Current Asset Management &

Short Term Financing

 Cash Management

Financial managers actively attempt to keep cash (non-earning asset) to

minimum

Critical to have sufficient cash for emergencies

To improve overall profitability of firm

•Minimize cash balances

•Have accurate knowledge of when cash moves in and out of firm

 Motives for Holding Cash Balances

Transactions balances: Payments towards planned

expenses, to pay day-to-day bills
Compensating balances for banks: Compensate bank
for services provided rather than paying directly for them
Precautionary needs: Emergency purposes when cash
inflows are less than projected. Important in seasonal and
cyclical industries
Speculative Motive: Take advantage of unexpected
opportunities
 Cash Flow Cycle
 Cash moves through a firm on a daily,
weekly and monthly cycle
 Cash flow cycle depends on:
-Payment pattern of customers
-Speed at which suppliers and creditors
process checks
-Efficiency of banking system
Inflows and outflows of cash must be
synchronized properly for transaction purposes
 Cash Flow Cycle

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 Improving Collections / Extending
Disbursements

Improving collection

-Setting up multiple collection centers at different locations

-Adopt lockbox system for fast check clearance at lower
costs
-Speedup processing of incoming checks

Extending disbursement

-Slow down payment procedures

 Electronic Funds Transfer

Funds moved between computer terminals without use of ‘cheque’

 Reduces float through use of terminal communications between

store and the bank

 Automatically charged against bank account before leaving the

store

International electronic fund transfer carried out through SWIFT

 Components of Credit Policy

Credit policy administration has three primary policy variables to

consider
Terms of Sale
- Credit period (usually 30-120 days)
- Cash discount and discount period

Credit Analysis
- Character / Capacity / Capital / Collateral / Conditions

Collection Policy
- Accounts receivable aging schedule
 Credit Analysis: 5 Cs of Credit

Character : Willingness to meet financial obligations. Moral and

ethical quality of the individual who is responsible for repaying
the loan.
Capital: Level of financial resources available to the company
seeking the loan and involves an analysis of debt to equity and
the firm's capital structure.
Capacity: Availability and sustainability of the firm's cash flow at
a level high enough to pay off the loan.
 Credit Analysis: 5 Cs of Credit
 Conditions: Sensitivity of the operating income and cash flows
to the economy.
 The more sensitive the cash flow to the economy, the
greater the credit risk of the firm.
 Collateral: Determined by assets that can be pledged against
loan.
 Firms can pledge assets that are available to be sold by
the lender if the loan is not repaid.
 The better the quality of collateral, the lower the risk of
loan.
 Collection Policy- Flexible Policy

 Flexible Policy
- Large amounts of cash and marketable securities
- Large amounts of inventory
- Liberal credit policies (large accounts receivable)
- Relatively low levels of short-term liabilities

High Liquidity
 Collection Policy- Restrictive Policy

Restrictive Policy
- Low cash and marketable security balances
- Low inventory levels
- Low accounts receivable)
- Relatively high levels of short-term liabilities

Low Liquidity
 Inventory Management

Inventory has three basic categories

- Raw materials – used in products
- Work in progress – partially completed products
- Finished goods – ready for sale

Amount of inventory affected by

- Sales
- Production
- Economic conditions
 Level versus Seasonal Production

Level (even) Production

 Enables maximum efficiency in manpower and machinery usage
 Results in high inventory buildup before shipment in seasonal
sectors
Seasonal Production
 Eliminates inventory buildup problems
 May result in unused capacity during slack periods
 May result in overtime wages and inefficiencies due to overused
equipment
 Inventory Decision Model

Two basic costs associated with inventory:

Carrying costs
- Interest on funds tied up in inventory
- Cost of warehouse space, insurance premiums, and material handling
expenses
- Implicit cost associated with the risk of obsolescence or perishability
and price change
Ordering costs
- Cost of ordering
- Cost of processing inventory into stock
 Economic Ordering Quantity
Economic Order Quantity =
Where
- S = Total sales in units
- O = Ordering cost for each order
- C = Carrying cost per unit in dollars

Assuming:
- S = 2000 units; O = $8; C or H = $0.20
- EOQ = 400
 Safety Stocks and Stock Outs

Stock out occurs when firm is

- Out of specific inventory item
- Unable to sell or deliver product

Safety stock of inventory reduces risk of losing

sales
- Increases cost of inventory due to rise in carrying costs
- Cost should be offset by
• Eliminating lost profits due to stockouts
 Safety Stocks and Stock cost

Carrying Cost =

Average Inventory =

Assuming that; EOQ = 400 units and safety stock = 50 units

Calculate inventory carrying cost.

Average Inventory = (400/2) + 50 = 250 units
Carrying costs = Average inventory in units × Carrying cost per unit
= 250 × $0.20 = $50
 Trade Credit or Accounts Payable

 Almost 40% of short-term financing is in form of accounts

payable usually extended for 30–60 days

 Extending payment period to unacceptable length may

Discourages suppliers from extending credit in the future
- Lower credit ratings
 Terms of Sale

Basic Form: 2/10 net 30

• 2% discount if paid in 10 days
• Total amount due in 30 days if discount is not taken

Buy $500 worth of merchandise with the credit terms

given above
• Pay $500* 0.02 = $10$
• $500 -$10 = 490 if you pay in 10 days
• Pay $500 if you pay in 30 days
 Compensating Balances

Average minimum account balance maintained as

alternative to fee charged by bank for services rendered

When interest rates are lower, compensating balance rises

 4. Compensating Balances

Amount that must be borrowed = Needed funds / (1-c)

Where c is compensating balance expressed as decimal
Example: $100,000 is needed, 20% of loan is
compensating balance
Amount needed
Amount to be borrowed 
1  c 
$100,000

1  0.2
 $125,000
 Interest Costs with Compensating Balances

Example: Assuming that 6% is the stated annual rate

and that 20% compensating balance is required

Effective rate with Interest

compensating balances 1  c 
6%
  7.5%
1  0.2
 Accounts Receivable Financing

Includes: Pledging accounts receivable as collateral for loan and factoring

receivables.

Advantage: Permits borrowing to be tied directly to level of asset expansion

at any point in time

Disadvantage: Relatively expensive method of acquiring funds

 Inventory Financing

Factors influencing use of inventory for financing:

• Marketability of pledged goods
• Associated price stability
• Degree of physical control that lender can exercise
over product
 Thank You

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