CU-BCOM-SEM-IV-Financial Management-Second Draft

owners. For this reason, dividends are paid off to mitigate agency conflicts between management and shareholders. Hence, ownership structure must also be considered a determinant of dividend policy. Al-Najjar and Kilincarslanfind that foreign ownership and state ownership are associated with lower probabilities of dividend payments in Turkey. In contrast, Setiawanposit that overall ownership structure has a positive effect on dividend policy. This contrast motivates further study, and thus we propose the following hypotheses. 12.4 THEORIES OF DIVIDEND We conduct data analysis in four stages. First we present relevant diagnostics, normality tests and unit root tests. Second, factors affecting the propensity to pay dividends are investigated with a Logit model. Third, factors influencing dividend payout are investigated with a fixed effect model. The appropriateness of each model is discussed accordingly. Finally, short-term relationships are investigated with Granger Causality Tests. Since p-values of the Jerque– Bera tests (available upon request) are higher than the 5 percent significance level, all independent variables are normally distributed. Levin–Lin–Chu tests (available upon request) to investigate the order of integration of variables reveal that-values of relevant variables are less than 0.05, indicating that variables are stationary in their levels. Accordingly, level variables are included in further analysis. The panel unit root test is not conducted for firm size (a non-stochastic variable). Factors affecting propensity to pay dividends Propensity to pay dividends results from a decision with two alternatives: to pay or not to pay dividends. As a binary variable, it can be addressed by a Probit or Logit model. Theoretically, there is little differentiation between the two models, resting on their assumptions on errors distribution. For simplicity and ease of interpretation, we proceed with the Logit model. The diagnostic Wald test results reveal that the binary parameters in the equations are not jointly equal to zero. Since the McFaddan R2 (0.334) value is between 0.2 and 0.4, the binary test represents a better prediction (goodness of fit) of propensity to pay dividends. It represents the significant factors that explain the propensity to pay dividends (the non-significant factors are lagged dividends, tax, business risk, leverage, liquidity, CFO gender, CFO experience, board gender composition and dividend premium). 12.4.1 Walter’s Model Walter Model : Professor James E. Walter has developed a theoretical model which shows the relationship between dividend policies and common stocks prices. According to him the dividend policy of a firm is based on the relationship between the internal rate of return (r) earned by it and the cost of capital or required rate of return (Ke). According to Walter, the choice of the dividend policy almost always affects the value of the company. According to him, the dividend policy of the companies must be framed by keeping in mind the availability of new investment opportunities. 201 CU IDOL SELF LEARNING MATERIAL (SLM)

If the company has abundant profitable investment opportunities, no cash dividends should he paid because retained earnings will be a source of fund for such investment. On the other hand, if there are no profitable investment opportunities available, a hundred per cent of earning should be distributed as dividend. For the situation between these two extremes, dividend payment will be between zero and a hundred. Walters model is based on the following assumptions  All investments are financed through retained earnings.  The company’s internal rate of return (r) and the cost of capital (k) is constant.  All earnings are either reinvested internally or distributed as dividend.  There is no change in key factors like EPS and DPS.  The company has a very long and perpetual life.  The market value of a share is affected by the present value of future dividends.  Retained earnings in the business affect the expected future dividend and this, in turn, affect the market value of a share. 12.4.2 Gordon’s Model Gordon’s theory on dividend policy is one of the theories believing in the ‘relevance of dividends’ concept. It is also called as ‘Bird-in-the-hand’ theory that states that the current dividends are important in determining the value of the firm. Gordon’s model is one of the most popular mathematical models to calculate the market value of the company using its dividend policy. Myron Gordon’s model explicitly relates the market value of the company to its dividend policy. The determinants of the market value of the share are the perpetual stream of future dividends to be paid, the cost of capital and the expected annual growth rate of the company. The Gordon’s theory on dividend policy states that the company’s dividend payout policy and the relationship between its rate of return (r) and the cost of capital (k) influence the market price per share of the company. Gordon’s model is based on the following assumptions.  The firm is an all Equity firm.  No external financing is available.  The internal rate of return (r) of the firm is constant.  The appropriate discount rate (K) of the firm remains constant.  The firm and its stream of earnings are perpetual. 202 CU IDOL SELF LEARNING MATERIAL (SLM)

12.4.3 MM Hypothesis There is perfect certainty by every investor as to future investments and profits of the firm. In other words; investors are able to forecast future prices and dividends with certainty. According to the M.M. hypothesis, the crux of the matter is the “arbitrage process” or the switching and balancing operation. It also refers to the simultaneous movement of two transactions which exactly offset each other. The two transactions involved are paying dividends and raising capital through external funds either through the sale of new shares or raising additional funds through loans to finance investment programs. If dividends are distributed, an amount will have to be raised through the sale of new shares. The increased value per share through dividends will be exactly offset by the external raising of shares. The terminal value of shares will decline. Shareholders are indifferent between retention of dividend or payment, but they are interested in the firm’s future earnings. According to Modigliani and Miller (M-M), dividend policy of a firm is irrelevant as it does not affect the wealth of the shareholders. They argue that the value of the firm depends on the firm’s earnings which result from its investment policy. 12.5 SUMMARY  Determinants of dividend policy are investigated employing dividend yield as a proxy. The Hausman test reveals that the p-value is higher than 0.05we proceed with the fixed effect model. The next step involves relevant diagnostics tests on regression assumptions. Correlations between independent variablesare used to ensure non- multi-collinearity. According to the Breusch–Godfrey serial correlation test, there is no serial correlation among residuals. The Breusch–Pagan test confirms that residuals are homoscedastic.  The Ramsey RESET Test for model specification reveals that the model has no omitted variables (details on the tests above are available upon request). Thus, diagnostic test results suggest the appropriateness of the fitted fixed effect modelwithout violations of assumptions. The regression model is significant at 1 percent level in explaining the dividend policy.  The adjusted R2 value implies that 68 percent of variation in dividend yields can be explained by model predictors. Past dividends, MBV ratio (proxy for investment opportunities), profitability (ROE), dividend premium and assets growth (proxy for investment opportunities) are significant determinants of corporate dividend policy. None of the other predictors reached significance. Hence, H1b, H3b, H10b, H11b and H16b are accepted, and H2b, H4b, H5b, H6b, H7b, H8b, H9b, H12b, H13, H14 and H15 are rejected. The coefficient values of explained variables suggest that lagged 203 CU IDOL SELF LEARNING MATERIAL (SLM)

