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STUDY 3

The document outlines key financial concepts including cash flow statements, working capital management, and cash management systems essential for business operations. It explains the importance of managing cash for transactions, precautionary measures, and investment opportunities, while also detailing the cash conversion cycle and inventory management strategies. Additionally, it introduces the 5 C's of credit, which help assess a customer's creditworthiness and repayment ability.

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6 views

STUDY 3

The document outlines key financial concepts including cash flow statements, working capital management, and cash management systems essential for business operations. It explains the importance of managing cash for transactions, precautionary measures, and investment opportunities, while also detailing the cash conversion cycle and inventory management strategies. Additionally, it introduces the 5 C's of credit, which help assess a customer's creditworthiness and repayment ability.

Uploaded by

trixxxt.t
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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1. What is Cash Flow Statement?

It is a process of closely monitoring of in and out of cash in the business.


Example: Ms. Amelia Enriquez engaged in a laundry shop. It was already her 2nd
year of operation and all the in and out of cash for the month as follows:

Let us assume that Amelia laundry shop projected 3 months of cash flow for planning an expansion of her
business. Let us say that there is an increase of collection of 25% and all expenses will stay the same. By month
of May, Amelia granted a loan amounted Php 150,000. How much is the cash flow ending balance of Amelia for
the month of May?
WORKING CAPITAL MANAGEMENT?
Businesses require adequate capital to succeed in business environment. There are two types of capital required
by business: fixed capital and working capital. Businesses require investment in asset, which has utilized over a
longer period. These long-term investments considered as fixed capital, e.g. plant, machinery, etc.

Working capital refers to company’s investment in short term asset such as cash, inventory, short-term
marketable securities, and account receivable.
Net Working capital refers to the difference between the firm’s current assets and current liabilities. If the firm’s
current assets exceed its current liabilities, the firm has a positive working capital. On the other hand, if current
liabilities exceed current assets, the firm has a negative working capital.

Working Capital Management specifically refers to the efficient management of the firm’s current assets (cash,
receivables, and inventory) and current liabilities (short-term payables). Through working capital management,
managers have given the challenge to balance risk and profitability that comes along each current asset and
liability to contribute positively to the firm’s value.

Cash Management System


The cash management involves the maintenance of a cash and marketable securities investment level, which will
enable the company to meet its cash requirements and at the same time optimize the income on idle funds.
A financial officer has the following specific objectives in monitoring cash balances:
To meet the ash disbursement needs (payments schedule)
To minimize the funds committed to transactions and precautionary cash balances; and
To avoid misappropriation and handling losses in the normal course of business

Reasons for Holding Cash


Although cash has generally considered a non-earning asset, business firms must hold cash for the following
reasons:
1. Transaction Motive - cash needed to facilitate the normal transactions of the business, that is, to carry out its
purchases and sales activities.
2. Precautionary Motive - Cash may held beyond its normal operating requirement level in order to provide for
a buffer against contingencies such as unexpected slow-down in accounts receivable collection, strike or increase
in cash needs beyond management’s original projections.
3. Speculative Motive- cash held ready for profit making or investment
opportunities that may come up such as a block of raw materials inventory offered at discounted prices or a
merger proposal.
4. Contractual Motive-A company may be required by a bank to maintain a certain compensating balance in its
demand deposit account as a condition of a loan extended to it.
Cash Conversion Cycle - A firm operating cycle begins from the time goods for sale manufactured to the eventual
collection of cash from the sale of these goods. The operating cycle of a firm is mainly composed of two current
asset categories:

inventories and accounts receivable. It measures as the sum of the Average Age of Inventory and Average
Collection Period. The average age of inventory refers to the time that lapsed when a good manufactured and
eventually sold. The average collection period on the other hand refers to the time when the sale made and
collected. Both measured in days.

Operating cycle= Average Age of Inventory + Average Collection Period

Cash Conversion Cycle = Operating Cycle – Average Payment Period

The average payment period is the time it takes for the firm to pay its accounts payable expressed in number of
days. The operating cycle less average payment period provides us the firm’s cash conversion cycle. Carefully
analyzing the equations provided above, a firm’s cash conversion cycle re expressed as follows.

Cash conversion cycle = Average Age of Inventory + Average Collection Period –Average payment period.

Illustration:
Bloom Manufacturing had an average age of inventory of 18.5 days, an average collection period of 48.5 days
and an average payment period of 53.5 days. Bloom is operating and cash conversion cycle obtained as follows:

Operating Cycle = Average Age of Inventory + Average Collection Period


= 18.5 days + 48.5 days
= 67days
Cash Conversion Cycle = Operating Cycle – Average Payment period
= 67days - 53.5 days
= 13.5 days
Inventory Management- The objective in managing inventory is to convert it as quickly as possible to cash without
losing sales due to stock outs. Therefore, the financial manager plays a crucial role in overseeing that the firm
maintains an appropriate quantity of inventory – not too much and not too little. Maintaining too much inventory
implies that the firm incurs more costs associated with carrying these inventories. However, carrying too little
inventory quantities might lead to possible stock outs that could further lead to lost sales, and worst, lost
customers.

Inventory in A Manufacturing Company - In a manufacturing company, there are three types of inventory:
a. Raw materials – these are purchased materials not yet put into production
b. Work in process – these are goods and labor put into production but not finished.
c. Finished goods – these are goods put into production and finished. These are ready to be sold.

One popular credit selection technique is the use of the 5 C’s of credit:

a. Character: The applicant’s record of meeting its past obligations has judged. However, if the applicant does
not have any credit history, he or she may be required to have a co-maker. A co-maker is another person who
signs the loan and assumes equal responsibility for repayment.

b. Capacity: This emphasizes the customer’s ability to repay its obligations in reference to its current financial
position or standing. It determines whether the customer has sufficient resources or sources of funds that it can
use to settle obligation
c. Capital: The applicant’s net worth which can be arrived at by deducting total liabilities from total assets.
d. Collateral: The amount of assets the customer has that could serve as a security in the event that the obligation
is not paid.
e. Condition: This includes current economic and industry conditions that might affect the customer’s ability to
repay its obligations.

The use of the 5C’s of credit will allow the firm to carefully assess the customer’s ability to repay its obligations
along with the level of risk that the firm
will be subjected to once it decides to grant credit to the customer. It requires
experience to fully assess and review the credit worthiness of customers and subsequently decide.

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