Business Finance

Module 6

Module Financial Planning Tools and

6 Concepts

Managing Working Capital

CASH

Being the most liquid asset, cash is an important account in the balance sheet that
will affect the liquidity and solvency of the company. It the most vulnerable asset when
it comes to theft. There must be a proper internal control over cash of a company or an
entity to safeguard the asset. The following are suggested internal controls over cash:

1. Separating cashiering function from the recording or accounting function. A

basic internal control system entails the assignment of custodial function and
recording function to separate individuals, unless you are the owner.
2. Issuing official receipts for collections and summarizing collections in a daily
collection report. It is important to know the collections from business everyday
as these collections reflect the health of the company. The daily collection report
is going to be useful for the next control measure for cash – depositing
collections.
3. Depositing collections. A good internal control over cash is by depositing all
collections intact. The daily collection report as are now compared with the
deposit slips to find out if all collections are indeed deposited.
4. Adopting the check voucher system for payments. If all the collections need to
be deposited, payments must be made through a check voucher system. The
cheque must have two signatories to provide check and balance. If the business
is small, the entrepreneur’s signature may suffice. For big operations, there can
be a set of check signatories authorized to sign depending on the amount. For
example, the Vice President for Finance and the Vice President for
Administration are the authorized signatories for payments amounting to a
maximum of Php 500,000. For payments exceeding the amount, the Vice
President for Finance and the President has to sign the check.

Having two signatories minimize the probability of issuing a flawed check, either
wrong payee or an incorrect amount.

A petty cash fund is used for small payments like cash given to a messenger. A
petty cash fund which should be a minimal amount and will be issued to a petty
cash fund custodian, such as the office administrator. Petty cash fund maybe
Php10,000 or Php20,000. Disbursements from this petty cash funds must be
supported by petty cash voucher signed by the recipient of the petty cash. When
the petty cash fund is almost depleted, the petty cash fund custodian will get
reimbursements. This reimbursement will go to the check voucher system where

1
 the custodian gets a check with the petty cash vouchers as supporting
documents.

The check must also be crossed -check by drawing two line on the payee section
of the check. This cross-checking requires depositing of a check and it cannot
be encashed. This makes it more difficult for somebody who stole a check to get
the money.

Figure 1: Sample Cross-Check

Motives for Holding Cash

 The following are the reasons for holding cash:
A. Primary Reasons
- Transactional. This is the cash use for paying expenses such as salaries, utilities,
rent and taxes, among the others.
- Compensating balance. This is the cash held to meet bank requirements such as the
minimum cash balance you maintain for checking accounts and if you have existing
loans, banks may require a minimum amount of deposit with your accounts.

B. Secondary Reasons

- Precautionary. Cash that is maintained for emergencies such as the additional cash
for you to keep during political and economic uncertainties. For example, if your
business requires substantial amount of importation, a relative higher amount of
cash has to be maintained when the exchange rate becomes highly volatile due to
political instability.
- Speculative. The cash held by the company to take advantage of opportunities
(buying stocks during major correction).

Budgeting Cash

The Cash Budget

- The cash budget provides information regarding the company’s expected cash
receipts and disbursements over a given period.
- It is useful for identifying future funding requirements or excess cash within a given
period. This allows managers to find the possible source of financing if the cash
budget shows cash shortage or identify appropriate tenors for money market
placements for excess cash.
- Normally. a cash budget is prepared for one-year period broken down into smaller
intervals like month to allow manager to see the seasonality of the business which
affects the cash flows.

2
 Figure 2: Sample Cash Budget

Parts of Cash Budget

1. Cash receipts include all of a firm’s inflows of cash in a given financial period.
Cash sales, collections of accounts receivables proceeds from loans or issuance
of new shares of stocks and advances from stockholders.
- Illustrative Example:
Source: Gitman, L. (1976). Principles of Managerial Finance. New York:
Harper & Row.

Bugay Industries, a defense contractor, developing a cash budget for October,

November, and December. Jungaya’s sales in August and September were
Php100,000 and Php200,000 respectively. Sales of Php400,000, Php300,000
and Php200,000 have been forecast to October, November and December
respectively.

