(^206) Financial Management
- Interest and dividends dependent on the capital structure of the company.
The first and the biggest component of cash management is the level of cash which is
supposed to come in. Cash forecasting was discussed earlier. Its importance in cash
management cannot be undermined. Once we have forecasted the level of cash that is
supposed to come in over the next few periods, then we can look at what is the base
level we need for our operations.
Managing Collections and Disbursements
The size up our problem of cash management let us examine the flow of cash through
a firmís accounts. It is useful to think of the process as cycle in which cash is used to
purchase materials, from which are produced goods, which are then sold to customers,
who later pay their bills. The firm receives cash from its customers and the cycle
repeats.
Opportunities to improve efficiency in collecting and disbursing funds centre on flows
through the current section of the balance sheet. Let us assume that XYZ Corporation
orders raw materials at point A and receives them 14 days later at B. Terms of 2/10,
net 30 are offered, so the firm pays the invoice 10 days later C. However, it takes 2
days for the cheque to clear, and XYZís bank account is not changed until point D.
XYZ turns its inventory six times per year, so 60 days after the materials are received,
the product is sold and the customer is billed, the collection period is 30 days, 28 for the
customer to pay and 2 for the cheque to arrive by mail(G). XYZ processes the payment
and deposit it 2 days later at H. Another 2 days elapses while XYZís bank collects the
funds from the customerís bank.
The firmís total financing requirements is affected by the total time lag from point B to
point J. The firm itself can control some factors that determine the various lags, but
some it cannot. Some of the lags affect the cash balance, while others affect other
components of working capital such as accounts receivable and inventory. In addressing
ourselves to Cash management, we are concerned with time periods BCD and FGHJ.
Time period AB is beyond the firmís control and does not directly affect its financial
statements, although it may affect production schedules. Time period DE is determined
by the firmís production process and inventory policy, and affects the total investment
in inventory. Time period EF is determined by the firmís credit terms and the payment
policies of its customers, and affect the total investment in accounts receivable we will
examine the management of inventory and accounts receivable in the next chapter.
Our present task is to examine what can be done to improve the efficiency of a firmís
cash management. We will focus on three areas: concentrating working balances
speeding collections, and controlling disbursements.