CHARTERED FINANCIAL

MANAGEMENT ANALYST
(MODULE 2)

JOHN ANTHONY M. LABAY

CPA, MBA, CAP, CFMA
WORKING CAPITAL MANAGEMENT
✓ CASH MANAGEMENT
✓ RECEIVABLES MANAGEMENT
✓ INVENTORY MANAGEMENT
✓ SHORT-TERM FINANCING
 CASH MANAGEMENT

Cash management is one of the key areas of working

capital management. Apart from the fact that it is the
most liquid current asset, cash is the common
denominator to which all current assets can be reduced
because the other major liquid assets, which are
receivables and inventory, get eventually converted into
cash.
 MOTIVES/REASONS FOR HOLDING CASH

Transaction Motives - refers to the holding of cash to

meet routine cash requirements to finance the
transactions which affirm carries on in the ordinary
course of business

Precautionary Motives - motive of holding cash implies

the need to hold cash to meet the unpredictable
obligations.
 MOTIVES/REASONS FOR HOLDING CASH

Speculative Motives - refers to the desire of a firm to take

advantage of opportunities which present themselves at
unexpected moments and which are typically outside the
normal course of business.

Compensating/Contractual Motives - another motive to

hold cash balances is to compensate banks for providing
certain services and loans.
 OBJECTIVES OF CASH MANAGEMENT

a. To meet the cash disbursement needs (payment

schedule)

b. To minimize funds committed to cash balances

 MANAGING CASH INFLOW
Reducing Float can Speed Up Cash Receipts
a. Mail Float: length of time from the moment a customer mails a
check until the firm begins to process it.
b. Processing Float: the time required by a firm to process a check
before it can be deposited in a bank.
c. Transit float: time required for a check to clear through the
banking system and become usable funds.
d. Disbursing float: occurs because funds are available in a firm’s
bank account until its payment check has cleared through the
banking system.
 MANAGING CASH INFLOW
Lockbox System
Instead of mailing checks to the firm, customers mail checks to a
nearby Post Office Box. A commercial bank collects and deposits
the checks. This reduces mail float, processing float and transit
float.

Preauthorized Checks (PACS)

Arrangement that allows firms to create checks to collect
payments directly from customer accounts. This reduces mail float
and processing float.
 MANAGING CASH INFLOW
Depository Transfer Checks (DTCS)
Moves cash from local banks to concentration bank accounts.
Firms avoid having idle cash in multiple banks in different regions of
the country.

Wire Transfers
Moves cash quickly between banks. Eliminates transit float.
 MANAGING CASH OUTFLOW
Zero Balance Accounts (ZBAS)
Different divisions of a firm may write checks from their own ZBA.
Division accounts then have negative balances. Cash is transferred
daily from the firm’s master account to restore the zero balance.
Allows more control over cash outflows.
 MANAGING CASH OUTFLOW
Payable-Through Drafts (PTDS)
Allows the firm to examine checks written by the firm’s regional
units. Checks are passed on to the firm, which can stop payment if
necessary.

Remote Disbursing
Firm writes checks on a bank in a distant town. This extends
disbursing float.
 DETERMINING CASH NEEDS
Baumol Model
The optimal amount of short-term securities sold to raise cash will
be higher when annual cash outflows are higher and when the cost
per sale of securities is higher. Conversely, the initial cash balance
falls when the interest is higher.

Cash Budget
Cash budget is a device to help a firm to plan and control the use of
cash. It is a statement showing the estimated cash inflows and
outflows over the planning horizon.
 MARKETABLE SECURITIES

Marketable securities are highly liquid, short-term, interest-earning

government, and nongovernment money market instruments. They
can be easily converted to cash.
REASONS FOR HOLDING MARKETABLE SECURITIES

a. They serve as a substitute for cash balances.

b. They are held as a temporary investment where a return is

earned while funds are temporary idle.

c. They are built up to meet known financial requirements such as

tax payments, maturing bond issue and so on.
 FACTORS INFLUENCING THE CHOICE OF
MARKETABLE SECURITIES
a. Risks such as financial risk

b. Maturity

c. Yield or returns on securities

d. Marketability/liquidity risk (ability to transform securities into

cash)
 ACCOUNTS RECEIVABLE MANAGEMENT

Accounts receivable are generated when a firm offers

credit to its customers. The first thing that needs to be
addressed when establishing a credit policy is to set the
standards by which a firm is judged in determining
whether or not credit will be extended.
 FACTORS TO CONSIDER FOR ACCOUNTS
RECEIVABLE POLICY

