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  2. SITI AISHAH BINTI KASSIM (FM1) Cash and Marketable Securities Management • Cash and Marketable Securities are also known as cash reserve. • Cash reserve: • Provide margin of safety against technical insolvency that is inability to meet current or maturing obligations. • To maintain certain level of liquidity involves risk-return tradeoffs (in terms of investment). • The goal is to minimize the level of cash reserve while maintaining adequate level of liquidity. It involves: • Determine the appropriate degree of liquidity. • Determine the appropriate mix of cash reserve.

  3. SITI AISHAH BINTI KASSIM (FM1) Cash Management • 4 primary reasons for holding cash: • Transactions – a firm must have enough cash on hand to make its day-to-day purchases of materials and pay all its obligations. • Precautionary – generally a function of the predictability of a firm’s cash inflows and outflows. • Speculation – to be able to take advantage of any “bargains” that may arise. • Compensating Balances – held at banks to compensate for services that they perform for the firm.

  4. SITI AISHAH BINTI KASSIM (FM1) Cash Management Activity The goal of cash management is to minimize the cash balances while maintaining certain level of liquidity. Speeding up receipts Management of firm cash flows Cash budgeting Slowing down disbursement Maintaining good banking relationship Determining the optimal cash balances Marketable securities investment strategies for cash excess ST financing strategies for cash shortfalls

  5. SITI AISHAH BINTI KASSIM (FM1) Operating Cycle, Cash Cycle and Cash Turnover • Operating Cycle (OC) – the lag time in days between the purchase of raw materials and the time cash is collected from sales of finished goods or receivables. • Cash Cycle (CC) – the lag time between cash outlay to purchase raw materials or inventories and cash is collected from receivables. • Cash Turnover (CTO) – the number of times the firm’s cash is actually turned over each year. • Minimum Operating Cash (MOC) – the firm’s cash cycles directly affect the amount of cash that need to be held at any given time to support the operations.

  6. SITI AISHAH BINTI KASSIM (FM1) Operating Cycle, Cash Cycle and Cash Turnover OC = 110 days AAI = 70 days ACP = 40 days Purchase Raw Materials Accounts Payable Sell Finished Goods Accounts Receivable 0 10 20 30 40 50 60 70 80 90 100 110 Pay Account Payable Cash Outflows Collect Account Receivable Cash Inflows CC = 80 days APP = 30 days

  7. SITI AISHAH BINTI KASSIM (FM1) Operating Cycle, Cash Cycle and Cash Turnover • The cash cycle equals to: OC0 = Average Age of Inventory (AAI) + Average Collection Period (ACP) = 70 days + 40 days = 110 days CC0 = Average Age of Inventory (AAI) + Average Collection Period (ACP) – Average Payment Period (APP) = 70 days + 40 days – 30 days = 80 days CTO0 = 360/Cash Cycle = 360/80 = 4.5 times

  8. SITI AISHAH BINTI KASSIM (FM1) Operating Cycle, Cash Cycle and Cash Turnover • To calculate MOC, consider that they has annual cash expenditures or outlays of RM 300,000. MOC0 = Annual Cash Outlays/Cash Turnover = RM 300,000/4.5 times = RM 66,666.67 **Therefore, they needs RM 66,666.67 as a minimum cash requirement to support the firm’s day-to-day operations without risk of technical insolvency.

  9. SITI AISHAH BINTI KASSIM (FM1) Managing Cash Cycle • Managing the basic elements of Cash Cycle that is (1) accounts payable; (2) accounts receivable; and (3) inventories. Several strategies: • Increasing Average Payment Period – delaying payments on accounts payable as late as possible without damaging the firm’s credit rating. • Reducing Average Age of Inventory – in order to increase inventory turnover. • Reducing Average Collection Period – speeding up collection of account receivable as soon as possible without losing potential sales. ** The implementation of the above strategies will reduce cash cycles, and thus will result in freeing some of the capital tied up in inventories and account receivables.

  10. SITI AISHAH BINTI KASSIM (FM1) Another Example: Let assume that the company in the above example able to: • Negotiate a better credit term with its supplier from net 30 to net 35. • Improve production process and selling effectiveness that reduces average age of inventory by 10 days to 60 days. • Decrease average collection period by 7 days to 33 days by changing its credit terms.

