CU-BBA-SEM-IV-Treasury Management

 Currency Swap:A currency swap is an agreement in which two parties exchange the principal amount of a loan and the interest in one currency for the principal and interest in another currency  Financial instruments: These are assets that can be traded, or they can also be seen as packages of capital that may be traded  Currency option (also known as a forex option): It is a contract that gives the buyer the right, but not the obligation, to buy or sell a certain currency at a specified exchange rate on or before a specified date. For this right, a premium is paid to the seller. 9.10 LEARNING ACTIVITY 1. Company A, based in Canada, recently entered into an agreement to purchase 10 advanced pieces of machinery from Company B, which is based in Europe. The price per machinery is €10,000, and the exchange rate between the euro (€) and the Canadian dollar ($) is 1:1. A week later, when Company A commits to purchasing the 10 pieces of machinery, the exchange rate between the euro and Canadian dollar changes to 1:1.2. Is it an example of transaction risk, economic risk, or translation risk? ___________________________________________________________________________ _____________________________________________________________________ 2. Company A, based in Canada, reports its financial statements in Canadian dollars but conducts business in U.S. dollars. In other words, the company makes financial transactions in United States dollars but reports in Canadian dollars. The exchange rate between the Canadian dollar and the US dollar was 1:1 when the company reported its Q1 financial results. However, it is now 1:1.2 when the company reported its Q2 financial results. Is it an example of transaction risk, economic risk, or translation risk? ___________________________________________________________________________ _____________________________________________________________________ 9.11 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Give the meaning of foreign exchange. 2. Define Forex risk 3. How will you measure the translation exposure 4. Recall the effects of economic exposure 151 CU IDOL SELF LEARNING MATERIAL (SLM)

5. What do you mean by mitigation of risks? 6. List out the major forex risks. Long Questions 1. Examine the causes of forex risk. 2. Discuss the types of forex risks 3. Elaborately explain the concept of Hedging arrangements to mitigate the risk. 4. Describe the strategy for translation exposure. 5. Analyse the operational strategy and currency risk mitigation for economic exposure 6. How will you mitigate the foreign exchange risks? B. Multiple Choice Questions 1. The --------- allows participants, including banks, funds, and individuals, to buy, sell or exchange currencies for both hedging and speculative purposes. a. Forex market b. Commodity market c. Bullion market d. Share market 2. ------market is a contract is agreed to buy or sell a set amount of a currency at a set price and date in the future. a. Option market b. Spot market c. Forward d. Future 3. ---------is a medium of exchange for goods and services a. Currency b. Commodity c. Government letter or credit d. Permission letter 152 CU IDOL SELF LEARNING MATERIAL (SLM)

4. ------ is the risk faced by a company when making financial transactions between jurisdictions. a. Transaction b. Translation c. Economic d. Corporate risk 5. Current Rate Method is the mitigation the ------ exposure a. Financial b. Transaction c. Translation d. Economic Answers 1-a, 2-d, 3-a. 4-a, 5-c 9.12 REFERENCES References books  Rajiv Srivastava and Anil Misra, Financial Management, Oxford university press.  S.N.Maheswari Financial Management, Sultan Chand, New Delhi Textbooks  Punidavathi pandiyan. Financial Management. Mumbai: Himalaya Publishing House.  I.M.Pandey, Financial Management, Pearson  Essentials of financial management, Pearson Websites  https://keydifferences.com/ddifference-between-treasury-management-and-financial- management.html  https://yourbusiness.azcentral.com/importance-treasury-management-26921.html  https://www.accountingtools.com/articles/2017/5/15/treasury-functions  https://www.coupa.com/blog/treasury/cash-management-and-role-treasury 153 CU IDOL SELF LEARNING MATERIAL (SLM)

 https://www.google.com/search?q=function+s+of+tresury&oq=function+s+of+tresury +&aqs=chrome..69i57.8486j0j7&sourceid=chrome&ie=UTF-8  google.com/search?q=perspectives+of+treasury+management&biw=1536&bih=754& sxsrf=ALeKk01QDYA2KSBQcbNM3YlfQUbyy_fbYw%3A1625395058894&ei=co _hYOuMNpuprtoP1rW50Ag&oq 154 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT - 10: WORKING CAPITAL MANAGEMENT 155 STRUCTURE 10.0 Learning Objectives 10.1 Introduction 10.2 Meaning of Working Capital 10.2.1 Definition of working capital 10.2.2 Components of working capital 10.3 Overview of working capital management 10.4 Scope of Working capital management 10.5 Concepts of working capital 10.5.1 Balance sheet concept 10.5.2 Operating cycle concept 10.6 Types of Working Capital 10.6.1 Working capital cycle 10.7 Importance of working capital 10.8 Factors Affecting Working Capital Requirements 10.9 Sources of working capital 10.10 Operating cycle 10.11 Cash cycle 10.11.1 Significance of cash cycle 10.12 Computation of working capital requirements 10.12.1 Estimation of working capital requirements 10.13Summary 10.14 Keywords 10.15Learning Activity 10.16 Unit End Questions 10.17 References 10.0 LEARNING OBJECTIVES After studying this unit, you will be able to: CU IDOL SELF LEARNING MATERIAL (SLM)

 Explain the concept of working capital  Discuss the importance of working capital  List the sources of working capital  Describe the cash cycle  Computation of working capital 10.1 INTRODUCTION Working capital and its management determine the solvency position of the business. Working capital decisions require an evaluation of the benefits and costs associated with each component of current assets. Working capital is normally alienated in two types, viz. gross working capital and net working capital. Gross Working Capital is nothing but the sum of current or circulating resources. Net working capital, means current assets minus current liabilities which provide an exact appraisal of the liquidity situation of firm with the liquidity- profitability dilemma solidly validated in the financial plan of obligations which mature within a twelve-month duration. The two main parts of the working capital are assets and liabilities. First, short-term, or current liabilities comprise the section of funds which have been intended for and raised. Since administrations have to be concerned with correct financial arrangement, these and other funds must be raised sensibly. Short-term or current assets comprise a part of the asset investment conclusion and necessitate meticulous appraisal by the firm’s executives. Further, since there exists a close association between sales fluctuations and invested amounts in current assets, a watchful preservation of the appropriate asset and funds should be ensured. 10.2 MEANING OF WORKING CAPITAL Working capital is the amount of cash a business can safely spend. It's commonly defined as current assets minus current liabilities. Working Capital = Current Assets - Current Liabilities It refers to the investment made by the firms in current assets. It is the measure of firm’s liquidity position. If a firm has positive working capital that means it has enough current assets to cover short- term debt. Current assets include cash and assets that can be turned into cash within one year, whereas current liabilities are debts due within one year of the date of the financial statement. If current liabilities exceed current assets, a company has a working-capital deficiency or a working-capital deficit. Working capital example: 156 CU IDOL SELF LEARNING MATERIAL (SLM)