1. Credit Standards
Character - customers’ willingness to pay
Capacity - customers’ ability to generate cash flows
Capital - customers’ financial sources
Conditions - current economic or business conditions
Collateral - customers’ asset pledged to secure debt
 FACTORS TO CONSIDER FOR ACCOUNTS
RECEIVABLE POLICY

2. Credit Terms
This defines the credit period and discount offered for
customers prompt payment. The following costs
associated with the credit terms must be considered:
cash discounts, credit analysis and collections costs, bad
debts losses and financing cost.
 FACTORS TO CONSIDER FOR ACCOUNTS
RECEIVABLE POLICY

3. Collection Program
Shortening the average collection period may preclude
too much investment in receivable (low opportunity cost)
and too much loss due to delinquency and defaults. The
same could also result to loss of customers if harshly
implemented.
 ACCOUNTS RECEIVABLE MANAGEMENT
Credit Management
Credit management strategically defines the quality of accounts
receivable collections. Credit and collection have a direct relationship.
If credit standards are high, the rate of collection is expected to be
high, and vice-versa.

Collection Management
Operationally, collection management starts from the date the
merchandise is sold to credit customers. Complete and reliable
records and corroborating documents should be maintained to
ensure an efficient basis of collection.
 ACCOUNTS RECEIVABLE MANAGEMENT
Receivable Portfolio Analysis
Receivable portfolio (i.e., “receivable spread) refers to the strategy of
spreading investments in receivables over a customer base. It gives
an impression of whether the management is strict or lax in imposing
its receivable policies and whether the management is conservative
and aggressive in its receivable investment.

*Aging of Accounts Receivable

Aging of accounts receivables classifies the accounts to their number
of days outstanding.
 INVENTORY MANAGEMENT

Inventory management is directly linked to the operating

goal of giving the best service to customers. When a
customer calls for a sales order, delivery must be done at
the fastest possible time at the lowest possible costs.
Traditionally, companies maintain a large stock of
inventories to meet the challenge of serving customers on
time.
OBJECTIVES OF INVENTORY MANAGEMENT

a. Reduce inventories while maintaining customer service

levels and quality. The firm can free needed cash to
finance both internal and external growth.

b. To establish production and inventory control.

 THE EOQ MODEL

The economic order quantity (EOQ) refers to the units of

materials that should be purchased to minimize total
relevant inventory costs. Total relevant inventory costs
include the sum of ordering and carrying costs. Total
relevant inventory costs do not include the purchase price
in the analysis because the unit purchase price remains
the same regardless of the order quantity the business
places.
 THE EOQ MODEL

Ordering costs include those spent in placing an order, waiting

for an order, inspection and receiving costs, setup costs, and
quantity discounts lost.

Carrying costs are those spent in holding, maintaining, or

warehousing inventories such as warehouse and storage costs,
handling and clerical costs, property taxes and insurance,
deterioration and shrinkage of stocks, obsolescence of stocks,
interest, and return on investment (e.g., lost return on
investment tied up in inventory).
 THE EOQ MODEL

Economic order quantity is the point where the total ordering

costs equal the total carrying cost. Also, at this point the total
inventory cost is at its minimum.

Reorder point refers to the inventory level where a purchase

order should be placed.

Lead time refers to the waiting time from the date the order is
placed until the date the delivery is received.
 THE EOQ MODEL

Safety stock is set to serve as a margin in case of variations in

normal usage and normal lead time. Hence, there is a safety
stock for variation in usage and a safety stock for variations in
time.

Stock-out (Shortage) Costs include those costs incurred when

an item is out of stock. These include the lost contribution
margin on sales plus lost customer goodwill.
 SHORT-TERM FINANCING

Short-term finance refers to financing needs for a small period

normally less than a year. In businesses, it is also known as
working capital financing. This type of financing is normally
needed because of uneven flow of cash into the business, the
seasonal pattern of business, etc. In most cases, it is used to
finance all types of inventory, accounts receivables etc.
 WHY DO FIRMS NEED SHORT-TERM FINANCING

• Cash flow from operations may not be sufficient to keep up with

growth-related financing needs.
• Firms may prefer to borrow now for their inventory or other short-
term asset needs rather than wait until they have saved enough.
• Firms prefer short-term financing instead of long-term sources of
financing due to:
- easier availability
- usually has lower cost
- matches need for short term assets, like inventory
 TYPES/SOURCES OF SHORT-TERM FINANCING

Trade Credit - It is the credit extended by the account’s payables.

