Topic 6 Cash Management Techniques.pptx

www.covenantuniversity.edu.n Cash Management Raising a new Generation of Leaders Techniques & Preparation of Cash Budget Dr. Folasade B. Adegboye  What are our stu...

www.covenantuniversity.edu.n Cash Management Raising a new Generation of Leaders Techniques & Preparation of Cash Budget Dr. Folasade B. Adegboye  What are our study Objectives? By the end of this topic, students should be able to: List and explain the motives for holding cash. Understand the purpose of efficient cash management. Define cash management and its role in effective financial operations. Discuss the management of cash, collections, and short-term investments as part of cash management. Explain the concept of current assets and their relationship to cash management. Understand the three main methods for preparing a cash budget. Explain the purpose and importance of preparing a cash budget. 4  www.covenantuniversity.edu.n Raising a new Generation of Leaders  What is Cash? In Economics, cash is money in the physical form of currency, such as banknotes and coins. In bookkeeping and financial accounting, cash is current assets comprising currency or currency equivalents that can be accessed immediately or near-immediately.  Motives for Holding Cash John Maynard Keynes suggested three reasons for individuals to hold cash.  Transactions, Speculative, and Precautionary. Shifting the emphasis away from individuals, we can use these three categories to describe the motives for corporations to hold cash. Transactions motive: to meet payments, such as purchases, wages, taxes, and dividends, arising in the ordinary course of business. Speculative motive: to take advantage of temporary opportunities, such as a sudden decline in the price of a raw material. Precautionary motive: to maintain a safety cushion or buffer to meet unexpected cash needs. The more predictable the inflows and outflows of cash for a firm, the less cash that needs to be held for precautionary needs. Ready borrowing power to meet emergency cash drains also reduces the need for this type of cash balance. 8  Introduction Cash management is the monitoring and maintaining of cash flow to ensure that a business has enough funds to function. Investments, bill payments, and unexpected liabilities can affect a business' inflows and outflows, and in turn their cash management. Cash management is essential for effective financial operations, involving the management of cash, collections, and short-term investments. It enables businesses to handle payroll, meet expenses, and allocate resources efficiently. 9 10  Contd. Cash Management involves managing monies of the firm to obtain maximum cash availability and maximum interest income on idle funds. The success of a firm is predicative on effective management and control of the cashflow at its disposal. Effective Cash Management Techniques Identification of cash available through cash budget. Establish investment goals. Determine investment instrument Daily routine for cash management through cash report, cash accounts and bank book balance as well as regular and effective bank reconciliation. 12 Methods of Cash Management Cash Monitoring. This entails that the organization financial resources are closely observe, ensuring that customers make effective payments as they fall due. It also involve banking of cash as soon as possible instead of causing the company’s cash to be idle. Cash Budgeting This involves predicting how the company’s cash can be generated and effectively utilized with a view to identifying periods of deficit and surplus. 14 Purpose of efficient cash management Liquidity  Ensures that the organization has enough cash on hand to meet its short-term obligations and cover operational expenses. Optimal Use of Funds  Helps in utilizing cash effectively by investing surplus funds to earn returns and minimizing idle cash that does not earn any returns. Risk Management  Reduces the risk of cash shortages and the need for emergency borrowing, which can be costly. Working Capital Management  Improves the management of working capital by ensuring that cash is available to fund day-to-day operations. Financial Planning  Facilitates better financial planning by providing a clear picture of expected cash inflows and outflows. 16  Contd. Decision Making Provides the information needed to make informed decisions about investments, expenses, and financing options. Cost Reduction Reduces costs associated with overdrafts, late payment penalties, and emergency borrowing. Creditworthiness Demonstrates to creditors and investors that the organization is well-managed and financially stable, enhancing its creditworthiness. Profitability Contributes to profitability by optimizing the use of funds and minimizing costs associated with cash management. Strategic Planning Supports strategic planning by ensuring that cash is available for strategic initiatives and investments. 17 Management of Cash Collections Efficient Invoicing Ensure invoices are accurate, clear, and sent promptly to accelerate payment. Offer Multiple Payment Options Provide customers with various payment methods (e.g., debit cards, online payments) to expedite collection. Monitor Accounts Receivable Regularly review outstanding invoices and follow up on overdue payments. Implement Cash Discounts Offer discounts for early payment to incentivize customers to pay sooner. Electronic Funds Transfer (EFT) Encourage customers to pay electronically to reduce processing time. 19 Your Turn Should cash be left idle? What effect will this result into? “Mopping up idle funds involves investing surplus cash to generate returns and improve overall financial efficiency”. 20  Short-Term Investment Evaluate Investment Options Assess various short-term investment instruments (e.g., money market funds, certificates of deposit) based on risk and return. Diversification Spread investments across different instruments to minimize risk. Liquidity Consideration Ensure investments can be easily converted to cash when needed. Investment Policy Develop and adhere to an investment policy that aligns with the organization's goals and risk tolerance. Monitor and Rebalance Regularly review investments to ensure they meet the organization's liquidity needs and adjust as necessary. Investment Duration Match the investment duration with the organization's cash flow requirements to optimize returns. 