Chapter 5

Cash Management

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 Cash Management

• What is Cash?
– Coins and currency plus deposit accounts (fixed
deposit accounts, current account – cheques)
– cash are the most liquid assets, used to meet
immediate day to day payments and other purposes
– it is non earnings assets i.e. it will not accumulate in
value unless invested in certain investment vehicles
– “ Cash is the oil that lubricates the wheel of business.
Without adequate oil, machine grinds to a halt and
business with inadequate cash will do like wise”
Eugene Brigham
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 Primary Reasons (Motives) For Holding Cash
1. Transactions Motives
• This means that there must be some amount of
cash on hand enough to support day to day
operation.
• To make payment in purchasing raw materials,
pay labor, pay electricity, water, telephone bills,
etc.

2. Precautionary Motives
• To hold some cash reserve for emergency
needs – for unpredictable cash flow e.g. in air
line industry cash flow uncertainty can be in the
form of rising in fuel cost, strike of operating
personnel etc.
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 Primary Reasons (Motives) For Holding Cash

3. Speculative Motives
• To be able to take advantage of any “bargain”
that may arise e.g. construction firms with
excess cash can take advantage of any drop in
price of building materials like lumber,
cements, steel bars, piling tubes or any other
building supplies.
• With cash firm can buy in large quantities at
low price thus reduce cost and increase net
profit margin.

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 Cash Management Techniques / Activity

• The goal of cash management is to

determine the desired level of cash i.e.
minimize cash balance but maintain certain
level of liquidity
• If too much liquidity it will reduce return
• If too little cash it will increase the risk of
exposure of running out of cash

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 Several techniques used are:
• Established proper procedure for collection from
debtors and payment to creditors.
a) Speeding Up Receipts
i. Collect cash more quickly
• Turnover inventory as quickly as possible – there
should be efficient management of inventory,
better production planning so as to avoid stock
out which may cause production shut down thus
loss in sales
ii. Collect accounts receivables as soon as possible
– give cash discount to encourage early
payments
– Proper credit policies, collection policies,
improve collection period 6
 Several techniques used are:
b) Slowing Down Disbursement
 Hold cash longer - Pay account payable as
late as possible WITHOUT DAMAGING
firm’s credit rating (specifying credit quality
of customers who can be given credit) and
take advantage of favorable cash discount
(e.g. 5/20 net 30)

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 Several techniques used are:
c) Maintain Good Banking Relationship
i. Established adequate cash floats and minimum bank
balances
– Regular check on difference between firms
checkbook balance and bank book
ii. Synchronize cash inflow and outflow
– Make arrangements so that cash receipt coincide
with timing of cash outflows so that firm can hold
transaction balance to a minimum

• With the above techniques, firm can ensure that there

is enough cash in order to invest in various investment
alternatives and repay debt when they are due.

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 CASH MANAGEMENT
A) CASH CYCLE (CC)
• It is defined as amount of time or days the
firm is WITHOUT CASH. It is the period
between cash outflow and cash inflow.
– time passes by between cash outlay to
purchase raw materials or inventories to
– the time when cash is collected from sales.
– This is the time when firm’s capital is tied up
until inventories are sold
 CASH CYCLE (CC)
• LOWER CASH CYCLE IS BETTER – because
cash outlay recovered in a shorter period.

• CASH CYCLE = AAI + ACP –APP

• AAI – Average Age Of Inventories

• ACP – Average Collection Period
(A/C Receivable X360/ Credit Sales)
• APP – Average Payment Period
 B) CASH TURNOVER (CTO)
• It is defined as the NUMBER OF TIMES
EACH YEAR THE FIRM’S CASH IS
ACTUALLY TURNED.
– HIGHER CTO AND LOWER CC means less
cash is maintained. So firm try to MINIMIZE
CTO so that firm DO NOT RUN OUT OF
CASH.

CTO = 360 / Cash Cycle

• C) MINIMUM OPERATING CASH (MOC)
• It is the minimum CASH NEEDED by the
firm in a year to avoid any cash shortages
in meeting all its payments i.e. the
minimum balance required in cash.

• MOC = ANNUAL CASH OUTLAYS /

CASH TURNOVER (CTO)
 EXAMPLE 1:

ABC Sdn Bhd has an average age of

inventories of 70 days, an average
collection period 40 days and an
average1payment period of 30 days.
Example
The company annual cash outlay is
RM 300,000. (Assume 360 days)
 Answer for Example 1

CC = 70+40-30 =80 days

CTO = 360/80=4.5 times

MOC = 300k/4.5=66,666.67
 Cash Management
Example 2
A2Z Co. is planning next year’s production. Its budgeted
expenses would be RM1 million worth of inventory on June
1st. on credit basis. The Co. will pay the amount at the end of
the credit period 2/10 net 40. A2Z Co also decided to sell the
finished goods to the customers on 1st. Sept and its credit
policy is as follows: 5/20 net 30. The customers of this goods
normally pay A2Z on the discount basis.
Calculate;
a) Cash cycle
b) Cash turnover
c) Minimum operating cash

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 Example 2
• a) Cash cycle
• CC = AAI + ACP – APP
• Tips: To calculate AAI
• Use Approximate Date (Assumed there are 30 days in
all months) when dates given on 1st of the month e.g.
1/6 or 1/7 etc.
• Use Exact Date ( Jan 31 days, Feb 28 days)
• When dates are given NOT on 1st of every month e.g
4/6 or 4/7

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 Example 2
CC = AAI + ACP – APP

AAI = the date the firm purchase the inventory till the
day Co. sells the inventory – ( 1st. June – 1st Sept =90
days)
Use Approximate Date:
1. June – (30 -1) = 29
2. July – (30) = 30
3. Aug – (30) = 30
4. Sept –(1) = 1
90 days
 Example 2
• ACP = The number of days the firm collects A/C
Receivable, in this case the customer pay during the
discount period ( 5/20 net 30) = 20 days

• APP = The number of days the Co. pays A/C payable, in

this case the Co normally pays at the end of the credit
period (2/10 net 40) = 40 days

Therefore,
CC = AAI + ACP – APP
= 90 + 20 – 40
= 70 days
 Example 2
CTO = 360/ CC
= 360/70
= 5.14 times

Minimum Operating Cash (MOC)

MOC =Annual Cash Expenditure / CTO
= RM1,000,000 / 5.14
= RM194,552.53
• This means the Co has to have a minimum of
RM194,552.53 before it can start operation.