Historically, 20% of the firm’s sales have been for cash, 50% have generated
accounts receivable collected after 1 month, and the remaining 30% have
generated accounts receivable collected after 2 months. In December, the firm
will receive a Php30 000 dividend from stock in subsidiary.
Required: Prepare the cash receipts section of the cash budget. Answer:

Figure 3: Total Cash Receipts

2. Cash disbursements include all outlays of cash by the firm during a given
financial period. The most common cash disbursements are the following: -
Cash purchases - Interest payments - Wages and salaries - Purchasing fixed -
Rent (and lease) - Principal payments
assets payments (loans)
- Payments of accounts - Cash dividend - Tax payable payments

3
 -It is important to recognize the depreciation and other noncash charges are not
included in the cash budget, because they merely represent a schedule write-off of an
earlier cash outflows.

-Illustrative Example:
Jungaya industries has gathered the following data needed for the preparation
of a cash disbursements schedule for October, November, and December.

Purchases: The firm’s purchases represent 70% of sales. Of this amount, 10% is paid
in cash, 70% is paid in the month immediately following the month of purchase, and
the remaining 20% is paid 2 months following the month of purchase.
Rent Payments: Rent of Php5,000 will be paid each month
Wages and Salaries: Fixed-salary cost for the year is Php Php96,000, 0r Php8,000 per
month. In addition, wages are estimated 10% of monthly sales.
Tax Payments: Taxes of Php25,000 must be paid in December.
Fixed Assets: New machinery costing Php130,000 will be purchased and paid for in
November.
Interest Payments: An interest payment of Php10,000 is due in December. Answer:

Figure 4: Total Cash Disbursements

3. Net Cash Flow, Ending Cash, Financing Cash and Excess Cash This is
computed by deducting cash disbursements from the collections for the period.
This provides information regarding the amount of excess cash or cash deficit for
the period.

-Illustrative Example:
Given the two illustrative examples, generate a cash budget showing the net cash flow,
ending cash flow, financing, and excess cash. At the end of September, Jungaya’s cash
balance was Php50,000, and its notes payable and marketable securities equaled
Php0. The company wishes to maintain a reserve for unexpected needs, a minimum
cash balance of Php25,000.
Answer:

4
 Figure 4: Net Cash Flow, Ending Cash, Financing and Excess Cash

Comprehensive Illustrative Example:

It was December 2014 and the president of DCD Corporation wants to find out if the
company has enough cash to pay the principal balance of the company’s loan worth
Php3 million by the end of 2015. He asked the chief accountant to prepare the cash
budget for 2015.

The following assumptions which will be used for the preparation of the cash budget
for 2015 are as follows:

1. Projected quarterly sales are as follows: First quarter = Php5 million

Second quarter = Php7.5 million
Third quarter = Php8.5 million
Fourth quarter = Php10million
Fourth quarter sales in 2014 was Php8 million.
Sales are collected 90% in the quarter the sales are made. The
remainingn10% is collected the following
quarter.
2. Cost of sales is 75%of sales. Merchandise inventories are purchased in the
quarter these are sold. All merchandise purchased in the quarter are paid in the
same quarter.
3. Operating expenses for each quarter paid in cash are as follows:
First quarter = Php500,000
Second quarter = Php750,000
Third quarter = Php850,000
Fourth quarter = Php1,000,000
On the top of these cash operating expenses, depreciation expense to be charged
to operations is Php150,000 per quarter.
4. Interest expense paid every quarter is Php75,000
5. Income tax rate is 30%. The income taxes to be paid every quarter will be as
follows:
First quarter = Php157,500 Second quarter
= Php270,000 Third quarter =
Php315,000
Fourth quarter = Php382,500
6. Expected cash balance at the end of the 2014 is about Php350,000. For 2015,
target cash balance is raised for Php500,000 because of the expected increase in
sales.

Given the above assumptions, a cash budget can now be prepared for 2015.

5
 Figure 5: DCD Corporation Cash Budget

ACCOUNTS RECEIVABLE

The term receivables are described as debt owed to the firm by the customers
resulting from the sale of goods or services in the ordinary course of business.
Receivables are forms of investment in any enterprise manufacturing and selling goods
on credit basis, large sums of funds are tied up in trade debtors. When company sells
its products, services on credit, and it does not receive cash for it immediately, but
would be collected in near future, it is termed as receivables.

Providing credit to costumers is one way of generating sells. To prove this point,
consider a real estate company which sells condominium at Php5 million per unit. How
many units can the property developer sell if he sells the units only in cash basis? Do
you think he can sell a lot? Probably not as many compared to providing instalment
payments.