Managers strive to balance incoming and outgoing payments in order to minimize net working capital and maximize free cash flow. Sports Management International (SMI) pays its athlete clients sooner than it collects on receivables from major sports franchises and needs a credit line to finance operations. Because it is a growing business, SMI is trying to shorten its working capital cycle and limit the interest expenses it faces from short-term financing. 10.2.1 Definition of Working Capital Brown and Housard: “Working Capital represents the overload of current assets over current liabilities” Weston the Brigham: “Working Capital to a firm’s investment in short term assets cash short term securities, accounts, receivables and inventories.” 10.2.2 Components of Working Capital The 4 Main Components of Working Capital are  Trade Receivables. It is also known as account receivables and is represented as current liabilities in balance sheet.  Inventory.  Cash and Bank Balances.  Trade Payables. 10.3 OVERVIEW OF WORKING CAPITAL MANAGEMENT Working capital management is a process of managing working capital requirements of an organization for smooth functioning. Management of working capital involves managing current assets and current liabilities of business for attaining better liquidity position. It mainly focuses on always maintaining sufficient amount of cash in an organization to easily meet its short-term debts and operating expenses. This process is not only concerned with maintaining proper liquidity in business but also with working capital financing. Working capital management performs ratio analysis of key elements of operating expenses such as inventory turnover ratio, working capital ratio and collection ratio. It aims at maintaining these three ratios at an optimum level which helps in smooth functioning of business 10.4 SCOPE OF WORKING CAPITAL MANAGEMENT A good working capital management determines the growth, profitability and liquidity of the company. Scope of Working capital management is as given below: 157 CU IDOL SELF LEARNING MATERIAL (SLM)

Ensures business continuity: Working capital management enables business in continuing their activities uninterrupted. Proper management of working capital will lead to availability of sufficient funds at all times. Business will receive regular supply of raw materials from supplier by paying them on time which will help in continuing production activities regularly. Improves business solvency: Business managing their working capital efficiently are able to maintain proper liquidity. It will improve their cash management and will reduce their dependency on external financing as large amount of funds is tied up in working capital. Management of working capital will enable them in paying all short-term debts and operating expenses on time. Ability to face crisis: Efficient management of working capital enables business in facing emergency situations such as depression. It ensures proper availability of funds at all times so that business can easily face time of crisis or peak demand where they need to boost up their production. Increase creditworthiness: Improving the business value and position in market is another important advantage of working capital management. Businesses having sound working capital position enjoy better liquidity and credit rating. It helps them in raising funds from various external sources easily at favourable terms. Better relations with supplier and creditors: Management of working capital leads to better relations with supplier and all creditors. It enables business in paying all dues to suppliers or trade creditors on time through always maintaining sufficient amount of funds. This will result in gaining confidence of creditors towards business. Helps in expansion: Every business wants to expand its activities over the time for which it needs additional capital. Proper management of cash will provide business with necessary funds timely and make expansion programs successful. Competitive advantage: Business through management of funds is able to reduce their cost and avoid wastages of resources. They can earn sufficient profits by offering their products even at low prices to customers. It will help in gaining competitive advantage in market and generating large revenue 10.5 CONCEPTS OF WORKING CAPITAL Working capital naturally means the firm’s property of current, or short-term, assets such as cash, receivables, stock, and saleable securities. Working capital refers to that fraction of firm’s capital which is requisite for financing short-term or current assets such as cash, saleable securities, debtors, and stocks. In the other words working capital means the sum of funds essential to wrap the cost of operating the venture. Working capital means the resources (i.e.; capital) obtainable and used for day-to-day workings of a venture. It consists generally the segment of assets of a company which are used in or connected to its current operations. It refers to resources which are used during the bookkeeping period to produce a 158 CU IDOL SELF LEARNING MATERIAL (SLM)

current income of a type which is consistent with main reason of a firm survival. Working Capital is the capital used to make goods and attract sales. The less Working Capital used to attract sales; the superior is likely to be the return on investment. Working Capital management is about the marketable and financial aspects of stock, credit, purchasing, marketing, and royalty and investment strategy. The superior the profit boundary, the lower is probable to be the level of Working Capital tied up in creating and selling titles. The quicker that we create and sell the books the higher is likely to be the return on investment. There are two probable interpretations of working capital concept: l. Balance Sheet Concept 2. Operating Cycle Concept 10.5.1 Balance Sheet Concept There are two interpretation of working capital under the balance sheet concept. It is represented by the surplus of current assets over current liabilities and it is the amount generally obtainable to finance current operations. But, occasionally working capital is also used as a synonym for gross or total current possessions. In that case, the surplus of current assets over current liabilities is known as the net working capital or net current assets. 10.5.2 Operating Cycle Concept A company’s operating cycle usually consists of three primary actions; purchasing resources, producing the product, and selling the product. These actions create funds flows that are both unsynchronized since cash disbursements typically take place before cash proceeds. Example: Payments for store purchases takes place before the collection of receivables. They are unsure because prospect sales and costs, which produce the particular receipts and disbursements, cannot be forecasted with total exactness. If the firm is to uphold a cash balance to pay the bills as they come outstanding. In addition, the corporation must invest in inventories to fill customer orders punctually. And, finally, the company invests in accounts receivable to extend credit to its consumers. 159 CU IDOL SELF LEARNING MATERIAL (SLM)

10.6 TYPES OF WORKING CAPITAL Figure 10.1 Types of Working Capital On the basis of Value Gross Working Capital: It denotes the company’s overall investment in the current assets. Net Working Capital: It implies the surplus of current assets over current liabilities. A positive net working capital shows the company’s ability to cover short-term liabilities, whereas a negative net working capital indicates the company’s inability in fulfilling short- term obligations. On the basis of Time Temporary working Capital: Otherwise known as variable working capital, it is that portion of capital which is needed by the firm along with the permanent working capital, to fulfil short-term working capital needs that emerge out of fluctuation in the sales volume. Permanent Working Capital: The minimum amount of working capital that a company holds to carry on the operations without any interruption, is called permanent working capital. 10.6.1 Working Capital Cycle The working capital cycle is the average time required to invest cash in assets and reconverting it into cash by selling the assets produced. The working capital cycle may vary from enterprise to enterprise depending on various factors, such as nature and size of business, production policies, manufacturing process, fluctuations in trade cycle, credit policy, terms and conditions for purchase and sales. 160 CU IDOL SELF LEARNING MATERIAL (SLM)