dividend (0.21) shows the highest positive impact on dividend yield, while other positive variables include profitability (0.02) and dividend premium (0.003) based on the coefficient size of the impact.  This study finds that corporate governance, earnings, industry influence, ownership structure (proxied by state ownership), past dividend decision, FCF and firm size have a significant positive influence on the propensity to pay dividends. Odds ratios reveal that the previous year’s dividend payers are 22.26 times more likely to pay dividends than non-payers, firms with state ownerships are 1.99 times more likely to pay dividends than the other firms, manufacturing firms are 1.39 times more likely to pay dividends than the other sector firms and firms with an independent board are 1.27 times more likely to pay the dividends than other firms.  Past dividends, profitability, investment opportunities and investor preferences are identified as determinants of the dividend payout. Out of them, there is a feedback between dividend premium (proxy for investor preference) and dividend yield at lag 2, whereas asset growth (proxy for investment opportunities) shows a unidirectional causality from assets growth to dividend yield in the short run. Even though earnings (EPS) are not significant in explaining dividend yield, causality results reveal a feedback relationship between EPS and DY at lag 1. Past dividend decision or payout, profitability and growth opportunities can be identified as the common set of determinants of dividend policy that significantly impact on propensity to pay dividends and its payout.  The impact of earnings and profitability on dividend policy in our sample of Sri Lanka firms support the signalling theory of dividends, an effect that cannot be replicated by firms that do not experience increases in permanent earnings. The complementary role of corporate governance encourages firms to pay dividends and gives an opportunity for investors to scrutinize firms when future funding is raised. Hence, the findings are also consistent with the outcome model of dividends.  This study has implications for investors, managers and researchers. If investors are interested in dividend-paying stocks in the near term, they should first consider organizations that have paid dividends in the recent past. Investors should also look at state owned, profitable, manufacturing firms as they show a higher propensity to pay dividends. Moreover, if investors are interested in higher dividend payout, they should consider past dividend payout and profitability of organizations, noticing that higher investment opportunities will lower payout.  Management should consider past dividend decisions, ownership structure (state or nonstate), profitability and industry type when making the decision to pay dividends. When deciding on dividend payout, it is important to consider past dividend payout and profitability of the organization. Moreover, if higher investment opportunities 204 CU IDOL SELF LEARNING MATERIAL (SLM)

exist, they should lower dividend payout. Future researchers should use propensity to pay dividends and its payout simultaneously when investigating dividend determinants in other countries so as to contribute for a consensus on the dividend determinant puzzle. 12.6 KEYWORDS  General Fund: The principal operating fund for a county government. The General Fund is used to account for all financial resources except those required by law, county policy, and generally accepted accounting principles that are to be accounted for in another fund.  General Obligation (G.O.) Bond: A bond secured by the pledge of the county’s full faith, credit, and taxing power. Many state and/ or county laws require voter approval of G.O. Bonds. These bonds are regarded as safer than bonds backed by a single revenue source, and generally command lower interest rates and lower reserve fund requirements.  General Revenue: Money received that may be used to fund general county expenditures such as education, public safety, public welfare, debt service, etc. Funds received that are restricted as to use are not general revenues and are accounted for in other funds.  General Wage Adjustment (GWA): An increase in salaries other than seniority- based merit increases (increments). GWA is also referred to as a Cost-of-Living Adjustment (COLA).  Grant: A payment from one level of government to another or from a private organization to a government. Grants are made for specified purposes and must be spent only for that purpose. 12.7 LEARNING ACTIVITY 1. Create a session on Walter’s model. ___________________________________________________________________________ ___________________________________________________________________________ 2. Create a survey on dividends policy. ___________________________________________________________________________ ___________________________________________________________________________ 205 CU IDOL SELF LEARNING MATERIAL (SLM)

12.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define cash dividends? 2. Define stock dividends? 3. What is dividend policy? 4. What is stock spilt? 5. Write the meaning of stable dividend policy? Long Questions 1. Explain the advantages of Walter’s model. 2. Elaborate the criticisms of Gordon’s model. 3. Discuss on the theories of dividend. 4. Illustrate the concept of MM hypothesis. 5. Examine the determinants of dividends policy. B. Multiple Choice Questions 1. What does land at prime locations, modern buildings, machinery in good condition, etc are accepted as? a. Funds b. Security c. Liquid cash d. Debt 2. Which refers the period between commencement of project construction and first commercial operation of the project a. Maturity period b. Initial period c. Gestation period d. Growth period 3. What is the financial risk perception is an influencing factor of? 206 a. Equity structure b. Preference structure c. Debt structure CU IDOL SELF LEARNING MATERIAL (SLM)

d. Capital structure 4. Which bonds are again superior to ordinary bonds in terms of sale ability? a. Redeemable b. Irredeemable c. Convertible d. Non-convertible 5. What is the risk averse prefers debt instruments, while the risk seekers go for? a. Equity investments b. Preference investments c. Debt investments d. None of these Answers 1-a, 2-b, 3-c, 4-d, 5-a 12.9 REFERENCES References  Eriotis, N. Vasiliou, D. & Ventoura-Neokosmidi, Z. (2007). How firm characteristics affect capital structure: an empirical study. Managerial Finance.  Falkender, M. & Petersen, M, A. (2006). Does the source of capital affect capital structure? The Review of Financial Studies.  Fama, E, F. & French, K, R. (1998). Taxes, financing decisions, and firm value. The Journal of Finance. Textbooks  Fan, J, P, P. Titman, S. & Twite, G. (2008). An international comparison of capital structure and debt maturity choices.  Fernandez-Arias, E. (1996).The new wave of private capital inflows: push or pull? Journal of Development Economics.  Ferreiro, J. Correa, E. & Gomez, C. (2008). Has capital account liberalisation in Latin American countries led to higher and more stable capital inflows? International Journal of Political Economy. Website 207 CU IDOL SELF LEARNING MATERIAL (SLM)

 https://www.ig.com/en/news-and-trade-ideas/dividend-policies--what-you-need-to- know-190821  https://www.yourarticlelibrary.com/company/dividend-policy/m-m-hypothesis- assumptions-and-limitations-dividend-policy/82562 208 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT-13 WORKING CAPITAL MANAGEMENT STRUCTURE 13.0 Learning Objective 13.1 Introduction 13.2 Needs 13.3 Estimation 13.4 Various Factors Affecting Working Capital Management 13.5 Cash Management 13.6 Summary 13.7 Keywords 13.8 Learning Activity 13.9 Unit End Questions 13.10 References 13.0 LEARNING OBJECTIVE After studying this unit, you will be able to  Explain the cocnept of capital management.  Illustrate the various factors affecting working capital management.  Explain the concept of cash management. 13.1 INTRODUCTION In Western Europe, after the fall of the Western Roman Empire, coins, silver jewellery and hacksilver (silver objects hacked into pieces) were for centuries the only form of money, until Venetian merchants started using silver bars for large transactions in the early Middle Ages. In a separate development, Venetian merchants started using paper bills, instructing their banker to make payments. Similar marked silver bars were in use in lands where the Venetian merchants had established representative offices. The Byzantine Empire and several states in the Balkan area and Kievan Rus also used marked silver bars for large payments. As the world economy developed and silver supplies increased, in particular after the colonization of South America, coins became larger and a standard coin for international payment developed from the 15th century: the Spanish and Spanish colonial coin of 8 reals. Its counterpart in gold was the Venetian ducat. 209 CU IDOL SELF LEARNING MATERIAL (SLM)