Management of accounts receivable is important. What if your company cannot

collect the accounts receivable? If this situation happens, the company will have to
shut down its operation.
The collectability of accounts receivables depends largely on the quality of
costumers. The quality of costumers depends on the standards or credit policies set up
and used by an organization. The same principles of credit evaluation apply to big and
small companies. The approach may probably vary as it is more formalized in big
companies.

• In any case, the following 5Cs of credit can be used in the credit evaluation.
1. Character. This refers to the integrity and reputation of the costumer. The
educational background and experience in the business are also considered.
2. Capacity. This refers to the capacity to pay or a costumer’s ability to generate
cash flows.
3. Collateral. This refers to a security pledged for payment for the loan.
4. Capital. Refers to a costumer’s financial resources.
5. Condition. Refers to currents economic or business conditions.

6
 • Proper management of accounts receivable entails having a good billing and
collection system.
- A good system should lead to the sending of statements of account
to costumer on time.
- Follow-ups through phone calls or any form of gentle reminders
should be made if costumers fail to pay on time. These follow-ups can also
serve as the management’s way of validating if the contact details given by
costumers still valid and if the customers still occupy the same office.

• Aging of receivables is also a control measure to determine the amount of

receivables that are still outstanding and past due.

Example:
Current Php 60 million
1-30 day past due 20 million
31-60 day past due 10 million
61-90 day past due 3 million
Over 90 days past due 7 million
Total Php100 million
- Accounts which have been past due for more than 90 days have
higher probability to default. The aging of receivables is useful in
determining the allowance for doubtful accounts.

INVENTORY MANAGEMENT

Involves the formulation and administration of plans and policies to efficiently

and satisfactorily meet production and merchandising requirements and minimize
costs relative to inventories. It is basically related to task of controlling the assets that
are produced to be sold in the normal course of the firm's procedures. Effective
inventory management becomes critical when the nature of the products is either
perishable (ex. Fruits, vegetables), fragile (ex. glasses), or toxic (ex. bleaching agent).

The following are the internal controls that should be considered by management
to safeguard inventories:
1. Separating custodial function s from the recording functions. Just like cash,
this internal control measure is also true to inventories and the other types of
assets.
2. Aging of inventories. Aging of inventories allows management to identify the
fast-moving items and the slow-moving items. Management must decide what
to do with slow- moving items before they further lose their values. One way to
dispose slow -moving items is by bundling them with other products of the
company. This is done by many consumer companies in the country. For
example, a toothpaste company may bundle toothpaste product with
toothbrush or mouthwash which they also produce and sell or “buy one take
one” promotions in department stores.
3. ABC Analysis. This approach classifies the inventories into three categories.: A,
B, And C. Inventories which are considered the most important are classified as
A, those at the middle are classified as B and the least important are classified
as C. The main reason for classifying them is to provide the kind of security due
to each category of inventories. This is not to say that category C inventories
are not important but that the company has limited resources. The more
valuable items have to be given better security. Diamond should be given better
security than fancy jewelry.

- Inventories classified as “A” are very high valued items which should be
safeguard the most.
- B items are average cost items that should be safeguard more than C
items but not as much as A.
- C items have low cost and is the least safeguard. To summarize:

7
 INVENTORY CLASS

A B C

Money value High Medium Low

Quality of control Very strict Strict Not to strict
Inventory movement (flows) Slow Relatively fast Fast
Sources:
Agamata, F. (2014), Management Services.
Gitman, L. (1976) Principles of Managerial Finance. New York, Harper & Row.
Gitman L. & Joehnk, M. (1981) Fundamentals of Investing, New York,
Harper & Row.
Horngren, C. (1972). Cost of Accounting: A Managerial Emphasis, Englewood
Cliffs, H.J:Prentice-Hall
Roque, R. (1990) Reviewer in Management Advisory Services, Roque Press, Inc.

Inventory in a Manufacturing Company

 There are three types of inventory in manufacturing company.

- Raw materials. These are purchased materials not yet put into
production. - Work in process. These are goods and labor put into production
but not yet finished.
- Finished goods. These are goods put into production and finished. These
are ready to be sold.

Explore

Here are some enrichment activities for you to work on to master and
strengthen the basic concepts you have learned from this lesson.

Enrichment Activity 1: True or False

Recall lessons in the tools in managing cash, receivables and inventory.