10.7 IMPORTANCE OF WORKING CAPITAL 1. Solvency of the company: Sufficient working capital helps in maintaining solvency of the company by providing Continuous flow of manufacture. 2. For Goodwill of business: Sufficient working capital enables a business concern to make punctual payments and hence helps in creating and maintaining goodwill. 3. Easy availability of loans: A business having sufficient working capital, high solvency and good credit standing can assemble loans from banks and other on easy and positive terms. 4. To avail cash discounts: Enough working capital also enables a concern to avail cash discounts on the purchases and hence it reduces costs. 5. Normal supply of raw materials: Enough working capital ensures usual supply of raw materials and regular production. 6. Usual payment for day-to-day commitments: A company which has plenty working capital can make usual payment of salaries, wages and other day-to-day commitments which raises the confidence of its employees, increases their competence, reduces wastages and costs and enhances manufacture and profits. 7. Utilization of favourable market situation: Only concern with sufficient working capital can exploit positive market conditions such as purchasing its necessities in bulk when the prices are lesser and by holding its inventories for upper prices. 8. Capability to face crisis: It facilitates to face company crisis in emergency periods such as gloominess because during such periods, usually, there is much pressure on working capital. 9. Rapid and regular return on investments: Every sponsor wants a quick and regular return on his investments. Adequacy of working capital enables a organization to pay quick and usual dividends to its investors as there may not be much force to plough back profits. This gains the assurance of its investors and creates a positive market to raise additional funds in the prospect. 10. High confidence: Sufficiency of working capital creates a surroundings of safety, confidence, and high self-esteem and creates overall competence in a business. 10.8 FACTORS AFFECTING CAPITAL REQUIREMENTS The working capital necessity of a concern depends upon a huge numbers of factors are: Nature of business The basic nature of the business influences the amount of working capital required trading. Organisation usually needs a small amount compared to a manufacturing organisation. This is because there is usually no processing therefore there is no distinction between raw material 161 CU IDOL SELF LEARNING MATERIAL (SLM)

and finished goods sales can be affected immediately upon the receipt of material. Sometimes even before that in a manufacturing business, however, raw material needs to be converted into finished goods. Before any sales become possible other factors remaining the same. Iterating business required less working capital similarly service industry which usually do not have to maintain inventory require less capital. Sales of operations For organizations which operate on a higher scale of operation the quantum of inventory and debtors required is generally high such organisations, therefore require a large amount of working capital as compared to the organisation which operate on a lower scale. Business cycle The sales, as well as protection, are likely to be a larger and therefore larger amount of working capital is required as against this the requirement for capital will be lower during the period of depression as the sales as well as protection will be small. Seasonal factors Most businesses have some seasonality in their operations in peak seasons because of the higher level of activity a large amount of working capital is required as against. This the level of activity as well as the requirement for working capital will be lowered during the lean season. Production cycle Production cycle is the time span between the receipt of raw materials and their conversion into finished goods. Some businesses have a longer production cycle will some have a shorter duration and the length of production cycle affect the amount of fund required for raw materials and expenses consequently working capital requirement is higher in form with long processing cycle and lower inform with shorter processing cycle. Credit allowed Different form allows different credit terms to their customers. This depends upon the level of competition that a firm faces as well as the creditworthiness of their client. Library credit policy results in a higher amount of debt or increasing the requirement of working capital. Credit availed Just as a firm allows created to its customer. It also may get credit from its supplier to the extent. It avail the credit on purchase the working capital requirement is reduced. Operating efficiency From manage their operations with varying degrees of efficiency, For example, if for managing its raw materials efficiently may be able to manage with smaller balance. This is reflected in a higher inventory turnover ratio similarly better debtor’s turnover their ratio may 162 CU IDOL SELF LEARNING MATERIAL (SLM)

be achieved reducing the amount. Tried up in receivables better sales referred me reduce. The average time for which finished goods inventory is held such efficiencies mein reduce the level of raw materials finished goods and lattice resulting in lower requirement of working capital. Availability of raw material If the raw materials and other required materials are available freely and continuously lower stock levels may sufficient. If however raw materials do not have a record of uninterrupted availability higher stock levels may be required in addition the time lag between the placement of the order and the actual receipt of the material is also relevant larger. The lead time larger than the quantity of material to be stored and larger will by the amount of working capital required. Growth prospects If the growth potential of a concern is perceived to be higher. It will require a larger amount of working capital, so that it is able to meet higher production and sales target whenever required. 10.9 SOURCES OF WORKING CAPITAL Intercorporate Loans and Deposits: In present corporate world, it is a common practice that the company with surplus cash will lend other companies for short period normally ranging from 60 days to 180 days. The rate of interest will be higher than the bank rate of interest and depending on the financial soundness of the borrower company. This source of finance reduces intermediation of banks in financing. Commercial Paper (CP): CP is a debt instrument for short-term borrowing that enables highly-rated corporate borrowers to diversify their sources of short-term borrowings, and provides an additional financial instrument to investors with a freely negotiable interest rate. The maturity period ranges from three months to less than 1 year. Since it is a short-term debt, the issuing company is required to meet dealers’ fees, rating agency fees and any other relevant charges. Commercial paper is short-term unsecured promissory note issued by corporation with high credit ratings. Funds Generated from Operations: Funds generated from operations, during an accounting period, increase working capital by an equivalent amount. The two main components of funds generated from operations are retained profit and depreciation. Working capital will increase by the extent of funds generated from operations. 163 CU IDOL SELF LEARNING MATERIAL (SLM)