Coin types would compete for markets. By conquering foreign markets, the issuing rulers would enjoy extra income from seigniorage (the difference between the value of the coin and the value of the metal the coin was made of). Successful coin types of high nobility would be copied by lower nobility for seigniorage. Imitations were usually of a lower weight, undermining the popularity of the original. As feudal states coalesced into kingdoms, imitation of silver types abated, but gold coins, in particular, the gold ducat and the gold florin were still issued as trade coins: coins without a fixed value, going by weight. Colonial powers also sought to take away market share from Spain by issuing trade coin equivalents of silver Spanish coins, without much success. In the early part of the 17th century, English East India Company coins were minted in England and shipped to the East. In England over time the word cash was adopted from Sanskrit कर्ष karsa,a weight of gold or silver but akin to the Old Persian ������������������ karsha, unit of weight (83.30 grams). East India Company coinage had both Urdu and English writing on it, to facilitate its use within the trade. In 1671 the directors of the East India Company ordered a mint to be established at Bombay, known as Bombay. In 1677 this was sanctioned by the Crown, the coins, having received royal sanction, were struck as silver rupees; the inscription runs \"The rupee of Bomb aim\", by the authority of Charles II. At about this time coins were also being produced for the East India Company at the Madras mint. The currency at the company's Bombay and Bengal administrative regions was the rupee. At Madras, however, the company's accounts were reckoned in pagodas, fractions, fanams, faluche and cash. This system was maintained until 1818 when the rupee was adopted as the unit of currency for the company's operations, the relation between the two systems being 1 pagoda = 3-91 rupees and 1 rupee = 12 fanams. Paper money was first used in China in the Tang Dynasty 500 years prior to it catching on in Europe. During his visit to China in the 13th century, Marco Polo was amazed to find that people traded paper money for goods rather than valuable coins made of silver or gold. He wrote extensively about how the Great Kaan used a part of the Mulberry Tree to create the paper money as well as the process with which a seal was used to impress on the paper to authenticate it. Marco Polo also talks about the chance of forgery and states that someone caught forging money would be punished with death.In the 17th century European countries started to use paper money in part due to a shortage of precious metals, leading to less coins being produced and put into circulation.At first, it was most popular in the colonies of European powers. In the 18th century, important paper issues were made in colonies such as Ceylon and the bordering colonies of Essequibo, Demerara and Berbice. John Law did pioneering work on banknotes with the Banque Royale. The relation between money supply and inflation was still imperfectly understood and the bank went under rendering its notes worthless, because they had been over-issued. The lessons learned were applied to the Bank of England, which played a crucial role in financing Wellington's Peninsular war against French troops, hamstrung by a metallic Franc de Germinal. 210 CU IDOL SELF LEARNING MATERIAL (SLM)

13.2 NEEDS Cash has now become a very small part of the money supply. Its remaining role is to provide a form of currency storage and payment for those who do not wish to take part in other systems, and make small payments conveniently and promptly, though this latter role is being replaced more and more frequently by electronic payment systems. Research has found that the demand for cash decreases as debit card usage increases because merchants need to make less change for customer purchases. Cash is increasing in circulation. The value of the United States dollar in circulation increased by 42% from 2007 to 2012.The value of pound sterling banknotes in circulation increased by 29% from 2008 to 2013.The value of the euro in circulation increased by 34% from August 2008 to August 2013 (2% of the increase was due to the adoption of euro in Slovakia 2009 and in Estonia 2011). A cashless society can be defined as one in which all financial transactions are handled through \"digital\" forms (debit and credit cards) in preference to cash (physical banknotes and coins). Cashless societies have been a part of history from the very beginning of human existence. Barter and other methods of exchange were used to conduct a wide variety of trade transactions during this time period. Since the 1980s, the use of banknotes has increasingly been displaced by credit and debit cards, electronic money transfers and mobile payments, but much slower than expected. The cashless society has been predicted for more than forty years,but cash remains the most widely used payment instrument in the world and on all continents.In 17 out of 24 studied countries, cash represents more than 50% of all payment transactions, with Austria at 85%, Germany at 80%, France at 68%. The United Kingdom at 42%, Australia at 37%, United States of America at 32%, Sweden at 20%, and South Korea at 14% are among the countries with lower cash usage. By the 2010s, cash was no longer the preferred method of payment in the United States.In 2016, the United States User Consumer Survey Study reported that three out of four of the participants preferred a debit or credit card payment instead of cash.Some nations have contributed to this trend, by regulating what type of transactions can be conducted with cash and setting limits on the amount of cash that can be used in a single transaction. Cash is still the primary means of payment (and store of value) for unbanked people with a low income and helps avoiding debt traps due to uncontrolled spending of money. It supports anonymity and avoids tracking for economic or political reasons.In addition, cash is the only means for contingency planning in order to mitigate risks in case of natural disasters or failures of the technical infrastructure like a large-scale power blackout or shutdown of the communication network.Therefore, central banks and governments are increasingly driving the sufficient availability of cash. The US Federal Reserve has provided guidelines for the continuity of cash services,and the Swedish government is concerned about 211 CU IDOL SELF LEARNING MATERIAL (SLM)

the consequences in abandoning cash and is considering to pass a law requiring all banks to handle cash. Because it allows businesses to be solvent enough to keep the company in business even during slow activity or economic downturns. If your business cannot meet its monthly obligations for operations and liabilities you are not solvent. This means that a downturn in the economy or any loss of sales could be devastating. Businesses that have poor cash management can fall behind in debt and monthly operational expenses, making it extremely hard to recoup stability. Sometimes when things are very rough lack of cash flow can prevent the processing of payroll. Employees will not work if they do not get paid. If your cash flow issues get to that point the business has little chance to recover. 13.3 ESTIMATION Capital budgeting is the evaluation and selection of long-term investments on the basis of their costs and potential returns. The process provides a framework for formulating and implementing the appropriate investment strategies. Cash flow estimates are used to determine the economic viability of long-term investments. The cash flows of a project are estimated using discounted and no discounted cash flow methods. The ultimate goal of a business firm is maximizing its economic profit rather than its accounting profit. Economic profit focused Business firms concentrate on improving the net cash return on invested capital. Cash returned on invested capital is a base for the cash out flows of the firm. A firm that aims at maximizing more cash returns from its investment needs to have a high scholastic knowledge of cash management and cash control. In most instances, the cause for failure of a business firm is the firm poor cash management and poor cash control Practices. A business firm that has good practices of controlling over its cash inflow and out flow within a firm has taken as a key measure for a business success and growth. Developing and maintaining a healthy cash flow of a business firm now and in the future needs to know a head either the current purchasing power of the future cash flow or the future value of the current cash flow. In most instance the business firm’s income is changeable from period to period because of this the cash inflow and outflow is uneven. A shortly decision of a business firm on either to invest or to borrow based on its uneven cash inflow is difficult unless it is supported by formulae. In order to have a more certainty equivalent projected cash flow, the firm projective uneven cash flows need to adjust with future risk, inflation and sensitivity rate. Cash flows projected incorporating these future speculative resistance rates such as future risk, inflation and sensitivity rate will have a high certainty equivalent cash flow when it comes to reality. A business firm performance which is to be measured by its economic profit, Economic value added, by which it focuses on generating net cash flow is a real 212 CU IDOL SELF LEARNING MATERIAL (SLM)

