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Business Finance Quarter 2 Module 2
BSED English (BLAW 2019, English 3)
Cebu Roosevelt Memorial College
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SOUTHERN MASBATE ROOSEVETL COLLEGE, INC.
KATIPUNAN, PLACER, MASBATE
ABM XII
BUSINESS FINANCE
QUARTER 2 MODULE 2-
Name: Teacher: EDMARK P. CATAGBO
At the end of the module, you will be able to explain the tools in managing cash, receivables, and inventory.
Specifically, this module will help you describe the concepts and tools in working capital management.
This is an example of a local Philippine company and its working capital practices.
Jollibee Foods Corporation Statements of Financial Position As of December 31, 2020
ASSET Cash and Cash Equivalents 7,618,000. Accounts Receivable 7,621,000.
LESSON 1
Tools in Managing Cash, Receivables and
Inventory
EXPECTATIONS
BRIEF INTRODUCTION
Inventories 5,972,000. Other Current Assets 2,810,000. Total Current Assets 24,021,000. Non-Current Assets 30,097,000. Total Assets 54,119,000.
Liabilities and Equity Current Liabilities Trade Payable 6,576,000. Other Current Liabilities 12,515,000. Total Current Liabilities 19,091,000. Non-Current Liabilities 6,950,000. Total Liabilities 26,041,000. Total Equity 28,078,000. Total Liabilities and Equity 54,119,000.
FINANCIAL PLANNING TOOLS AND CONCEPTS
The different Working Capital Assets and their importance in the operations of the company will be discussed in this module. Working capital is the company’s investment in current assets such as cash, accounts receivable, and inventories while Net Working capital is the difference between current assets and current liabilities.
This is the flow of the operating cycle of the business.
The operating cycle is the sum of days of inventory and days of receivables. This is how to compute the Days of Inventory and Days of Receivables. Days of Inventory or inventory conversion period or average age of inventories is the average number of days to sell its inventory. A DSI of 20 days means that on the average it takes 20 days to sell its inventory. Since the Statement of Financial Position tells the financial condition of a company at the end of the period; we take Average Inventory for the year in our calculation.
The formula is:
Permanent and Temporary Working Capital
Permanent Working Capital is the minimum level of current assets required by a firm to carry-on its business operations given its production capacity or relevant sales range.
Temporary working capital is the excess of working capital over the permanent working capital given its production capacity or relevant sales range.
The Working Capital Financing Policies
Financing policies can either be aggressive, conservative or maturity-matching:
Maturity-matching working capital financing policy
Based on the maturity-matching working capital financing policy, permanent working capital requirements should be financed by long- term sources while temporary working capital requirements should be financed by short- term sources of financing. Long-term sources of financing include longterm debt and equity such as common stock and preferred stock. Short-term sources include short-term loans from a bank. These short-term loans from banks are called working capital loans which perfectly describe the reasons why these loans are incurred. In maturity- matching, all permanent working capital must be financed by long-term sources while temporary working capital requirements should be financed by short-term sources.
Aggressive Working Capital Financing Policy
Under the aggressive working capital financing policy, some of the permanent working capital requirements are financed by short-term sources of financing.
Why do managers of some companies adopt this policy? It is because long-term sources of funds have higher cost as compared to short- term sources of financing. By financing some of the permanent working capital requirements with short-term sources of financing, financing cost is minimized which in turn, improves net income. But what is the trade-off? Since it is short-term, the debt has to be paid soon and the company may not yet have enough cash by the time the debt matures. This refers to liquidity risk and this risk increases with the aggressive working capital financing policy.
Conservative Working Capital Financing Policy
Based on the conservative working capital financing policy, some of the temporary working capital requirements are financed by long-term sources of financing. This policy minimizes liquidity risk and reduces the company’s profitability because long-term sources of financing entail higher cost.
Cash
Being the most liquid asset, cash is an important account in the balance sheet that will affect the liquidity, and solvency of a company. A good internal control must be properly implemented to safeguard this asset. A basic internal control system entails the assignment of custodial function and recording function to separate individuals unless you are the owner. Why is this so? Imagine a cashier of a company who is also the chief accountant. If tempted, this person can steal cash from the company and can manipulate the records so that nobody can discover that he is stealing.
Cash collections should be supported by official receipts which are summarized in a daily collection report. The daily collection report is going to useful for the next control measure for cash – depositing collections.
If all collections need to be deposited, then payments must be made through a check voucher system. There must also be two signatories in the check to provide a check and balance.
For small payments like the fare given to a messenger, a petty cash fund is used. A petty cash fund which should be minimal in amount, will be issued to a petty cash fund custodian, say the office administrator. The petty cash fund may be PHP10,000 or PHP20,000. Disbursements from this petty cash funds must be supported by a petty cash voucher signed by the recipient of the petty cash. When the petty cash fund is almost depleted, the petty cash fund custodian will get reimbursements. This reimbursement will go through the check voucher system where the custodian gets a check with the petty cash vouchers as supporting documents. The check must also be cross-checked by drawing two lines on the payee section of the check. This cross-checking requires depositing of a check. It cannot be in-cashed. This makes it more difficult for somebody who stole a check to get the money.
Motives For Holding Cash These are the following reasons for holding cash:
Primary Reasons a. Transactional. This is the cash used for paying expenses such as salaries, utilities, rent and taxes, among others. b. Compensating balance. This is the cash held to meet bank requirements such as the minimum cash balance you maintain for checking accounts and if you have existing loans, banks may also require a minimum amount of deposit with them.