Retained Profit: Profit is the accretion of fund which is available for finance internally, to the extent it is retained in the organization. Retained profits are an important source of working capital finance. Depreciation Provision: Since there is no cash outflow to the extent of depreciation provided in the accounting, it is used for financing the internal operations of a firm. The amount deducted towards depreciation on fixed assets is not immediately used in acquisition of fixed assets and such amount is retained in business for same time. This is used as a temporary source of working capital so long as the capital expenditure is postponed. Amortization Provisions: Any provisions made for meeting the future payments or expenses such as provision for dividend, provision for taxation, provision for gratuity etc. provide a source of finance so long as they are kept in the business. Deferred Tax Payments: Another source of short-term funds similar in character to trade credit is the credit supplied by the tax authorities. This is created by the interval that elapses between the earning of the profits by the company and the payment of the taxes due on them. Deferred payment of taxes is also used as a temporary source of working capital so long as the amount is deposited with the tax authorities. The taxes deducted at sources, collection of sales tax and excise duty, retirement benefits deducted from salaries of staff etc. also retained in business for some time and used as a source of working capital. Accrued Expenses: Another source of spontaneous short-term financing is the accrued expenses that arise from the normal conduct of business. An accrued expense is an expense that has been incurred, but has not yet been paid. For most firms, one of the largest accrued expenses is likely to be employees’ accrued wages. For large firms, the accrued wages held by the firm constitute an important source of financing. Usually, accrued expenses are not subject to much managerial manipulation. Deposits and Advances:The deposits collected from dealers and advances received from customers will also constitute a source of finance. Public Deposits: Deposits from the public is one of the important source of finance particularly for well- established big companies with huge capital base. The period of public deposits is restricted to a maximum 5 years at a time and hence, this source can provide finance only for short- term to medium-term, which could be more useful for meeting working capital needs of the 164 CU IDOL SELF LEARNING MATERIAL (SLM)

company. It is advisable to use the amounts of public deposits for acquiring assets of long- term nature unless its pay back is very short. 10.10 OPERATING CYCLE In the business, sales do not convert into cash directly: there is invariably a time- lag between the sale of goods and the receipt of cash. There is, consequently, a need for working capital in the form of current assets to deal with the difficulty arising out of the lack of instant realization of cash against goods sold. Therefore, working capital is required to maintain day to day activities. The operating cycle is also known as cash cycle. The simplest meaning of the term operating cycle is, “The standard time between purchasing or acquiring inventory and receiving cash earnings from its sale.” The operating cycle can be said to be at the spirit of the need for working capital. The continuing flow from cash to suppliers, to inventory, to accounts receivable and back into cash is what is called the operating cycle. In other words, the term cash cycle means the duration of time essential to complete the following cycle of events:  Change of cash into inventory  Change of inventory into receivables  Change of receivables into cash. Operating cycle = Inventory conversion period + Receivables conversion period The inventory conversion period is the length of time required to produce and sell the product. It is defined as follows: Average inventory Inventory conversion period = ------------------------------- Cost of sales/365 The payables deferral period is the length of time the firm is able to defer payment on its various resource purchases (for example, materials, wages, and taxes). Equation is used to calculate the payables deferral period: Accounts payable + Salaries, benefits, and Payroll taxes payable Payables deferral period = (Cost of sales + Selling, general andAdministrative expense) /365 Finally, the cash conversion cycle represents the net time interval between the collection of cash receipts from product sales and the cash payments for the company’s various resource purchases. It is calculated as follows: 165 CU IDOL SELF LEARNING MATERIAL (SLM)

Cash conversion cycle = Operating cycle – Payable deferral period Figure 10.2Operating Cycle 166 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 10.3Working Capital Cycle The formula for calculation of operating cycle: 167 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 10.4 Operating Cycle Formula 2. processing period Figure 10.5Processing period Formula 168 CU IDOL SELF LEARNING MATERIAL (SLM)

169 CU IDOL SELF LEARNING MATERIAL (SLM)

170 CU IDOL SELF LEARNING MATERIAL (SLM)

10.11 CASH CYCLE Meaning of Cash Cycle The cash cycle, also called the Cash Conversion Cycle (CCC), is a measure of the length of time it takes to get from paying cash for stock to getting cash after selling it. It is equal to: Stock days + Debtor days – Creditor days. In other terms it may also be said that the Cash Cycle (CC) is a metric. This metric looks at the amount of time needed to sell inventory, the amount of time needed to collect receivables and the length of time the company is afforded to pay its bills without incurring penalties. Cash conversion cycle: The Cash Conversion Cycle (CCC) is a metric that shows the amount of time it takes a company to convert its investments in inventory to cash. The conversion cycle formula measures the amount of time, in days, it takes for a company to turn its resource inputs into cash. The cash conversion cycle formula is aimed at assessing how efficiently a company is managing its working capital. 171 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 10.6Cash conversion cycle 10.10.1 Significance of Cash Cycle This cycle is extremely important for retailers and similar businesses. This measure illustrates how quickly a company can convert its products into cash through sales. The shorter the cycle, the less time capital is tied up in the business process, and thus the better for the company’s bottom line. Cash Cycle helps to determine more easily why and when the business needs more cash to operate, and when and how it will be able to repay the cash. It is also used to distinguish between the customer’s stated loan purpose and the borrowing cause. The analyst is able to judge whether the purpose, repayment source and structure of the loan are the adequate ones. The length of the cash cycle dictates the amount of money that needs to be tied up in working capital proportionate to sales. A shorter cash conversion cycle is better, other things being equal. 10.12 COMPUTATION OF WORKING CAPITAL REQUIREMENTS Working Capital (Current Assets-Current Liabilities) = (Raw Materials Stock + Work-in- progress Stock +Finished Goods Stock+ Debtors + Cash Balance) – (Creditors +Outstanding Wages +Outstanding Overheads). Where, Raw Materials = Cost (Average) of Materials in Stock Work-in-progress Stock = Cost of Materials+ Wages +Overhead of Work-in-progress. 172 CU IDOL SELF LEARNING MATERIAL (SLM)

Finished Goods Stock = Cost of Materials + Wages +Overhead of Finished Goods. Creditors for Material = Cost of Average Outstanding Creditors. Creditors for Wages = Averages Wages Outstanding. Creditors for Overhead = Average Overheads Outstanding. Thus, Working Capital = Cost of Materials in Stores, in Work-in-progress, in Finished Goods and in Debtors. Less: Creditors for Materials Plus: Wages in Work-in-progress, in Finished Goods and in Debtors. Less: Creditors for Wages Plus: Overheads in Work-in-progress, in Finished Goods and in Debtors. Less: Creditors for Overheads. 10.12.1 Estimation of Working Capital Requirements The work sheet for estimation of working capital requirements under the operating cycle method may be presented as follows: Estimation of working capital requirements I Current Assets Amount Amount Amount Minimum Cash **** Balance Inventories: Raw Materials **** Work-in progress **** Finished Goods **** **** Receivables: Debtors **** Bills receivables *** **** Gross Working Capital (CA) *** **** 173 CU IDOL SELF LEARNING MATERIAL (SLM)