measuring tool so as to project the firm’s cash flow. The projection is based on risk, inflation and sensitivity rates adjusted performance rate, which is the rate, at which the current economic profit, EVA, growth from the previous. In order to calculate projected uneven cash flows, which base on risk, inflation and sensitivity rate adjusted performance rate shortly for decision to either invest or to borrow from creditors, need to have a future and present value formulae. The problem to find the present and future value formulae for uneven cash flow estimation stayed unsolved for long periods (Pandey, (1999)). However, on this paper it wanted to show the present and future value formulae based on risk, inflation, and sensitivity rate adjusted performance rate to match the value of the projected cash flow to that of the actual cash flow value. The initial value of this adjusted cash flow can be any amount of cash on hand which is excess above consumption or a portion of it and the next after the first amount progress according to the growth of adjusted performance rate. The purpose of this paper is to show how the sum of uneven cash flow either for investment or for repayment of borrowed loan from bank based on a risk, inflation, and sensitivity-adjusted performance of the business firm can be determined. Risk is unexpected variation of actual to the expected cash flows. This unexpected variation may arise from uncertain economic condition, variability of future return of a firm, uncertain condition under which the firm operates its activities, market instability and so on. Inflation is to mean the declination of money purchasing power because of the general rise of price for the same goods in the past. The main cause for this inflation can be the country dependability on import goods rather than using substitution products within the country. Sensitivity rate (l), defined by this paper, is the rate at which a change in one of the various forecast variables, by which we arrived at the net cash flows, will affects to change the net present value of the business firm. The reliability of net cash flow is a base for the reliability of net present value(Colin et al (2004); Pandey, (1999)). The present value formula of this paper gives an advantage to borrowers since it relieves borrowers’ suffering from paying huge amount at the beginning periods. The firm at initial stage assumed at high establishment cost and eventually after covering the investment cost the loan repayment assumed to raise according to the investment performance rate. The repayments calculated and set for each loan periods by creditors/banks in such a way will benefit them in collection of loan interest. Because, at the beginning years (periods) the principal loan amount is not much affected by the small repayments comparing to the next periods repayments for each of which assumed to clear first the interest amount and the principal by the excess above the interest amount. On the other hand, future value formula relaxed depositors for they can deposit each periods’ excess above of their consumption. A newly entrant business firm into market does have a little amount of cash at initial stage and eventually after covering the establishment cost the liquidity amount on hand grows accordingly. The growth of the cash inflow of the business firm depends on its performance. When performance of the business improves, its profit and cash inflows increase in the same way. As result of this, the depositor can deposit the excess above his/her 213 CU IDOL SELF LEARNING MATERIAL (SLM)

business consumption starting by a small amount of money, which can eventually increase from period to period to a higher amount according to the business performance 13.4 VARIOUS FACTORS AFFECTING WORKING CAPITAL MANAGEMENT The firm must estimate its working capital very accurately because excessive working capital results in unnecessary accumulation of inventory and wastage of capital whereas shortage of working capital affects the smooth flow of operating cycle and business fails to meet its commitment. Length of Operating Cycle The amount of working capital directly depends upon the length of operating cycle. Operating cycle refers to the time period involved in production. It starts right from acquisition of raw material and ends till payment is received after sale. Scale of Operation The firms operating at large scale need to maintain more inventory, debtors, etc. So they generally require large working capital whereas firms operating at small scale require less working capital. Business Cycle Fluctuation During boom period the market is flourishing so more demand, more production, more stock, and more debtors which mean more amount of working capital is required. Whereas during depression period low demand less inventories to be maintained, less debtors, so less working capital will be required. Seasonal Factors The working capital requirement is constant for the companies which are selling goods throughout the season whereas the companies which are selling seasonal goods require huge amount during season as more demand, more stock has to be maintained and fast supply is needed whereas during off season or slack season demand is very low so less working capital is needed. Technology and Production Cycle If a company is using labour intensive technique of production then more working capital is required because company needs to maintain enough cash flow for making payments to labour whereas if company is using machine-intensive technique of production then less working capital is required because investment in machinery is fixed capital requirement and there will be fewer operative expenses. Credit Allowed 214 CU IDOL SELF LEARNING MATERIAL (SLM)

Credit policy refers to average period for collection of sale proceeds. It depends on number of factors such as creditworthiness, of clients, industry norms etc. If company is following liberal credit policy then it will require more working capital whereas if company is following strict or short term credit policy, then it can manage with less working capital also Credit Avail Another factor related to credit policy is how much and for how long period company is getting credit from its suppliers. If suppliers of raw materials are giving long term credit then company can manage with less amount of working capital whereas if suppliers are giving only short period credit then company will require more working capital to make payments to creditors. 13.5 CASH MANAGEMENT Cash management is the process of collecting and managing cash flows. Cash management can be important for both individuals and companies. In business, it is a key component of a company's financial stability. For individuals, cash is also essential for financial stability while also usually considered as part of a total wealth portfolio. Individuals and businesses have a wide range of offerings available across the financial marketplace to help with all types of cash management needs. Banks are typically a primary financial service provider for the custody of cash assets. There are also many different cash management solutions for individuals and businesses seeking to obtain the best return on cash assets or the most efficient use of cash comprehensively. Cash is the primary asset individuals and companies use to pay their obligations on a regular basis. In business, companies have a multitude of cash inflows and outflows that must be prudently managed in order to meet payment obligations, plan for future payments, and maintain adequate business stability. For individuals, maintaining cash balances while also earning a return on idle cash are usually top concerns. In corporate cash management, also often known as treasury management, business managers, corporate treasurers, and chief financial officers are typically the main individuals responsible for overall cash management strategies, cash-related responsibilities, and stability analysis. Many companies may outsource part or all of their cash management responsibilities to different service providers. Regardless, there are several key metrics that are monitored and analysed by cash management executives on a daily, monthly, quarterly, and annual basis The cash flow statement is broken down into three parts: operating, investing, and financing. The operating portion of cash activities will vary based heavily on net working capital which is reported on the cash flow statement as a company’s current assets minus current liabilities. 215 CU IDOL SELF LEARNING MATERIAL (SLM)

The other two sections of the cash flow statement are somewhat more straight forward with cash inflows and outflows pertaining to investing and financing. 13.6 SUMMARY  Furthermore, since EVA (Economic Value Added) considered as a measure of both performance and value of a business firm, it assumed as a way to determine the value created excess above the required return for the shareholder of the business firm. The firm creates wealth for the shareholder when the revenue of the firm exceeds over the cost of doing business and the cost of capital. A business firm creates value for its shareholders on the bases of positive EVA rather than simply making accounting profits.  The positive magnitude of EVA indicates as the business firm is improving its net cash return on invested capital. The increment of EVA of the firm from year to year will result an increase of the market value of the firm( Aswath,(2001)). The existence of accounting information of a firm for a single accounting period helps the manager to grasp the basic know how of the firm performance in that accounting period. A manager who has good experience of the firm performance helps in facilitating to predict future performance of a firm basing on the past financial statement such as income statement and balance sheet.  The availability of past trend records help to calculate and predict progressive performance rate of the firm so as to determine progressive cash inflow on the firm investment return and the firm progressive bank loan repayment.( Alexander Hamilton Institute (1998); Reilly and Schweihs (2000)). Since the firm's performance rate has assumed progressive, the cash flow of the firm assumes to grow from period to period. Performance rate is a percentage by which the current performance of a firm (in this case, EVA) growth from the previous.  The paper deeply focused on how business firms determine their cash inflow or out flow based on their economic profit (or economic value added) .As revealed by the formulae, the first payment , which is excess above consumption , which can be assigned for payment of debt or for saving into bank account is very small amount. The next after the first cash flow amounts progress or growth along with the business firm’s performance rate. Since this performance rate shows the relative level of growth of a firm, current to last economic profit, it embraces all activities of the firm. EVA reflects net of the cash generated and the cash invested by the business firm. As EVA fluctuates from period to period, the net cash left to the business firm also fluctuates from period to period.  This fluctuation of the firm’s cash inflow or out flow can exactly reflect by the business performance rate ( n r ). Financing organs, like banks, use ordinary annuity 216 CU IDOL SELF LEARNING MATERIAL (SLM)