  11. SITI AISHAH BINTI KASSIM (FM1) Solutions: CC1 = 60 days + 33 days – 35 days = 58 days CTO1 = 360/58 days = 6.21 times MOC1 = RM 300,000/6.21 times = RM 48,309.17 The above changes will have several impacts: • Shorter cash cycle, and thus higher cash turnover. Change in CC = CC1 – CC0 = 58 days – 80 days = (22 days) Change in CTO = CTO1 – CTO0 = 6.21 times – 4.5 times = 1.71 times

  12. SITI AISHAH BINTI KASSIM (FM1) • Lower minimum operating cash requirements, and hence lower investment in cash to support the firm’s operations. Change in investment MOC = MOC1 – MOC0 = RM 48,309.17 – RM 66,666,67 = (RM 18,357.50) • Lower cost of financing and higher profits. If the cost of funds is at 10%, the firm can realize a yearly saving of RM 1,835.75. Change in cost of financing = Change in MOC x Cost of Funds = (RM 18,357.50) x 10% = (RM 1,835.75) **Therefore, proper cash management will have a direct impact on the firm’s liquidity and profits.

  13. SITI AISHAH BINTI KASSIM (FM1) Marketable Securities Management • Provide much lower yields than firm’s operating assets. • There are several reasons for a firm holding these types of liquid assets: • Marketable securities are substitute for cash. • Marketable securities as a temporary investment. Factors Influencing the Choice of Securities: • Default Risk • Interest Rate Risk • Purchasing Power Risk • Liquidity Risk • Return of Securities.

  14. SITI AISHAH BINTI KASSIM (FM1) Alternative Investment • Treasury Bills (T-Bills) – matures in 91 – 182 days, with longer maturities such as 9 months or 1 year are sold from time to time in smaller amount. • Treasury Notes (T-Notes) – maturity is between 1 – 7 years. Held in the marketable securities portfolio because of security and liquidity. • Negotiable Certificate of Deposits (NCDs) – the amount (smallest RM 100,000) and the maturity (commonly 30 days) are based on the investor’s (depositor’s) needs. • Commercial Paper (CP) – maturities may range from 3 – 270 days, as longer maturities require a formal registration. • Banker’s Acceptance (BAs) – similar to cashier’s check payable in the future, with typical maturity of 30 days or 180 days.

  15. SITI AISHAH BINTI KASSIM (FM1) Accounts Receivable Management The outstanding amounts owed to a firm by its customers, because of credit sales. Credit Policy A system for managing accounts receivable that includes credit terms, credit standards, and collection policy. Very important as it could smooth out selling process, provides service to customers, and attracts more sales.

  16. SITI AISHAH BINTI KASSIM (FM1) Credit Standards It refers to the minimum financial strength and moral standings of acceptable credit customers. It involves the determination of (1) willingness to pay, and (2) the ability to pay of the applicants must be done. Can be evaluated by using the 5 C’s of credit: • Character – willingness to pay that is the probability that customers will try to make an honest effort to honor their obligations. • Capacity – a subjective and objective judgment of the customer’s ability to pay. • Capital – focus on working capital of the firm as it is directly available for payments of obligations. • Collateral – tangible and intangible assets offered to creditors as security to obtain credit facilities. • Conditions – the impact of general trends or other specific conditions in the market that may affect a customer’s business operations and the ability to meet the obligations.

  17. SITI AISHAH BINTI KASSIM (FM1) Credit Terms Dictates the conditions under which the credit facilities are granted. It relates to cash discount for early payments, discount period, credit period, and financial charges for late payments. The most common terms are: • Open terms • Cash before delivery (CBD) • Cash in advance (CIA) • Cash with order (CWO) • Cash on delivery (COD) • Net 30 • Net 10 end of month (EOM) • 2/10 net 30 • 2/10 prox, net 30 • 2/10 EOM, net 40 • 2/10 ROI, net 40 Not involve credit transactions. According to industry practices

  18. SITI AISHAH BINTI KASSIM (FM1) Collection Policy Provides guidelines for appropriate actions to be taken when established credit terms are violated, or when accounts are overdue. The firms must initiate some actions to collect and depends on the amount of time the accounts had been passed due. It involves 3 stages: • Reminder – remind customer that the account is overdue without payment. • Follow up – sending successive follow up letters with increasing firmness, telegram, telephone, and personal visits. • Drastic action – the last stage that includes drawing a draft on a customer, collection by attorney, or collection agency.

  19. SITI AISHAH BINTI KASSIM (FM1) Miscellaneous Considerations • If a firm imposes a carrying charge or interest charge on outstanding receivable, then credit sales may actually be more profitable than cash sales. • It is illegal to offer more favorable credit terms to one customer or class of customers than to another, unless the differences can be cost-justified. • Most credit is offered on open account; but there are a variety of legal credit instruments that can be used for credit sales. • A firm should continuously monitor the effectiveness of its credit policy to be sure that standards are being enforced.