II Current Liabilities: Creditors for **** Purchases Creditors for **** Wages Creditors for **** **** Overheads Total Current **** **** Liabilities (CL) Excess of CA **** over CL + Safety Margin **** Net Working **** Capital The subsequent points are also worth noting while estimating the working capital requisite: Depreciation: A significant point worth noting while estimating the working capital necessity is the depreciation on permanent assets. The depreciation on the fixed assets, which are used in the manufacture process or other activities, is not considered in working capital assessment. The depreciation is a non-cash expense and there is no funds locked up in depreciation as such and then, it is unseen. Depreciation is neither incorporated in valuation of work-in-progress nor in finished goods. The working capital considered by ignoring depreciation is known as cash basis working capital. In case, depreciation is incorporated in work ing capital calculations, such estimation is known as total basis working capital. Margin of Safety: Occasionally, a firm may also like to have a safety margin of working capital in order to congregate any emergency. The safety margin may be expressed as a % of total current assets or total current liabilities or net working capital. The safety margin, if necessary, is included in the working capital estimates to find out the net working capital required for the firm. There is no hard and fast rule about the quant um of safety margin and depends upon the nature and uniqueness of the firm in addition to the current assets and current liabilities. 174 CU IDOL SELF LEARNING MATERIAL (SLM)

Solution: In the books of Shri. Aruna Industries Ltd. Statement showing requirements of Working Capital (For the period of 2018-19) Particulars Amt. (Rs.) Amt. (Rs.) I Current Assets Stock of Raw Material (2,500×2×100) 5,00,000 Work-in-progress Raw Materials (2,500×100) 2,50,000 Manufacturing Expenses 18,750 2,68,750 25% of (2,500×30) Finished Goods: Raw Materials 1,25,000 175 CU IDOL SELF LEARNING MATERIAL (SLM)

(2,500×½×100) Manufacturing Expenses (2,500×½×30) 37,500 1,62,500 Debtors (2,500×150) 3,75,000 Total 13,06,250 Cash Balance (13,06,250×5/95) 68750 Net working capital requirement 13,75,000 Note: Selling, administration and financial expenses have not been incorporated in valuation of closing stock 1. Following is the information of Ashok Industries Ltd. Latur for the year 31stMar. 2017. You are required to calculate the working capital requirements from the following information: Particulars Rs Raw materials 160 Direct labour 60 Overheads 120 Total cost 340 Profit 60 Selling price 400 Raw materials are held in stock on an average for 1 month period. Materials are in process on an average for ½ month period. Finished goods are in stock on an average for 1 month period. Credit allowed by suppliers is 1 month period and credit allowed to debtors is 2 month period. Time lag in payment of wages is 1½ weeks. Time lag in payment of overhead expenses is 1 month. 1/4th of the sales are made on cash basis. Cash in hand and at the bank is anticipated to be Rs. 50,000; and anticipated level of production Cash in hand and at the bank is anticipated to be Rs. 50,000; and anticipated level of production amounts to 1,04,000 units for a year of 52 weeks. You may assume that production is carried on evenly throughout the year and a time period of four weeks is equivalent to amonth. Particulars Amt. (Rs.) Amt. (Rs.) 176 CU IDOL SELF LEARNING MATERIAL (SLM)

I Current Assets: 6,40,000 50,000 Cash Balance 3,60,000 12,80,000 Stock of Raw Materials (2,000×160×4) Work-in-progress; 10,00,000 Raw Materials 27,20,000 (2,000×160×2) 40,80,000 Labour and Overheads (2,000×180×2)×50% 91,30,000 12,80,000 Finished Goods (2,000×340×4) 1,80,000 9,60,000 Debtors (2,000×75%×340×8) 24,20,000 Total Current Assets 67,10,000 Creditors (2,000×Rs. 160×4) 177 Creditors for Wages (2,000×Rs. 60×1½) Creditors for Overheads (2,000×Rs. 120×4) Total Current Liabilities Net Working Capital (CA– CL) CU IDOL SELF LEARNING MATERIAL (SLM)

10.13 SUMMARY  Working capital is a financial metric which represents operating liquidity available to a business.  Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital.  It is calculated as current assets minus current liabilities.  If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit.  Working capital represents the funds available with the company for day-to-day operations. Working capital finances the cash conversion cycle.  Company cannot survive with negative working capital which represents that the company has no funds for day-to-day operations.  Some of the factors that can affect a firm’s working capital level are type/nature of business, volume of sales, seasonality and lengths of operating and cash cycle.  The need for working capital (WC) arises from the cash/operating cycle of a firm.  It refers to the length of time required to complete the following sequence of events conversion of cash into inventory, inventory into receivables and receivables into cash.  The operating cycle creates the need for working capital and its length in terms of time span required to complete the cycle is the major determinant of the firm’s working capital needs.  Working capital requirements are determined by a variety of factors.  These factors, however, affect different enterprises differently.  In general, the factors relevant for proper assessment of the quantum of working capital required are: general nature of business, production cycle, business cycle, production policy, credit policy, growth and expansion, availability of raw materials, profit-level, level of taxes, dividend policy, depreciation policy, price level changes and operating efficiency.  Manufacturing and trading enterprises require fairly large amounts of working capital to maintain a sufficient amount of cash, inventories and book debts to support their production and sales activity.  Service enterprises and hotels, restaurants and eating houses need to carry less WC.  The longer is the production cycle, the larger is the WC needed or vice versa 178 CU IDOL SELF LEARNING MATERIAL (SLM)

 Cash Cycle helps to determine more easily why and when the business needs more cash to operate, and when and how it will be able to repay the cash. 10.14 KEYWORDS  Cost of Sales: Cost of sales is equal to the difference between the sales and the gross profit.  Current Assets: Current assets are cash and other assets expected to be converted to cash, sold, or consumed either in a year or in the operating cycle, without disturbing the normal operations of a business.  Current Liabilities: A company’s debts or obligations due within one year.  Working Capital: It means the firm’s holdings of current or short-term asset. Working capital is also known as circulating capital.  Commercial Papersrepresent a short-term unsecured promissory notes issued by firms that have a fairly high credit (standing) rating. It is an alternative source of finance and proves to be helpful during the period of tight bank credit, it is a cheaper source of short-term finance when compared to the bank credit.  Commercial banks are the major source of working capital finance and loaning of funds to business is one of their primary functions.  Bank Finance -Forms of bank finance are loans, overdrafts, cash credits, purchase or discounting of bills and letter of credit.  Factoring service may be offered to the client in two ways: (a) with recourse to the drawer(s) and (b) without recourse to the drawer(s).  Accounts Receivable: Money owed to a firm by its suppliers.  Acid Test Ratio: A liquidity measure which is defined as current liabilities.  Commercial Papers (CPs): Commercial paper represents a short-term unsecured promissory note issued by firms that have a fairly high credit (standing) rating.  Loans: Loan is an advance – a sum given to borrower against some security.  Overdrafts: Overdraft facility is an agreement between the borrower and the banker, where the borrower is allowed to withdraw funds in excess of the balance in his/her current accounts up to a certain limit during a specified period.  Trade Credit: Trade credit refers to the credit extended by the supplier of goods or services to his/her customer in the normal course of business. 179 CU IDOL SELF LEARNING MATERIAL (SLM)