formula as to determine loan capacity as well as loan repayment of the borrowers. Since the formula does not contain any measure of the performance of the borrowing organ, Most of the business loan are seen getting into nonperforming loan category, letting other things being constant. Because of this, Banks always lay their own rules and regulations to minimize nonperforming loans at hand but could not reach at a conclusive solution for long periods.  Unless otherwise there existed stiff control to collect the disbursed loan, the increment of bad debt from period to period will exactly harm the economic condition of the country as a whole. However, the present value formula stated by this paper calculates the projected fluctuating repayment amount along with the performance of the borrowing organ based on the real cash on hand which is excess above the consumption. The future value formula enables people, who have no excess cash on hand for investment, to decide now saving a portion of income according to their earnings growth from period to period so as to realize their dream after some fixed period.  This also encourages the saving habits of people those who have low income and those who are salaried, people who get their income from their employment at a fixed period interval such as monthly or annually. Most business organs use EVA as a measure of both value and performance. In Ethiopia huge business firms like construction and business bank sc (CBB) uses EVA as a measure of its performance. Construction and business bank sc is the only bank long stayed leading the market by lending long-term construction loan in Ethiopia (CBB, 2010).  Cash management, also known as treasury management, is a process that involves collecting and managing cash flows.  Chief financial officers, business managers, and corporate treasurers are usually the main individuals responsible for overall cash management strategies, stability analysis, and cash related responsibilities.  Many businesses fail at cash management and the reasons vary. Typically, a poor understanding of the cash flow cycle, profit versus cash, lack of cash management skills, and bad capital investments are the reasons for failing at cash management.  In an organization, chief financial officers, business managers, and corporate treasurers are usually the main individuals responsible for overall cash management strategies, stability analysis, and other cash-related responsibilities. However, many organizations may outsource part or all of their cash management responsibilities to some service providers.  The cash flow statement is the main component of a company’s cash flow management. The cash flow statement comprehensively records all of the 217 CU IDOL SELF LEARNING MATERIAL (SLM)

organization’s cash inflows and outflows. It includes cash from operating activities, cash paid for investing activities, and cash from financing activities. The bottom line of the cash flow statement shows how much cash is readily available for an organization.  The cash flow statement is divided into three parts: investing, financing, and operating activities. The operating part of cash activities is based heavily on the net working capital, which is presented on the cash flow statement as a company’s current assets minus current liabilities. Businesses strive to make the current assets balance exceed the current liabilities balance.  The other two parts of the cash flow statement are somewhat more straightforward with cash inflows and outflows connected to investing and financing, such as investments into real estate, buying new equipment and machinery, and originating stock repurchases, or paying out dividends as part of the financing activities.  There are many internal controls utilized to manage and achieve efficient business cash flows. Some of a business’s major cash flow considerations comprise the average length of account receivables, write-offs for uncollected receivables, collection processes, rates of return on cash equivalent investments, liquidity, and credit line management. 13.7 KEYWORDS  Impact Fees: An impact fee is a one-time charge that requires new development to pay a proportionate share of the revenue needed for construction or expansion of capital facilities to serve the new development. Impact Fees can be collected for many things, including roads, schools, and water system improvements.  Incremental Funding: The provision of budgetary resources for a program or project based on obligations estimated to be incurred within a fiscal year when such budgetary resources will cover only a portion of the obligations to be incurred in completing the program or project as programmed.  Individual Retirement Account (IRA): For qualified individuals, a savings account in which the contributions are tax deductible and the interest accrues tax free, provided the funds are held until retirement. On withdrawal, both contributions and accrued interest are subject to tax.  Lapse: The reduction of gross personnel costs by an amount believed unnecessary because of turnover, vacancies, and normal delays in filling positions. The amount of lapse will differ among departments, and from year to year.  Lease-Purchase Agreement: A contractual agreement which is termed “lease,” but is in substance a purchase contract with payments made over time. 218 CU IDOL SELF LEARNING MATERIAL (SLM)

13.8 LEARNING ACTIVITY 1. Create a session on Working Capital Management. ___________________________________________________________________________ ___________________________________________________________________________ 2. Create a survey on Cash Management. ___________________________________________________________________________ ___________________________________________________________________________ 13.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define the term commercial paper? 2. What is meaning of cash? 3. Define the management of cash? 4. Write the main type of Cash? 5. What is commercial bank money? Long Questions 1. Explain the scope of Cash management. 2. Elaborate the Various Factors Affecting Working Capital Management. 3. Illustrate the estimation of cash management. 4. Discuss on the needs of Cash management. 5. Examine the functions of working capital management. B. Multiple Choice Questions 1. What are accepted as Land at prime locations, modern buildings, machinery in good condition? a. Funds b. Security c. Liquid cash d. Debt 2. What refers the period between commencement of project construction and first commercial operation of the project 219 CU IDOL SELF LEARNING MATERIAL (SLM)

a. Maturity period. b. Initial period. c. Gestation period d. Growth period 3. Which of the factors influencing financial risk perception? a. Equity structure b. Preference structure. c. Debt structure. d. Capital structure. 4. Which bonds are again superior to ordinary bonds in terms of sale ability? a. Redeemable b. Irredeemable c. Convertible d. Non-convertible 5. When capital market is booming, firms can take market route to a. Raise capital. b. Decrease capital c. Stop growing d. Stagnate Answers 1-a, 2-b, 3-c, 4-d, 5-a 13.10 REFERENCES References book  Graham, J. & Harvey, C. 2001. The theory and practice of corporate finance: evidence from the field. Journal of Financial Economics, 60(5): 187-244.  Green, C.J., Murinde, V. & Suppakitjarak, J. 2003. Corporate financial structures in India. South Asia Economic Journal, 4(2): 245-273.  Grullon, G., Michaely, R. & Swaminathan, B. 2002. Are dividend changes a sign of firm maturity? The Journal of Business. 75(3): 387-424. Textbook references 220 CU IDOL SELF LEARNING MATERIAL (SLM)

 Gupta, M.C. 1969. The effect of size, growth, and industry on the financial structure of manufacturing companies. The Journal of Finance, 24(3): 517-529.  Gwatidzo, T. & Ojah, K. 2009. Corporate capital structure determinants: evidence from five African countries. African Finance Journal, 11(1): 1-23  Gwatidzo, T. & Ojah, K. 2009. Corporate capital structure determinants: evidence from five African countries. African Finance Journal, 11(1): 1-23 Website  https://www.educba.com/cash-management/  https://corporatefinanceinstitute.com/resources/knowledge/finance/cash-management/  https://www.yourarticlelibrary.com/management/top-13-factors-affecting-the- working-capital-of-a-company/8742 221 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT-14 INVENTORY MANAGEMENT STRUCTURE 14.0 Learning Objective 14.1 Introduction 14.2 Concept of Inventory Management 14.3 Receivables Management 14.4 Current Assets Financing 14.5 Summary 14.6 Keywords 14.7 Learning Activity 14.8 Unit End Questions 14.9 References 14.0 LEARNING OBJECTIVE After studying this unit, you will be able to:  Understand the concept of Inventory Management.  Illustrate the concept of Receivables Management.  Explain the concept of Current Assets Financing. 14.1 INTRODUCTION The word inventory doesn't have the same meaning in the USA and in the UK. In American English and in a business accounting context, the word inventory is commonly used to describe the goods and materials that a business holds for the ultimate purpose of resale. In American English, the word stock is commonly used to describe the capital invested in a business, while in British English, the sentence stock shared is used in the same context. In the rest of the English speaking world stock is more commonly used, although the word inventory is recognized as a synonym. In British English, the word inventory is more commonly thought of as a list compiled for some formal purpose, such as the details of an estate going to probate, or the contents of a house let furnished. In both British and American English, stock is the collective noun for one hundred shares as shares were usually traded in stocks on Stock Exchanges. For this reason the word stock is used by both American and British English in the term Stock Exchange. Inventories are materials stored, waiting for processing, or experiencing processing. They are ubiquitous throughout all sectors of the 222 CU IDOL SELF LEARNING MATERIAL (SLM)