Short-Term Loans - can be availed from banks and other financial

institutions.

Business Line of Credit - a type of short-term financing, is most

appropriate for temporary working capital needs. In this type of
financing, an amount is approved by the issuing bank or financial
institution.
 TYPES/SOURCES OF SHORT-TERM FINANCING

Invoice Discounting - is another source of short-term finance where

the receivable invoices can be discounted with the financial
institutes or banks or any third party.

Factoring - is also a similar arrangement like invoice discounting

where the accounts receivables of a business are sold to a third
party at a price which is lower to the realizable value of the accounts
receivable.
 ACCOUNTS RECEIVABLE AS COLLATERAL

A pledge is a promise that the borrowing firm will pay the lender any
payments received from the accounts receivable collateral in the
event of default. Since accounts receivable fluctuate over time, the
lender may require certain safeguards to ensure that the value of the
collateral does not go below the balance of the loan. So, normally a
bank will only loan you 70 -75% of the receivable amount. Accounts
receivable can also be sold outright. This is known as factoring.
 INVENTORY AS COLLATERAL

A major problem with inventory financing is valuing the inventory. For

this reason, lenders will generally make a loan in the amount of only a
fraction of the value of the inventory. The fraction will differ
depending on the type of inventory. If inventory is long lived, i.e.
lumber, they (lender or a customer) may loan you up to 75% of the
resale value. If inventory is perishable, i.e., lettuce, you will not get
much.
 SHORT-TERM VS LONG-TERM FINANCING

The most important differences between the two types of financing

are the time period, the purpose and the cost of financing.

1. The time period is simple to understand. Short-term financing is

normally for less than a year and long-term could even be for 10, 15
or even 20 years.
 SHORT-TERM VS LONG-TERM FINANCING

2. The purposes are totally different for both types of financing.

Short-term financing is normally used to support the working capital
gap of business whereas the long term is required to finance big
projects, PPE, etc.

3. The cost of financing which is higher in case of short-term and

comparatively lower in case of long-term barring abnormal
economic conditions.
SAMPLE PROBLEMS

36
 PROBLEM 1

The Company turns out 200 calculators a day at a cost of P250 per
calculator for materials and variable conversion cost. It takes the
firm 18 days to convert raw materials into calculator. The usual
credit terms extended to its customers is 30 days, and the firm
generally pays its suppliers in 20 days.
Required:
a. What is the length of the firm’s cash conversion cycle?
b. If the foregoing cycles are constant, what amount of working
capital must Company finance?
 PROBLEM 1
a. What is the length of the firm’s cash conversion cycle?
Cash Conversion Cycle = *Inventory cycle days + Ave. collection period
– Ave. Accounts Payable payment days
CCC = 18 + 30 – 20 = 28 days
*inventory cycle days or inventory conversion period

b. If the foregoing cycles are constant, what amount of working

capital must Company finance?
Daily working capital required: 200 x P250 P50,000
Total working capital needed: 28 days x P50,000 P1,400,000
 PROBLEM 2

You estimate a cash need for P4 million over a one-month period

where the cash account is expected to be disbursed at a constant
rate. The opportunity interest rate is 6 percent per annum, or 0.5
percent for a one-month period. The transaction cost each time you
borrow or withdraw is P100.
Required:
a. What is the Optimum Level of Cash Holding for the company as per
the Baumol Model?
b. What is the number of transactions you should make during the
month?
 PROBLEM 2

a. What is the Optimum Level of Cash Holding for the company as per
the Baumol Model?

= √ (2 x 4,000,000 x 100) ÷ .005

The optimal transaction size is: P400,000.

The average cash balance is: C/2 = P400,000/2 = P200,000
 PROBLEM 2

b. What is the number of transactions you should make during the

month?

The number of transactions required are:

= P4,000,000/P400,000
= 10 transactions during the month.
 PROBLEM 3

The Corporation is preparing its cash budget for August. The

budgeted beginning cash balance is P17,000. Budgeted cash receipts
total P187,000 and budgeted cash disbursements total P177,000. The
desired ending cash balance is P40,000. The company can borrow up
to P120,000 at any time from a local bank, with interest not due until
the following month.