10.15 LEARNING ACTIVITY 1. What are the types of working capital? ___________________________________________________________________________ _____________________________________________________________________ 2. Explain the sources of working capital. ___________________________________________________________________________ _____________________________________________________________________ 3. What are all current liabilities? ___________________________________________________________________________ _____________________________________________________________________ 10.16 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define working capital 2. What is the difference between Gross working capital and Net working capital? 3. State the components of working capital. 4. Outline the concepts of working capital. 5. What are all current assets? 6. What do you mean by overdraft? Long Questions 1. Explain the importance of working capital. 2. Enumerate the factors affecting the working capital. 3. Discuss the concept of operating cycle. 4. Describe the scope of working capital management 5. Summarize the sources of working capital 6. Prepare an estimate of working capital requirements. (i) Projected annual sales — 80,000 units. (ii) Selling price Rs. 8 per unit. (iii) Percentage of profit 20%. (iv)Credit allowed to debtors — 10 weeks. (v) Credit allowed to suppliers — 8 weeks. (vi) gencies. (Ans: 1,41,786) B. Multiple Choice Questions 180 CU IDOL SELF LEARNING MATERIAL (SLM)

1. Working capital is also called__________ 181 a. Circulating capital b. Preference capital c. Overdraft d. Assets 2. Inventory is an example of __________ a. Fixed assets b. Current assets c. Current liability d. Intangible assets 3. The ------- also called the Cash Conversion Cycle (CCC a. Operating cycle b. Working capital c. Financial planning d. Cash cycle 4. The longer is the production cycle, the ------ is the WC needed a. Medium b. Smaller c. Larger d. Very small 5. Commercial paper is source of _________. a. Working capital b. Individual c. Long term fund d. Cooperative society CU IDOL SELF LEARNING MATERIAL (SLM)

Answers 1-a, 2-b, 3-d. 4-c, 5-a 10.17 REFERENCES References books  Rajiv Srivastava and Anil Misra, Financial Management, Oxford university press.  S.N.Maheswari Financial Management, Sultan Chand, New Delhi Textbooks  Punidavathi pandiyan. Financial Management. Mumbai: Himalaya Publishing House.  I.M.Pandey, Financial Management, Pearson  Essentials of financial management, Pearson Websites  https://keydifferences.com/ddifference-between-treasury-management-and-financial- management.html  https://yourbusiness.azcentral.com/importance-treasury-management-26921.html  https://www.accountingtools.com/articles/2017/5/15/treasury-functions  https://www.coupa.com/blog/treasury/cash-management-and-role-treasury  https://www.google.com/search?q=function+s+of+tresury&oq=function+s+of+tresury +&aqs=chrome..69i57.8486j0j7&sourceid=chrome&ie=UTF-8  google.com/search?q=perspectives+of+treasury+management&biw=1536&bih=754& sxsrf=ALeKk01QDYA2KSBQcbNM3YlfQUbyy_fbYw%3A1625395058894&ei=co _hYOuMNpuprtoP1rW50Ag&oq 182 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT - 11: MANAGEMENT STRATEGIES FOR 183 WORKING CAPITAL STRUCTURE 11.0 Learning Objectives 11.1 Introduction 11.2 Working capital investment policy 11.3 Strategies to Manage Working Capital 11.4 Inventory Management 11.4.1 Techniques of Inventory Management 11.5 Cash Management 11.5.1 Objectives of cash management 11.5.2 Factors influencing optimum level 11.5.3 Cash flowing Management Strategies 11.5.4 Importance of cash management 11.5.5 Functions of cash management 11.6 Accounts Receivables Management 11.7 Summary 11.8 Keywords 11.9 Learning Activity 11.10 Unit End Questions 11.11 References 11.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Explain the policy of investing working capital  Discuss the techniques to manage the inventory.  Analyse the cash flow management strategies  Find out the key areas of Accounts Receivable Management  Identify the Receivable management functions CU IDOL SELF LEARNING MATERIAL (SLM)

11.1 INTRODUCTION Every business needs sufficient amount of working capital to run its operations smoothly. Furthermore, it needs to utilize its working capital in the most efficient way possible. This is to ensure maximum return on investment and utilization of fixed assets productively. This is possible only if various elements of working capital are managed proficiently. Thus, Current assets and current liabilities form the major components of working capital as per the working capital equation. Hence, mismanagement of any of these components may lead to severe consequences. This may include even going out of business in certain cases. For instance, shortage of cash may result in incapacity of the firm to meet its short term obligations. Similarly, inadequate inventories may put production on hold and force the business to purchase raw materials at exaggerated prices. Hence, lack of working capital may result in business failure. However, adequate working capital gives a push to the business during the days in which there is less business activity. Hence, to produce goods without any obstruction and sustain sales, a business needs funds for inventories and accounts receivable. Working capital financing strategies basically deals with the sources and the amount of working capital that a company should maintain. A firm is not only concerned about the amount of current assets but also about the proportions of short-term and long-term sources for financing the current assets. There are three working capital management strategies of a firm may adopt after taking into account the variability of its cash inflows and outflows and the level of risk. 11.2 WORKING CAPITAL FINANCING POLICY Working capital financing policy basically deals with the sources and the amount of working capital that a company should maintain. A firm is not only concerned about the amount of current assets but also about the proportions of short-term and long-term sources for financing the current assets. There are several working capital investment policies a firm may adopt after taking into account the variability of its cash inflows and outflows and the level of risk. Conservative Policy: A conservative strategy suggests not to take any risk in working capital management and to carry high levels of current assets in relation to sales. Surplus current assets enable the firm to absorb sudden variations in sales, production plans, and procurement time without disrupting production plans. It requires to maintain a high level of working capital and it should be financed by long-term funds like share capital or long-term debt. 184 CU IDOL SELF LEARNING MATERIAL (SLM)