economy. Observation of almost any company balance sheet, for example, reveals that significant portion of its assets comprises inventories of raw materials, components and subassemblies within the production process, and finished goods. Most managers don't like inventories because they are like money placed in a drawer, assets tied up in investments that are not producing any return and , in fact, incurring a borrowing cost. They also incur costs for the care of the stored material and are subject to spoilage and obsolescence. In the last two decades there have been a spate of programs developed by industry, all aimed at reducing inventory levels and increasing efficiency on the shop floor. Some of the most popular are conwip, Kanban, just-in time manufacturing, lean manufacturing, and flexible manufacturing. Nevertheless, in spite of the bad features associated with inventories, they do have positive purposes. Raw material inventories provide a stable source of input required for production. A large inventory requires fewer replenishments and may reduce ordering costs because of economies of scale. In- process inventories reduce the impacts of the variability of the production rates in a plant and protect against failures in the processes. Final goods inventories provide for better customer service. The variety and easy availability of the product is an important marketing consideration. There are other kinds of inventories, including spare parts inventories for maintenance and excess capacity built into facilities to take advantage of the economies of scale of construction. Because of their practical and economic importance, the subject of inventory control is a major consideration in many situations. Questions must be constantly answered as to when and how much raw material should be ordered, when a production order should be released to the plant, what level of safety stock should be maintained at a retail outlet, or how in-process inventory is to be maintained in a production process. These questions are amenable to quantitative analysis with the help of inventory theory  Inventory (American English) or stock (British English) refers to the goods and materials that a business holds for the ultimate goal of resale, production or utilisation.  Inventory management is a discipline primarily about specifying the shape and placement of stocked goods. It is required at different locations within a facility or within many locations of a supply network to precede the regular and planned course of production and stock of materials.  The concept of inventory, stock or work in process (or work in progress) has been extended from manufacturing systems to service businesses and projects,by generalizing the definition to be \"all work within the process of production - all work that is or has occurred prior to the completion of production\".  In the context of a manufacturing production system, inventory refers to all work that has occurred – raw materials, partially finished products, finished products prior to sale and departure from the manufacturing system. In the context of services, inventory refers to all work done prior to sale, including partially process information. 223 CU IDOL SELF LEARNING MATERIAL (SLM)

 Inventory proportionality is the goal of demand-driven inventory management. The primary optimal outcome is to have the same number of days' (or hours', etc.) worth of inventory on hand across all products so that the time of runout of all products would be simultaneous.  In such a case, there is no \"excess inventory\", that is, inventory that would be left over of another product when the first product runs out. Holding excess inventory is sub- optimal because the money spent to obtain and the cost of holding it could have been utilized better elsewhere, i.e. to the product that just ran out.  The secondary goal of inventory proportionality is inventory minimization. By integrating accurate demand forecasting with inventory management, rather than only looking at past averages, a much more accurate and optimal outcome is expected. Integrating demand forecasting into inventory management in this way also allows for the prediction of the \"can fit\" point when inventory storage is limited on a per-product basis.  The technique of inventory proportionality is most appropriate for inventories that remain unseen by the consumer, as opposed to \"keep full\" systems where a retail consumer would like to see full shelves of the product they are buying so as not to think they are buying something old, unwanted or stale; and differentiated from the \"trigger point\" systems where product is reordered when it hits a certain level; inventory proportionality is used effectively by just-in-time manufacturing processes and retail applications where the product is hidden from view.  One early example of inventory proportionality used in a retail application in the United States was for motor fuel. Motor fuel (e.g. gasoline) is generally stored in underground storage tanks.  The motorists do not know whether they are buying gasoline off the top or bottom of the tank, nor need they care.  Additionally, these storage tanks have a maximum capacity and cannot be overfilled.  Finally, the product is expensive. Inventory proportionality is used to balance the inventories of the different grades of motor fuel, each stored in dedicated tanks, in proportion to the sales of each grade.  Excess inventory is not seen or valued by the consumer, so it is simply cash sunk (literally) into the ground. Inventory proportionality minimizes the amount of excess inventory carried in underground storage tanks. This application for motor fuel was first developed and implemented by Petrol soft Corporation in 1990 for Chevron Products Company. Most major oil companies use such systems today 224 CU IDOL SELF LEARNING MATERIAL (SLM)

14.2 CONCEPT OF INVENTORY MANAGEMENT Inventory is an important resource of every business to run its day-to-day operations uninterruptedly. It impacts various steps of the supply chain such as manufacturing, warehousing, sales etc. The amount of inventory available with a business should be sufficient enough so that various activities of the business are not adversely affected. Likewise, there should not be excessive amount of investment in inventories. This is because over investment can lead to inventories remaining idle. Thus, it would result in blocking of working capital. Therefore, inventory plays a very important role in managing the various operations of the business. So, let’s understand what is inventory and various types of inventory before understanding the concept of inventory management. Inventory management and supply chain management are the backbone of any business operations. With the development of technology and availability of process driven software applications, inventory management has undergone revolutionary changes. In the last decade or so we have seen adaptation of enhanced customer service concept on the part of the manufacturers agreeing to manage and hold inventories at their customers end and thereby effect Just In Time deliveries. Though this concept is the same in essence different industries have named the models differently. Manufacturing companies like computer manufacturing or mobile phone manufacturers call the model by name VMI - Vendor Managed Industry while Automobile industry uses the term JIT - Just In Time whereas apparel industry calls such a model by name - ECR - Efficient consumer response. The basic underlying model of inventory management remains the same. Inventory management refers to the process of ordering, storing, using, and selling a company's inventory. This includes the management of raw materials, components, and finished products, as well as warehousing and processing of such items. A company's inventory is one of its most valuable assets. In retail, manufacturing, food services, and other inventory-intensive sectors, a company's inputs and finished products are the core of its business. A shortage of inventory when and where it's needed can be extremely detrimental. At the same time, inventory can be thought of as a liability (if not in an accounting sense). A large inventory carries the risk of spoilage, theft, damage, or shifts in demand. Inventory must be insured, and if it is not sold in time it may have to be disposed of at clearance prices—or simply destroyed. For these reasons, inventory management is important for businesses of any size. Knowing when to restock inventory, what amounts to purchase or produce, what price to pay—as well as when to sell and at what price—can easily become complex decisions. Small businesses will often keep track of stock manually and determine the reorder points and quantities using spreadsheet (Excel) formulas. Larger businesses will use specialized enterprise resource 225 CU IDOL SELF LEARNING MATERIAL (SLM)