Required:
Prepare the company's cash budget for August in good form.
 PROBLEM 3
The Corporation
Cash Budget
August 2021

Cash balance, beginning P 17,000

Cash receipts 187,000
Total cash available P 204,000
Cash disbursements (177,000)
Excess (deficiency) P 27,000
Borrowings 13,000
Cash balance, ending P 40,000
 PROBLEM 4

The Company sells on terms 3/10, net 30. Total sales for the year are
P900,000. Forty percent of the customers pay on the tenth day and
take discounts; the other 60 percent pay, on average, 45 days after
their purchases. What is the average amount of receivables?

Days Sales Outstanding = (40% x 10) + (60% x 45)

= 31 days

Average Accounts Receivable = (P900,000/360) x 31 days

= P77,500
 PROBLEM 5
Let us assume ABC Company with the credit terms 2/10, n/30, has
the following aging of accounts receivable:
Account Group Amount
Current account P 6,000,000
Past due accounts:
1 – 30 days 1,000,000
31 – 60 days 500,000
61 – 90 days 200,000
More than 90 days 100,000
Total A/R P7,800,000
 PROBLEM 5
And further assume that the collectability rates of each group are as
follows:
Account Group Collectability Rate
Current account 99%
Past due accounts
1 – 30 days 95%
31 – 60 days 90%
61 – 90 days 80%
More than 90 days 50%
 PROBLEM 5
Required:
a. Determine the credit balance needed in a company’s Allowance for
Doubtful Accounts.
b. Compute the net realizable value of accounts receivable.
 PROBLEM 5
a. Determine the credit balance needed in a company’s Allowance for
Doubtful Accounts.
Percent of Required
Amount Uncollectible allowance
Not yet due 6,000,000 1% 60,000
1 – 30 days past due 1,000,000 5% 50,000
31 – 60 days past due 500,000 10% 50,000
61 – 90 days past due 200,000 20% 40,000
Over 90 days past due 100,000 50% 50,000
Total 7,800,000 250,000
 PROBLEM 5

b. Compute the net realizable value of accounts receivable.

Accounts receivable P 7,800,000

Less: Allowance for doubtful accounts 250,000
Net realizable value P 7,550,000
 PROBLEM 6

What is the economic order quantity for the following inventory

policy: A firm sells 32,000 bags of premium sugar per year. The cost
per order is P200 and the firm experiences a carrying cost of P0.80
per bag.

EOQ = √ 2 x annual demand x cost per order ÷ ccpu

= √ (2 x 32,000 x 200 ÷ 0.8)
= 4,000 bags
 PROBLEM 6

@ EOQ: Ordering Cost = Carrying Cost

Ordering Cost: Carrying Cost:

= Cost per order x no. of orders = CCPU x average inventory
= P200 x (32,000 / 4,000) = P0.80 x (4,000 / 2)
= P1,600 = P1,600
 PROBLEM 7

The Company has developed the following data to assist in

controlling one of its inventory items:
Economic order quantity 1,000 liters
Average daily use 100 liters
Maximum daily use 120 liters
Working days per year 250 days
Safety stock 140 liters
Cost of carrying inventory P 1.00 per liter per year
Lead time 7 working days
 PROBLEM 7

Required:
a. Order point
b. Average inventory
c. Maximum inventory assuming normal lead time and usage
d. Cost of placing one order (CO)
 PROBLEM 7

a. Order point
= (normal usage x normal lead time) + safety stock
= (100 x 7 days) + 140 = 840 liters
b. Average inventory
= 140 + (1,000/2)
= 640 liters
c. Maximum inventory assuming normal lead time and usage
= 140 + 1,000
= 1,140 liters
 PROBLEM 7

d. Cost of placing one order (CO)

1,000 = √ (2 x 25,000 x CO) ÷ 1
1,000 = √50,000 CO
1,000,000 = 50,000 CO
CO = P20
 PROBLEM 8

With credit terms of 3/8, n/30, what is the customer’s payment

decision date?

A. Three days after the invoice is received.

B. The 8th day is the customer’s decision date.
C. Anytime during the period, 8th to the 30th.
D. The 30th day is the primary decision date.
GOODLUCK &
GODBLESS!!!

jalcpa