Availability of sufficient working capital will enable the smooth operational activities of the firm and there would be no stoppages of production for want of raw materials, consumables. Sufficient stocks of finished goods are maintained to meet the market fluctuations. The higher liquidity levels reduce the risk of insolvency. Figure 11.1 Conservative Approach Long-term funds = Fixed assets + Total permanent current assets + Part of temporary current assets Short-term funds = Part of temporary current assets Aggressive Policy: Aggressive working capital financing policy is a risky policy that requires maximum amount of investment in current assets. Fluctuating as well as permanent current assets under this policy will be financed through short-term debt. In this policy debt is collected on time and payments to the creditors are made as late as possible. 185 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 11.2Aggressive Policy Under this approach current assets are maintained just to meet the current liabilities without keeping any cushion for the variations in working capital needs. The core working capital is financed by long-term sources of capital, and seasonal variations are met through short-term borrowings. Adoption of this strategy will minimize the investment in net working capital and ultimately it lowers the cost of financing working capital. The main drawbacks of this strategy are that it necessitates frequent financing and also increases risk as the firm is vulnerable to sudden shocks. A conservative current asset financing strategy would go for more long-term finance which reduces the risk of uncertainty associated with frequent refinancing. The price of this strategy is higher financing costs since long-term rates will normally exceed short term rates. But when aggressive strategy is adopted, sometimes the firm runs into mismatches and defaults. It is the cardinal principle of corporate finance that long-term assets should be financed by long-term sources and short-term assets by a mix of long and short- term sources. Long-term funds = Fixed assets + Part of permanent current assets Short-term funds = Part of permanent current assets + Total temporary current assets Highly Aggressive Policy: This is a highly risky policy for financing the working capital. As per this policy, even some part of fixed assets is financed through short-term sources. Excessive reliance on short-term sources makes this policy highly risky. 186 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 11.3 Aggressive Policy Hedging Policy: One of the policies by which a firm finances its working capital needs is the hedging policy, also known as matching policy. This policy works in an arrangement where the current assets of the business are used perfectly to match the current liabilities. As per this approach, fixed and permanent current assets are financed through long-term sources and fluctuating current assets are financed through short-term sources. This policy is a medium risk proposition and requires a good amount of attention. For example, if a bank loan is due to be paid after six months, the company will ensure that sufficient amount of cash will be available to repay the loan on the date of maturity even though it may or may not currently have sufficient cash. 187 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 11.4 Hedging Policy 11.3 STRATEGIES OF WORKING CAPITAL MANAGEMENT Different elements of working capital such as bills receivable, cash, inventory etc need to be taken care of in order to manage working capital of a business. Let’s understand how each of these components are managed individually to have an optimum level of working capital. 11.4 INVENTORY MANAGEMENT In business terms, inventory management means the right stock, at the right levels, in the right place, at the right time, and at the right cost as well as price. Inventory is one of the important components of working capital of many businesses. The term inventory includes: Finished goods that a business offers for sale Components that form part of finished goods (raw materials, work – in – progress etc.) are also included in the category of inventory Management of inventories refer to investing an optimum amount of working capital in inventories. This means that the investment is neither too low nor too high. Low amount of investment in inventories stalls the production process. Whereas excessive investment in inventories lead to blockage of funds. Thus, the investment in inventories should neither inadequate nor excessive. This means a business needs to determine and maintain an optimum level of inventory. 188 CU IDOL SELF LEARNING MATERIAL (SLM)

A good inventory management strategy improves the accuracy of inventory orders. Proper inventory management helps to figure out exactly how much inventory need to have on-hand. This will help the companies to prevent product shortages and allow to keep just enough inventory without having too much in the warehouse 11.4.1 Techniques of Inventory Management Various techniques are used by a business to determine optimum level of inventory. These include: ABC Analysis ABC analysis is an approach for classifying inventory items based on the items' consumption values. Consumption value is the total value of an item consumed over a specified time period, for example a year. Their consumption values are lower than A items but higher than C items. Figure 11.5 ABC Analysis -I The first diagram suggests the percentage of the total number of inventory items. Here Category A comprises only 10% of products, B contains 20% items, and C has the maximum number with 70% of products. Second diagram of ABC Analysis 189 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 11.6 ABC Analysis -II In the second diagram in lieu of the percentage of average inventory value, the structure reverses. Here, A gains the with almost 70% of inventory value and revenue generation, while B retains its 20% of inventory value. C only generates 10% of revenue; hence it has limited control. Thus ABC plays a significant role in the inventory management Just in Time Just-in-time, or JIT, is an inventory management method in which goods are received from suppliers only as they are needed. The main objective of this method is to reduce inventory holding costs and increase inventory turnover. The purpose of just-in-time inventory is to reduce inventory costs, decrease waste, and increase efficiency. With this inventory management system, a company operates with low stock because goods are only ordered as needed. Retailers, restaurants, on-demand publishing, tech manufacturing, and automobile manufacturing are some examples of industries that have benefited from just-in-time inventory. 190 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 11.7 Just In Time Just-in-time advantages and disadvantages The main advantages of JIT are that • It can improve production efficiency and competitiveness • preventing over-production • minimizing waiting times and transport costs • saving resources by streamlining your production systems • reducing the capital you have tied up in stock • dispensing with the need for inventory operations • decreasing product defects • It can also bring many of these benefits to your customers, so if you have a JIT approach it can win you knew business. Despite the many advantages, there are some possible disadvantages of the just-in-time system. For example, JIT procedures can require a major overhaul of your business systems - they may be difficult and expensive to introduce. JIT or lean manufacturing also opens businesses to a number of risks, notably those associated with your supply chain. With no stocks to fall back on, a minor disruption in 191 CU IDOL SELF LEARNING MATERIAL (SLM)

supplies to your business from just one supplier could force production to cease at very short notice. Risk of Running Out of Stock - With JIT manufacturing, you do not carry as much stock and Dependency on Suppliers - Having to rely on the timelessness of suppliers for each order puts you at risk of delaying your customers' receipt of goods. Inventory Turnover Ratio Inventory turnover indicates the rate at which a company sells and replaces its stock of goods during a particular period. The inventory turnover ratio formula is the cost of goods sold divided by the average inventory for the same period. An inventory turnover ratio of 2 to 4 is ideal. Minimum Safety Stocks The minimum safety stock is the level of inventory which an organization maintains to avoid the stock-out situation. It is the level when the trader places the new order before the existing inventory is over. Figure 11.8 Inventory Techniques Economic Order Quantity Economic order quantity is a technique used in inventory management. Economic order quantity (EOQ) is the order size that minimizes the sum of ordering and holding costs related to raw materials or merchandise inventories. 192 CU IDOL SELF LEARNING MATERIAL (SLM)