planning (ERP) software. The largest corporations use highly customized software as a service (SaaS) applications. Appropriate inventory management strategies vary depending on the industry. An oil depot is able to store large amounts of inventory for extended periods of time, allowing it to wait for demand to pick up. While storing oil is expensive and risky—a fire in the UK in 2005 led to millions of pounds in damage and fines—there is no risk that the inventory will spoil or go out of style. For businesses dealing in perishable goods or products for which demand is extremely time-sensitive—2021 calendars or fast-fashion items, for example—sitting on inventory is not an option, and misjudging the timing or quantities of orders can be costly. For companies with complex supply chains and manufacturing processes, balancing the risks of inventory gluts and shortages is especially difficult. To achieve these balances, firms have developed several methods for inventory management, including just-in-time (JIT) and materials requirement planning (MRP). 14.3 RECEIVABLES MANAGEMENT Account receivables refer to the outstanding invoices or money which is yet to be paid by your customers. Until it is paid, such invoices or money is accounted as accounts receivables. Also known as bills receivables. You need cash all the time to keep your business running smoothly and ensuring the accounts receivables are paid on time is essential to manage cash flow efficiently. And as the term suggests, management of your accounts receivable is called receivable management. Basically, the entire process of defining the credit policy, setting payment terms, sending payment follow ups and timely collection of the due payments can be defined as receivables management. Even though management of receivables seems to be simple, but it could become a very tedious task to manage, depending on the nature of your business. As your business grows, your processes also evolve and become more and more complex, thus, the accounting software to manage your receivables must mould itself to match up to your company standards and needs. Now to run a business successfully, what is that one thing that you need? Money! Right? So, to keep your cash inflow at its optimum, it is crucial that you keep a close watch your receivables. Thus, below are some of the primary objectives to receivables management. It is obvious that sound receivable management will help business owners keep their cash inflow steady. This process will give you a clear picture of where your cash is stuck, while maintaining a systematic record of all sales transactions. It ensures that you have sufficient amount of cash to take care of your everyday transactions, and you do not give credit facilities over and above your credit policies or credit limit. Management of receivables refers to planning and controlling of debt owed to the customer on account of credit sales. In 226 CU IDOL SELF LEARNING MATERIAL (SLM)

simple words, the successful closure of your order to sales is determined only when you convert your sales into cash. Till your sales are converted into cash, you need to manage ‘how much you need to receive? from whom? And when? To do this, you need accounts receivables management, popularly known as a credit management system in place. Another reason, accounts receivables are one of the key sources of cash inflow and given the volume of credit sales, a large amount of money gets tied-up in accounts receivables. This simply implies that so much of money is not available till it is paid. If these are not managed efficiently, it has a direct impact on the working capital of the business and potentially hampers the growth of the business. Managing accounts receivables efficiently will benefit the business in several ways. The most important being the increased cash inflow by faster realization of sales to cash. It also helps you to build a better relationship with your customer by not having the discrepancies in pending bills and mitigates the risk of bad debts. All these require you to be top of your account’s receivables and you can easily achieve this by using accounting software. It helps you track, monitor and on-time action on overdue/long-pending bills resulting in increased inflow of cash that is essential for business growth. 14.4 CURRENT ASSETS FINANCING Corporate finance literature traditionally focuses on long term financial decisions and their influence on the profitability of firms. Howeverin in recent years working capital management has gained importance as managers and academicians recognize the importance of the efficient management of a firm’s liquidity as vital in the survival of the firm, especially at a time of global financial turmoil. It is also noted that the management of current assets and liabilities which are financed by the working capital takes a lot of managerial time and effort and thus assumes greater importance. Extensive research resources discuss working capital management and its effect on profitability. These researchers focused on the relation between net trade cycle and profitability and stressed the importance of working capital management as an integral part of the overall corporate strategy to increase shareholder value. Managing a balance between the profitability and liquidity of the firm assume vital importance in working capital management. Researchers point out that the heavy investments in inventory and trade credit yield lower profits. An excessive level of working capital may affect the return on assets negatively while an insufficient amount may lead to shortages and difficulties in managing day to day operations. These studies advocated the need for an efficient working capital management system that ensures a balance between profitability and risk. They also highlighted the fact that constant attention paid to the overall working capital management builds the financial flexibility to respond to unexpected changes in the economic environment and thus gain competitive advantage. Working capital is the value of current assets and current liabilities. Current assets include cash, accounts receivables, raw materials, work-in- 227 CU IDOL SELF LEARNING MATERIAL (SLM)

progress, and finished goods inventories, while current liabilities include accounts payables, notes payables, and accruals. Many corporate finance managers focus on the management of these individual components of the working capital to improve overall efficiency. However, an working capital management integrated approachyields better results as evidenced by the overall financial performance of the firm. If firms follow an aggressive working capital policy, they may try to keep low levels of current assets such as cash, short term investments, accounts receivables and stock inventory, or make late payments to creditors. Firms can reduce their financing costs or make more funds available for long term investments by minimizing the investment in current assets. Thus most countrywise empirical studies support the belief that reducing working capital investment increases the profitability of the firms. However, there are a few studies which have reported a negative relationship between aggressive working capital policy and profitability. They support the view that lower current assets may lead to shortages, illiquidity and difficulties in managing day to day operations and will reduce the firm’s profitability. Lack of liquidity in extreme situations can lead to the firm’s insolvency. A conservative working capital policy would support maintaining high levels of current assets such as inventories. This reduces the risk of liquidity associated with the opportunity cost of funds that may have been invested in long-term assets. Also, high inventory levels reduce the cost of interruptions in the production process, decrease supply cost and protect against price fluctuation and loss of business due to scarcity of product, thus improving the profitability of firms. Similarly, a generous trade credit policy, may increase sales in a low-demand period, such as an economic recession, and strengthen customer relations. However, several studies report that excessive investments in current assets lead the firm to lowrisk-low profitability scenario, especially considering the cost of discounts for early payment. These studies addressed working capital management issues in general, without segregating them based on size. However, the size of the firm is an important determinant in deciding the perceptions on working capital management. The financial profiles of smaller firms are significantly different from those of larger corporations. These differences get reflected in the management's attitudes, including the willingness to assume risk, and significantly impact small businesses. The small firms are generally undercapitalized and hence dependent on owner-financing, trade credit and short-term bank loans. Further, the size makes these firms more vulnerable to working capital fluctuations Refusehas pointed out the insufficiency of working capital as the major reason for the failure of small businesses in the developed as well as the developing countries. Small businesses generally maintain large amounts of current assets and show fluctuating cash flow and focus mostly on strategies to improve marginal returns indicating poor working capital management. These problems are relevant not only to business start-ups or growing firms, but also to firms in more advanced stages of their life-cycle. 228 CU IDOL SELF LEARNING MATERIAL (SLM)