22  Current Assets and Cash Management The relationship between current assets and cash management is crucial for maintaining liquidity and managing working capital effectively. Current assets, such as cash, accounts receivable, and inventory, represent the resources a company can convert into cash within a short period, typically one year. Cash and Cash Equivalents  Cash management involves overseeing the company's cash balances to ensure there is enough liquidity to meet short-term obligations.  This includes managing cash inflows and outflows, optimizing cash reserves, and investing surplus cash to earn returns. 24  Contd. Accounts Receivable  Efficient management of accounts receivable is essential for cash flow.  By monitoring and collecting receivables promptly, a company can accelerate cash inflows and reduce the risk of bad debts, improving overall cash management. Inventory  Inventory management directly impacts cash flow.  By controlling inventory levels, a company can minimize holding costs and reduce the risk of obsolete inventory, freeing up cash for other purposes. Working Capital Management  Working capital is the difference between current assets and current liabilities and represents the funds available for day- to-day operations.  Effective cash management is crucial for optimizing working 25  What is Cash Budgeting? Cash budgeting is the process of estimating and planning an organization's cash inflows and outflows over a specific period, typically monthly, quarterly, or annually. It helps organizations anticipate cash shortages or surpluses, enabling them to make informed decisions to manage their cash flow effectively. 27 Methods of Preparing Cash Budget Receipts and Disbursements Method:  Based on anticipated cash receipts and cash disbursements during the budget period.  Requires estimating the timing and amount of cash inflows from sales, investments, loans, etc., and outflows for expenses such as salaries, utilities, purchases, and debt repayments.  The closing cash balance is calculated by adding the beginning cash balance to the net cash flow (receipts minus disbursements) for each period. 29  Contd. Adjustments to Net Income Method:  Starts with the budgeted net income from the income statement.  Adjusts the net income by adding non-cash expenses (e.g., depreciation) and subtracting non-cash revenues to arrive at the net cash flow from operations.  Additional adjustments are made for changes in working capital (e.g., increase/decrease in accounts receivable, inventory, accounts payable) to determine the net cash flow from operating activities.  Other cash inflows and outflows (e.g., investments, financing activities) are added or subtracted to arrive at the closing cash balance for each period. 30  Contd. Percentage of Sales Method:  Estimates cash receipts based on a percentage of projected sales revenue.  Cash disbursements are estimated based on historical data or industry averages for expenses such as cost of goods sold, operating expenses, and taxes.  The closing cash balance is calculated by adding the beginning cash balance to the net cash flow (receipts minus disbursements) for each period. 31 Contd. Cash Flow Forecasting Method:  Involves preparing a detailed cash flow forecast for each period based on anticipated cash inflows and outflows.  Factors in seasonality, economic conditions, market trends, and other relevant factors to estimate cash flows accurately.  The closing cash balance is calculated by adding the beginning cash balance to the net cash flow (receipts minus disbursements) for each period. 32  Importance of Cash Budgeting Provides Helps in managing liquidity by ensuring that the organization has enough cash to meet its obligations. Insights into cash flow patterns and helps in identifying potential cash shortages or surpluses. Facilitates effective financial planning and decision- making by aligning cash inflows and outflows with the organization's goals and objectives. 34  Illustration ABC Enterprises is preparing Purchases: its cash budget for the next – January: NGN 30,000 three months. The following – February: NGN 35,000 – March: NGN 40,000 information is available in – 80% of purchases are paid in the Naira (NGN): same month Sales: – 20% of purchases are paid in the – January: NGN 50,000 following month – February: NGN 60,000 Other Cash Payments: – March: NGN 70,000 – Rent for January: NGN 5,000 Cash Collections: – Advertising for February: NGN – 70% of sales are collected 3,000 – Maintenance for March: NGN in the same month 2,000 – 30% of sales are collected Cash balance on January 1st: NGN in the following month 10,000 Minimum desired cash balance: NGN  Solution JANUARY (₦) FEBRUARY (₦) MARCH (₦) TOTAL (₦) CASH 35,000 57,000 67,000 159,000 COLLECTIONS TOTAL INCOME 35,000 57,000 67,000 159,000 PURCHASES 24,000 34,000 39,000 97,000 RENT 5,000 5,000 ADVERTISING 3,000 3,000 MAINTENANCE 2,000 2,000 TOTAL 29,000 37,000 41,000 107,000 EXPENSES NET CASH FLOW 6,000 20,000 26,000 52,000 BEGINNING 10,000 16,000 36,000 BALANCE ENDING 16,000 36,000 62,000 BALANCE 37  Comments: Note that only cash information is recorded in the cash budget. Also, ABC Enterprises has ending cash balance of ₦62,000 by end of March, which meets the minimum desired cash balance of ₦5,000 for all three months. This budget allows ABC Enterprises to plan its cash inflows and outflows effectively, ensuring that it has enough cash to meet its obligations and maintain financial stability. 38  What are we Taking Away? Cash management is crucial for liquidity and maximizing returns. A cash budget tracks cash inflows and outflows, aiding in planning. Poor cash management leads to shortages, missed payments, and financial distress. Motive of holding money are: Transactionary, Speculative and Precautionary. Excess cash should not be left idle, than can be invested in short-term investments to yield returns. 40 Quizzes 1. What is cash management? 2. Why is cash management important for businesses? 3. What are the primary purposes of cash management? 4. What are the key components of a cash budget? 42  Answers 1. Cash management refers to the process of collecting, managing, and investing cash in a way that maximizes liquidity while minimizing the risk of insolvency. 2. Cash management is crucial for businesses to ensure they have enough cash to meet their obligations, such as paying suppliers and employees, while also maximizing the return on their cash holdings. 3. Liquidity Optimal use of fund, working capital management, risk management etc. 4. Income (Inflow); Expense (outflow); and Ending balance. 43