The economic order quantity (EOQ) is a model that is used to calculate the optimal quantity that can be purchased or produced to minimize the cost of both the carrying inventory and the processing of purchase orders or production set-ups. Assumptions of EOQ model The rate of demand is constant, and total demand is known in advance. The ordering cost is constant. The unit price of inventory is constant, i.e., no discount is applied depending on order quantity. Delivery time is constant. Replacement of defective units is instantaneous. Economic order quantity formula The following formula is used to determine the economic order quantity (EOQ): Where, D = Demand per year Co = Cost per order Ch = Cost of holding per unit of inventory Problem: 1 193 CU IDOL SELF LEARNING MATERIAL (SLM)

Problem: 2 194 CU IDOL SELF LEARNING MATERIAL (SLM)

Problem; 3 VED Analysis This type of classification is generally used in industries where machines are used for production. In this inventory are classified into vital, essential and desirable VED stands for Vital Essential and Desirable. Organizations mainly use this technique for controlling spare parts of inventory. Like, a higher level of inventory is required for vital parts that are very costly and essential for production. Others are essential spare parts, whose absence may slow down the production process, hence it is necessary to maintain such 195 CU IDOL SELF LEARNING MATERIAL (SLM)

inventory. Similarly, an organization can maintain a low level of inventory for desirable parts, which are not often required for production. In this inventory are classified into vital, essential and desirable Figure 11.9 Inventory Control Fast, Slow & Non-moving (FSN) Method This method of inventory control is very useful for controlling obsolescence. All the items of inventory are not used in the same order; some are required frequently, while some are not required at all. So this method classifies inventory into three categories, fast-moving inventory, slow-moving inventory, and non-moving inventory. The order for new inventory is placed based on the utilization of inventory. 196 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 11.10 FSN Analysis A list of 20 inventory items is penned down in the decreasing order of their annual usage. Inventory turnover rates are also computed for these items. 10% of the total inventory items that rank highest on the parameter of annual usage are put under the “F-class category”. They denote the items that have the maximum demand and are turned over into sales the maximum number of times. Thereafter, 30% of the total inventory items that are ranked in the middle are classified as “S-class category”. Lastly, 60% of the items that have the lowest annual usage are categorized as “N-class inventory”. Since they have the least demand, they must be disposed of as early as possible. 197 CU IDOL SELF LEARNING MATERIAL (SLM)

Under this system, inventories are controlled by classifying them on the basis of the frequency of usage of items of inventory. The management can identify dead stock which is not moving at all and dispose it of. Once slow-moving and non-moving items are identified, they can be bought just in limited quantities to avoid extra purchases from the next time. On similar grounds, by using FSN analysis, a company would be able to effectively allocate monetary resources towards fast-moving items and avoid blocking money in slow and non- moving items. 11.5. CASH MANAGEMENT Cash is the most liquid of all current assets. All the current assets like receivables and inventory get converted into cash eventually. Meaning: Cash management as the word suggests is the optimum utilization of cash to ensure maximum liquidity and maximum profitability. It refers to the proper collection, disbursement, and investment of cash. For a small business, proper utilization of cash ensures solvency. Hence, cash management is a vital business function; it is a function that manages 198 CU IDOL SELF LEARNING MATERIAL (SLM)

the collection and utilization of cash. Hence, cash management is of utmost importance. Furthermore, cash management is an important component of working capital management. Cash includes coins, currency, drafts, cheques and bank deposits. Furthermore, it also includes marketable securities as these get easily converted into cash. So, cash is an important component of current assets. Therefore, a business should have an adequate amount of current assets at all times. It means that cash should neither be inadequate nor in excess. This is because inadequate cash would hold production. Whereas excessive cash will remain idle and impact the profitability of the business. Thus, a business needs to manage cash in order to manage its working capital. 11.5.1 Objectives of cash management Now, the basic objectives behind cash management are: To make payments when they become due To minimize idle cash Five types of cash management tools (or savings tools) include checking accounts, savings accounts, money market deposit accounts, certificates of deposit, and savings bonds. 11.5.2 Factors influencing optimum level There are several factors that can aid in determining the optimum cash balance. Cash management is a forward-looking activity, in that the optimum cash balance must reflect the expected need for cash in the next budget period, for example in the next month. The cash budget will indicate expected cash receipts over the next period, expected payments that need to be made, and any shortfall that is expected to arise due to the difference between receipts and payments. This is the transactions need for cash, since it is based on the amount of cash needed to meet future business transactions. However, there may be a degree of uncertainty as to the timing of expected receipts. Debtors, for example, may not all pay on time and some may take extended credit, whether authorized or not. In order to guard against a possible shortfall of cash to meet future transactions, companies may keep a ‘buffer stock’ of cash by holding a cash reserve greater than called for by the transactions demand. This is the precautionary demand for cash and the optimum cash balance will reflect management’s assessment of this demand. Beyond this, a company may decide to hold additional cash in order to take advantage of any business opportunities that may arise, for example the possibility of taking over a rival company that has fallen on hard times. This is the speculative demand for cash and it may contribute to the optimum cash level for a given company, depending on that company’s strategic plan. 199 CU IDOL SELF LEARNING MATERIAL (SLM)

11.5.3 Cash flow management strategies Cash Flow Management Strategies are  Collection Policy. Enforce a formal collection policy to manage your accounts receivable balance.  Offer Discounts.  Manage Inventory Effectively.  Better System A business can follow the above strategies in order to manage cash efficiently. Business can prepare cash budgets in order to project cash flows. Cash budgets can help a business to plan and control the use of cash. A business needs to determine an optimum level of cash balance by comparing risk with profitability. Various methods are used to determine optimum level of cash. The business can plan for the utilization of the available cash resources. This can be done after determining the cash flow projections and optimum cash balances. Thus, a business can focus on either increasing cash inflows or reducing cash outflows. 11.5.4 Importance of cash management The most important task for business managers is to manage cash. No cash situation creates stress to the small scale business. Therefore Management needs to ensure that there is adequate cash to meet the current obligations while making sure that there are no idle funds. This is very important as businesses depend on the recovery of receivables. If a debt turns bad (irrecoverable debt) it can jeopardize the cash flow. Therefore, cash management is also about being cautious and making enough provision for contingencies like bad debts, economic slowdown, etc. 11.5.5. Functions of cash management Major Functions of Cash Management Cash Planning: cash budget is a plan for an organization to obtain and use resources over a specific period of time. Purpose of Cash Planning: Provides detailed projection on where the money is coming from, useful if you have more than one source of income. Provides details of where the money goes. Provides a good insight into what is affordable for regular savings and retirement planning. Managing Cash Flows 200 CU IDOL SELF LEARNING MATERIAL (SLM)