Assessment 1
Directions: Write TRUE if the statement is correct and FALSE if the statement is
incorrect.
__________ 1. A good internal control over cash is by depositing all collections intact.
__________ 2. Cross check cannot be encashed.
__________ 3. Precautionary is one of the primary reasons in holding cash.
__________ 4. Transactional refers to the cash held to meet bank requirements.
__________ 5. Cash budget is useful in identifying future funding requirements or
excess cash within a given period.
__________ 6. Depreciation and other noncash charges are included in the cash budget
__________ 7. Providing credit terms to costumers is one of generating sales. __________
8. Proper management of accounts receivable entails having a good billing and
collection system.
__________ 9. Follow-ups can also serve as the management’s way of validating if the
contact details are still valid.
__________ 10. ABC Analysis is an approach that classifies inventories into 3 categories
- A, B & C wherein C is strict in the quality of control.

8
Enrichment Activity 2: JUMBLED WORDS
What are the 5Cs of credit that can be used in the credit evaluation used by small and
big companies?
What are the reasons for holding cash?
Assessment 2
Directions: Rearranged the jumbled letters to come up with the correct answer.

1.
_________________________________________________

2.
_____________________________________________________

3.
______________________________________________________

4.
______________________________________________________

5.
_________________________________________________

6.
_______________________________________________________

7.
_______________________________________________________

8.
_______________________________________________________

9.
________________________________________________________

10.
________________________________________________________

Enrichment Activity 3: IDENTIFICATION

What are the tools in managing cash, receivables and inventories?

Assessment 3:
Directions: Read and analyze the question carefully before answering.

________________________1. One primary reason for holding cash

aside from compensating balance.
________________________2. A cash maintained during emergencies.
________________________3. A cash held by the company to take
advantage of opportunities.

9
________________________4. It provides information regarding the
company’s expected cash receipts and disbursements over a given period.
________________________5. It springs out of the need to sell merchandise.
________________________6. This refers to the willingness of the borrower to repay the
loan.
________________________7. It is the security pledged for payment of the loan.
________________________8. This allows management to identify the fast-moving items
and the slow-moving items.
________________________9. This approach classifies inventories into three categories:
A, B, and C.
________________________10. A type of inventory in a manufacturing company which
refers to the goods put into production and finished.

ACTIVITY
Directions: Read carefully each item. Use separate sheet for your answers. Write only
the letter of the best answer for each test item.
_____ 1. What asset is the most liquid and an important account in the balance sheet
that will affect the liquidity and solvency of the company?
A. Accounts receivables
B. Cash
C. Equity
D. Inventories

_____ 2. What is transactional which is a primary reason for holding cash?

A. Cash held by the company to take advantage of opportunities.
B. Cash maintained for emergencies
C. Cash used for paying expenses
D. Minimum cash balance for checking accounts

_____ 3. A part of cash budget which includes collections from receivables, proceeds
from loans, or issuance of new shares of stock and advances from subsidiaries.
A. Cash disbursements
B. Cash receipts
C. Cumulative excess or funding requirements
D. Net cash flow for the period

_____ 4. What part of cash budget includes the payments to suppliers and other service
providers, payments for loans and cash dividends?
A. Cash disbursements
B. Cash receipts
C. Cumulative excess or funding requirements
D. Net cash flow for the period

_____ 5. What 5Cs used in credit evaluation refers to costumer’s financial resources?
A. Capacity
B. Capital
C. Character
D. Collateral

_____ 6. Give an example of good or product where the ABC Analysis is used
A. Clothes
B. Diamond
C. Fancy jewelries
D. Foot wares

10
_____ 7. What is true about this statement – “Minimizing loss from exposure to
accounts receivable starts with its organization.”
I. Costumer who is given a credit terms must be worthy.
II. In large companies, credit committee decides which costumer
should be given credit terms.
III. If the company is small, the costumer’s will no longer be screened.
A. I & II are true.
B. I & III are true.
C. II is false.
D. III is false.

_____ 8. What word makes the statement FALSE in this sentence- “Effective inventory
management is not critical not the nature of the products is either perishable, fragile or
toxic?”
A. Fragile
B. Not
C. Perishable
D. Toxic

_____ 9. What word makes the sentence FALSE in this statement – “Follow-ups through
phone calls or any form of gentle reminders should be made to all customers?”
A. All
B. Follow-ups
C. Phone calls
D. Reminders

_____ 10. What is TRUE about Cash Budget?

I. Cash budget is a part of planning.
II. Helps managers anticipate future funding requirements.
III. Helps the managers avoid usurious rate.
A. I & II are true.
B. II & III are true.
C. II is false.
D. III is false.

11