leading to another set of savings in operating costs.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 NEED FOR WORKING CAPITAL
 Given the objective of financial decision making to maximise the shareholders’ wealth, it is
necessary to generate sufficient profits.
 Sales do not convert into cash instantly; there is invariably a time-lag between the sale of goods
and the receipt of cash. There is, therefore, a need for working capital in the form of current
assets to deal with the problem arising out of the lack of immediate realisation of cash against
goods sold. This is called operating cycle
 Since cash inflows and outflows do not match, firms have to necessarily keep cash or invest in
short-term liquid securities so that they will be in a position to meet obligations when they
become due.
 PERMANENT WORKING CAPITAL : Certain minimum level of working capital on a continuous and
uninterrupted basis
 TEMPORARY (FLUCTUATING/VARIABLE WORKING CAPITAL) – Working capital needed to meet
seasonal as well as unpredictable requirements.
 The changes in the level of working capital occur due to three basic reasons: (i) changes in the
level of sales and/or operating expenses, (ii) policy changes, and (iii) changes in technology
FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA
 INVENTORY MANAGEMENT
 Inventory refers to the stockpile of the products a firm is offering for sale and the components that
make up the product
 Inventory is composed of assets that will be sold in future in the normal course of business
operations.
 The assets which firms store as inventory in anticipation of need are (i) raw materials, (ii) work-in-
process (semi-finished goods) and (iii) finished goods
 Raw material inventory - Items that are purchased by the firm from others and are converted into
finished goods through the manufacturing (production) process. They are an important input of the
final product
 Work-in-process inventory consists of items currently being used in the production process. They
are normally semi-finished goods that are at various stages of production in a multi-stage
production process
 Finished goods represents final or completed products which are available for sale. The inventory
of such goods consists of items that have been produced but are yet to be sold

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 OBJECTIVES – INVENTORY MANAGEMENT
 In order to minimize cash requirements, inventory should be turned over as quickly as possible,
avoiding stock-outs that might result in closing down the production line or lead to a loss of
sales.
1. To minimise investments in inventory, and
2. To meet a demand for the product by efficiently organizing the production and sales
operations.
 Minimizing investment in inventory implies that maintaining inventory involves costs, such that
the smaller the inventory, the lower is the cost to the firm
 The larger the inventory, the better it facilitates for smooth functioning of firm.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 COSTS OF HOLDING INVENTORY
1. ORDERING COSTS
 Firms have to place orders with suppliers to replenish inventory of raw materials. The expenses
involved are referred to as ordering costs.
 The cost of acquiring materials consists of clerical costs and costs of stationery
 Generally fixed per order placed, irrespective of the amount of the order.
 The larger the orders placed, or the more frequent the acquisition of inventory made, the higher
are such costs.
 The larger the inventory, the fewer are the acquisitions and the smaller/lower are the order costs.
 The acquisition costs are inversely related to the size of inventory: they decline with the level of
inventory.
 Acquisition of a large quantity would increase the cost associated with the maintenance of
inventory, that is, carrying costs.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 COSTS OF HOLDING INVENTORY
2. CARRYING COSTS
 Variable costs per unit of holding an item in inventory for a specific time period. The carrying costs
and the inventory size are positively related and move in the same direction. If the level of
inventory increases, the carrying costs also increase and vice-versa
 Costs that Arise Due to the Storing of Inventory –
 Storage cost like tax, depreciation, insurance, maintenance of the building, utilities and janitorial
services;
 insurance of inventory against fire and theft;
 deterioration in inventory because of pilferage, fire, technical obsolescence, style obsolescence
and price decline;
 serving costs, such as, labour for handling inventory, clerical and accounting costs
 Opportunity cost of Funds –
 This consists of expenses in raising funds (interest on capital) to finance the acquisition of
inventory. If funds were not locked up in inventory, they would have earned a return.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 TECHNIQUES OF INVENTORY
MANAGEMENT
 ABC System – Divides inventory into three categories of descending importance based
on the rupee investment of each.
 TECHNIQUES OF INVENTORY
MANAGEMENT
 EOQ Model - Firm should place neither too large nor too small orders. On the basis of a
trade-off between benefits derived from the availability of inventory and the cost of
carrying that level of inventory, the appropriate or optimum level of the order to be
placed should be determined.
 Level of inventory order that minimises the total cost associated with inventory
management.
 Trial and Error (Analytical) Approach - The trial and error or long analytical approach for
the determination of EOQ uses different permutations and combinations of lots of
inventory purchases so as to find out the least ordering and carrying cost combination.

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 OTHER TERMINOLOGIES OF INVENTORY
MANAGEMENT
 Reorder Point - level of inventory where fresh order should be placed with the suppliers for
procuring additional inventory equal to the economic ordering quantity.

 Lead Time – Time normally taken in receiving delivery after placing order with suppliers

 Safety Stock – Minimum additional inventory to serve as a safety margin or buffer or cushion to
meet an unanticipated increase in usage resulting from unusually high demand or an
uncontrollable late receipt of incoming inventory.

 Stock Out Cost - Cost associated with shortage of inventory

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 EOQ – Economical Ordering Quantity

 Number of orders = Demand per year/order size

 Average inventory = Order size/2
 Total carrying cost = Average inventory Carrying cost per unit
 Total ordering cost = Number of orders Cost per order
 Total cost = Cost of items purchased + Total carrying and ordering cost
 Mathematical Formula :

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 EOQ – Economical Ordering Quantity

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

EOQ - Problem

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA

 YOUTUBE VIDEOS YOU COULD LISTEN TO:
 Cash Management | Working Capital Management | Financial Management | Introduction |
Meaning: https://www.youtube.com/watch?v=s3-LWmKAB_Q,
https://www.youtube.com/watch?v=3jt6H7QZtHI
 Inventory Management | Working Capital Management | Financial Management | Inventory -
Meaning : https://www.youtube.com/watch?v=FgusuwLrTVs ,
https://www.youtube.com/watch?v=Vd0j6DxLL_A
 Working Capital Management | Financial Management | Introduction | Gross & Net Working
Capital: https://www.youtube.com/watch?v=F32GYj_nFUU
 ABC ANALYSIS IN INVENTORY MANAGEMENT: https://www.youtube.com/watch?v=BWbnKgFNcKg
 SIGNIFICANCE OF EOQ IN HINDI | Concept & Significance/Importance | BBA/MBA/Bcom |:
https://www.youtube.com/watch?v=UkMKYrkLTak
 What is Inventory Management? Objectives of Inventory Management-Hindi:
https://www.youtube.com/watch?v=gMZtcTDoOfg
 What is Inventory Control?Need, Importance &Objectives of inventory Control With Examples-
https://www.youtube.com/watch?v=kO66lTiQVKA

FACULTY OF LAW - BBA LLB (HONS.), MARGIE ACHARYA