14.5 SUMMARY  Gutmandefined the cash conversion cycle as the number of days from the time the firm pays for its purchases of the most basic form of inventory to the time that the firm collects the payments for the sale of the finished product. Based on the accrual accounting principle, it analyses the liquidity of the firm from the view point of an on- going concern. The longer the cash cycle, the larger will be the investment in working capital. Cash conversion cycle analysis can also lead the investigator to policy measures to reduce investments in current assets and thereby improve the liquidity of the firm. Deloofshowed a significant and negative relationship between the cash conversion cycle and the profitability of Belgian firms.  He also analysed the relationship of the firm’s profitability with the individual components of the cash conversion cycle, namely inventory, accounts 7 receivables and accounts payables periods. Shin and Soelenconfirmed the significant negative relationship between the net trade cycle and the profitability of US firms. Karadumanreported similar results by return on assets of companies listed on the Istanbul Stock Exchange. While confirming similar results for firms in Jordan, Al Shubiriargued that funds committed to working capital can be seen as hidden sources useful for improving the firm’s profitability.  However, working capital management strategies in the firm can be affected by many external as well as internal factors. The sensitivity of working capital management to market imperfections such as asymmetric information, agency conflicts or financial distress was examined by Caballero. Their results showed that the working capital competes with investment in fixed assets for funds when the firm has financial constraints. The ability of the firm to find sufficient working capital depends on the bargaining power and other financial factors such as the availability of internal finance, cost of finance and access to capital markets. Uyarexamined the relationship among the cash conversion cycle, size and profitability of the firms listed in the Istanbul Stock Exchange.  The results showed a significant negative correlation between the cash conversion cycle and profitability and also between the cash conversion cycle and firm size. The results showed that a shorter cash conversion cycle exists for the retail/wholesale industry compared to that of the manufacturing industry. Boisjolyexamined the effect of working capital policy on financial ratios and found that cash flow per share and productivity significantly improved due to aggressive management of the working capital. A similar study by Lazaridis and Tryfonidison the firms listed in the Athens Stock Exchange added that the proper and optimal handling of the components of the working capital by executives can improve the profitability of their firms. 229 CU IDOL SELF LEARNING MATERIAL (SLM)

 Most of the existing working capital management papers examine the relationship between working capital management and the profitability of large firms applying regression or correlation techniques. Though working capital management is crucial for all firms, small firms are more vulnerable given their capital-starved nature and limited access to external capital. Commenting on the poor standards of credit management among small firms in the UK, Howorth and Wilsonpointed out that long- term financial stability and ability to plan cash flow based on expected payments was important to tide over financial problems.  Johnsfound out that small firms hold less market power and less expert control over trade debtors compared to large firms and are forced to reduce the net trade credit which, in turn, affects the financial structure of the small firms. Working capital management decisions are of particular importance to small business firms due to their heavy dependence on owner finances, trade credit and short term bank loans. When coupled with inadequate long-term financing, poor working capital management can lead to the failure of small business firms.  Further, several researchers made in-depth critique of the impact of trade credit on the sustainability of small firms. Most of these works summarized the role of trade credit in financial disintermediation, price discrimination and reduction of asymmetric information. Schwartzand Emerystressed on the role of trade credit in financial disintermediation and identified that the relationship with the creditors help the small firms in obtaining funds other than institutional credit. Also, with immediate payment, the firms get discounts and it can act as a price discrimination device in the market. In addition to this, trade credit smoothens the asymmetric informationbetween firms and its financial sources, also the firm and its suppliers.  This is empirically evidenced by Deloof and Jegersand Ng. Further, Cunatlinked firms’ liquidation and bankruptcy , explained the supplier dependency of small firms. Rodriguez-Rodriguezproved that the smallest firms mostly seek short term finances through suppliers using panel data from Canary Island firms from 1990-1996. Padachianalysed the working capital management efficiency of a sample of 58 small manufacturing firms in Mauritius.  The study concluded that the owner managers could increase their profits by shortening the working capital cycle. To respond to the changes in working capital needs over time, it is important to synchronize the assets and liabilities using the best management practices in the sector. This study stressed the importance of the adoption of relevant improved financial management practices in small firmsanalysed the effectiveness of working capital management in small and medium firms in Nigeria using standard working capital ratios and observed that the selected firms show signs of overtrading and illiquidity, low debt recovery and credit payment. The study stressed the need for a standard credit policy to ensure continuity, growth and 230 CU IDOL SELF LEARNING MATERIAL (SLM)

solvency. Several industry-specific, country specific studies have also been made to feature the link between size and dependence on different components of short term finances. 14.6 KEYWORDS  Mission: The desirable end result of any activity. Missions are generally broad and long range in nature compared to goals, which are more specific and immediate. An example of a mission is: “to provide safe, reliable, and cost-efficient public transportation to the residents of the county.  Operating Budget: A financial plan that presents proposed expenditures for a given period (typically a fiscal year) and estimates of revenue to finance them. Usually excludes expenditures for capital assets.  Operating Expense: Those costs, other than expenditures for personnel costs and capital outlay, which are necessary to support the operation of the organization, such as charges for contractual services, telephones, printing, motor pool, and office supplies.  Partial Capitalization: The process of either expensing or transferring to the fixed asset account group prior fiscal year expenditures for ongoing capital projects only.  Pension Trust Funds: Accounting entities for assets held by the county from which retirement annuities and other benefits are paid to former employees. 14.7 LEARNING ACTIVITY 1. Create a session on inventory management. ___________________________________________________________________________ ___________________________________________________________________________ 2. Create a survey on receivables management. ___________________________________________________________________________ ___________________________________________________________________________ 14.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define the term finished goods? 2. Define the term raw materials? 231 CU IDOL SELF LEARNING MATERIAL (SLM)

3. What is inventory management? 4. Write the meaning of inventory? 5. What is financing? Long Questions 1. Explain the criticism of inventory management. 2. Elaborate the criticism of current assets financing. 3. Illustrate the scope of current assets financing. 4. Discuss on the needs of receivables management. 5. Examine the advantages of receivables management. B. Multiple Choice Questions 1. Which among the following is a type of inventory system that is used to manage independent demand items? a. Order point system b. Material requirements planning c. Time phased order point d. Enterprise resource planning 2. What is an effective inventory management minimizes the investment in inventory by effectively meeting? a. Functional requirement b. Customer requirement c. Process reliability d. Sales forecasting of a firm 3. How to achieve in purchasing and transportation, goods may be purchased in larger quantities than the actual demand.? a. Continuation b. Quality c. Cost efficiency d. Potential value 4. Which among the following is the objective of the Enterprise Resource Planning system? 232 CU IDOL SELF LEARNING MATERIAL (SLM)

a. Manage purchase order b. Control the flow of dependent demand inventories c. Organise external management information d. Balance supply and demand 5. Which among the following models is used to calculate the timing of the inventory order? a. Economic order quantity model b. Fixed order quantity model c. Reorder point model d. Fixed order inventory model Answers 1-c, 2-a, 3-c, 4-d, 5-c 14.9 REFERENCES References  Harris, J, R. Schiantarelli, F. & Siregar, M, G. (1994). The effect of financial liberalisation on the capital structure and investment decisions of Indonesian manufacturing establishments. The World Bank Economic Review.  Henry, P, B. (2000). Stock market liberalisation, economic reform, and emerging market equity prices. The Journal of Finance.  Homaifar, G. Zietz, J. & Benkato, O. (1994). An empirical model of capital structure: some new evidence. Journal of Business Finance and Accounting. Textbooks  Hübler, O. Menkhoff, L. & Suwanaporn, C. (2008). Financial liberalisation in emerging markets: how does bank lending change? The World Economy.  Jensen, M, C. & Meckling, W, H. (1976). Theory of the firm: managerial behaviour, agency costs and ownership structure. Journal of Financial Economics.  Kaminsky, G, L. & Reinhart C, M. (1999). The twin crises: the causes of banking and balance-of-payments problems. The American Economic Review. Website  https://efinancemanagement.com/costing-terms/types-of-inventory-stock  https://www.researchgate.net/publication 233 CU IDOL SELF LEARNING MATERIAL (SLM)

 https://www.graydon.nl/en/resources/wiki/accounts-receivable-management 234 CU IDOL SELF LEARNING MATERIAL (SLM)