Secondary Reasons
a. Precautionary. This is the cash maintained for emergencies such as the additional cash you keep during political and economic uncertainties. For example, if your business requires a substantial amount of importation, a relatively higher amount of cash must be maintained when the exchange rate becomes highly volatile due to political instability such as what happened during EDSA II. b. Speculative. This refers to the cash held by the company to take advantage of opportunities (e., buying stocks during major corrections such as what happened at the height of the global financial crisis in 2008 and 2009 where stock valuations went down by as much as 80% for some companies).
Budgeting Cash
Cash Budget provides information regarding the company’s expected cash receipts and disbursements over a given period. It is useful for identifying future funding requirements or excess cash within a given period. This allows Page 11 of 21 Learning Module for Business Finance managers to find possible sources of financing if the cash budget shows cash shortage or identify appropriate tenors for money market placements for excess cash. Normally, a cash budget is prepared for a one-year period broken down into smaller intervals like months. This allows managers to see the seasonality of the business which affects the cash flows.
Basically, cash budget has the following parts:
Cash Receipts include all a firm’s inflows of cash in each financial period. The most common components of cash receipts are cash sales, collections of accounts receivable, and other cash receipts.
Cash Disbursements include all outlays of cash by the firm during a given financial period. The most common cash disbursements are:
inventory management becomes critical when the nature of the products is either perishable (e., fruits, vegetables), fragile (e., glasses), or toxic (e., bleaching agent).
Proper inventory management involves the determination of reasonable levels of inventories considering the size and nature of business. Maintaining too much inventories has costs such as carrying or holding costs, possible obsolescence or spoilage. On the other hand, too low inventory can result to stock out, and eventually lost sales.
Inventory in A Manufacturing Company
In a manufacturing company, there are three types of inventories: Raw materials – these are purchased materials not yet put into production; Work in process – these are goods and labor put into production but not yet finished; and Finished goods – these are goods put into production and finished. These are ready to be sold.
Working capital is the company’s investment in current assets such as cash, accounts receivable, and inventories while Net Working capital is the difference between current assets and current liabilities. Working Capital Management is the administration and control of the company’s working capital whose objective is to achieve a balance between profitability and risk. There are three types of working capital financing policies: (1) Maturitymatching working capital financing policy; (2) Aggressive working capital financing policy; and (3) Conservative working capital financing policy. Cash, being the most liquid asset, is an important account in the balance sheet that will affect the liquidity, and solvency of a company. It is also the most vulnerable when it comes to theft. A good internal control must be properly implemented to safeguard this asset. Accounts receivables spring out of the need to sell merchandise. An excellent business proposition is to generate sales without offering a credit facility to customers. However, this concept is theoretically sound, but not sustainable. Proper management of accounts receivable entails having a good billing and collection system.
Directions: Choose the letter corresponding to the correct answer for each of the questions provided below.
- What is a Working capital management? a. It is the placement of the firm’s debt and equity issues. b. It is the financing and management of the firm’s current assets. c. It is also known as inventory management. d. It is the management of the firm’s capital assets.
- What is the transactional motive of holding cash? a. To keep a cash reserve for purchasing goods and services to balance out the cash inflows and outflows. b. To keep the cash for all the transactions made during a periodic term. c. To keep the cash for transactions mandatory for day-to-day activities. d. To keep the transactions for foreign trading.
REMEMBER
Take the challenge
Activity 1
- Below are all components of working capital except: a. Cash b. Inventories c. Marketable Securities d. Notes Payable
- In what order will a company’s current assets appear on a classified balance sheet? a. Alphabetical order b. Company’s choice c. From largest to smallest amount d. Order of Liquidity
- Which of the following would not be important in examining the firm's buildup of accounts receivable, cash, and current assets: a. A brief cash budget b. Cash receipts and cash payments schedules c. Income Statement d. Sales forecast
Directions: Write TRUE if the statement is CORRECT; Write FALSE if the statement is INCORRECT.
__________1. Working capital is the same as net working capital. __________2. The amounts needed to compute a company’s working capital come from Income Statement. __________3. The operating cycle for most companies will be longer than one year. __________4. Accounts Receivable affects the working capital of a company. __________5. Time as consideration is unimportant in inventory management. __________6. Current assets should always be financed by current liabilities. __________7. Account receivable is also known as notes receivable. __________8. The financial manager of a firm is mostly interested in the company’s available balance, not its book balance of cash. __________9. In accounts receivable management, credit analysis is the process of determining the probability that customers will not pay. __________10. Current asset is the asset that can be converted into cash within one year.
Directions: Choose the letter corresponding to the correct answer for each of the questions provided below.
- What is the advantage of using short-term funds? a. There is no advantage b. Easily obtained c. Interest rates are normally lower d. None of the above
- Which of the following would not be financed from working capital? a. A new personal computer unit for the office b. Accounts receivable c. Cash float d. Credit sales
- Which of the following statements is not true as regards to matching strategy? a. All assets should be financed with permanent long-term capital. b. Temporary current assets should be financed with temporary working capital.
Activity 2
Activity 3
Business Finance Quarter 2 Module 2
Course: BSED English (BLAW 2019, English 3)
University: Cebu Roosevelt Memorial College
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