BDPW3103: Cash Management is a Broad Term that Refers to the Collection: Introductory Finance Assignment, OUM, Malaysia

Subject BDPW3103: Introductory Finance


Cash management is a broad term that refers to the collection, concentration, and disbursement of cash. The goal is to manage the cash balances of an enterprise in such a way as to maximize the availability of cash not invested in fixed assets or inventories and to do so in such a way as to avoid the risk of insolvency. Factors monitored as a part of cash management include a company’s level of liquidity, its management of cash balances, and its short-term investment strategies.

In some ways, managing cash flow is the most important job of business managers. If at any time a company fails to pay an obligation when it is due because of the lack of cash, the company is insolvent. Insolvency is the primary reason firms go bankrupt. Obviously, the prospect of such a dire consequence should compel companies to manage their cash with care. Moreover, efficient cash management means more than just preventing bankruptcy. It improves profitability and reduces the risk to which the firm is exposed.

Cash management is particularly important for new and growing businesses. Cash flow can be a problem even when a small business has numerous clients, offers a product superior to that offered by its competitors, and enjoys a sterling reputation in its industry. Companies suffering from cash flow problems have no margin of safety in case of unanticipated expenses. They also may experience trouble in finding the funds for innovation or expansion. It is, somewhat ironically, easier to borrow money when you have money. Finally, poor cash flow makes it difficult to hire and retain good employees.

It is only natural that major business expenses are incurred in the production of goods or the provision of services. In most cases, a business incurs such expenses before the corresponding payment is received from customers. In addition, employee salaries and other expenses drain considerable funds from most businesses. These factors make effective cash management an essential part of any business’s financial planning. Cash is the lifeblood of a business. Managing it efficiently is essential for success.

When cash is received in exchange for products or services rendered, many small business owners, intent on growing their company and tamping down debt, spend most or all of these funds. But while such priorities are laudable, they should leave room for businesses to absorb lean financial times down the line. The key to successful cash management, therefore, lies in tabulating realistic projections, monitoring collections and disbursements, establishing effective billing and collection measures, and adhering to budgetary restrictions.

  1. Transaction Motive: The transaction motive refers to the cash required by a firm to meet the day to day needs of its business operations. In an ordinary course of business, the firm requires cash to make the payments in the form of salaries, wages, interests, dividends, goods purchased, etc.

Likewise, it also receives cash from its sales, debtors, investments. Often the firm’s cash inflows and outflows do not match, and hence, the cash is held up to meet its routine commitments.

  1. Precautionary Motive: The precautionary motive refers to the tendency of a firm to hold cash, to meet the contingencies or unforeseen circumstances arising in the course of business.

Since the future is uncertain, a firm may have to face contingencies such as an increase in the price of raw materials, labour strikes, lockouts, changes in demand, etc. Thus, in order to meet these uncertainties, the cash is held by the firms to have uninterrupted business operations.

  1. Speculative Motive: The firms hold cash for speculative purposes to avail the benefit of bargain purchases that may arise in the future. For example, if the firm feels the prices of raw materials are likely to fall in the future, it will hold cash and wait till the prices actually fall.

Thus, a firm holds cash to exploit the possible opportunities that are out of the normal course of business. These opportunities could be in the form of the low-interest rate charged on the borrowed funds, expected fall in the raw material prices, or favorable change in the government policies.

Thus, cash is the most significant and liquid asset that the firm holds. It is significant as it is used to pay off the firm’s obligations and helps in the expansion of business operations.

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a) 1) Current ratio

This is the ratio to assess the organization ability to meet its short-term obligations. It’s the ratio of short-term assets to short time liabilities also called the working capital.

In this case, current ratio= Current Assets = Current Liabilities

Current Assets:

                      2017 (RM)                      2018 (2018)
Cash                      15,000                      30,000
Marketable securities                      8,000                      16,000
Accounts receivable                      42,000                      34,000
Inventories                      50,000                      60,000
Total                      115,000                      140,000

Current Liabilities:

                 2017 (RM)               2018 ( RM)
Accounts payable                 48,000               50,000
Notes payable                 16,000                10,000
Accruals                 6,000                5,000
Total                  70,000                65,000

This implies that:

Current ratio 2017: 115,000 ÷ 70,000 =1.6428 Times

Current ratio 2018: 140,000 ÷ 65,000 = 2.1538 Times

2) Quick Ratio

This ratio is similar to the Current Ratio  but it does not include stock and payments in advance since it is assumed that stock may take longer to be sold and the purpose of this ratio is to measure immediate liquidity

            2017 ( RM)               2018 (RM)
Cash             15,000               30,000
Marketable securities              8,000                16,000
Accounts receivable             42,000                 34,000
Total             65,000                 80,000

Current Liabilities

                 2017 (RM)               2018 ( RM)
Accounts payable                 48,000               50,000
Notes payable                 16,000                10,000
Accruals                 6,000                5,000
Total                  70,000                65,000

This Implies That ;

Quick Ratio 2017 = 65,000 ÷ 70,000 = 0.928 Times

Quick Ratio 2018 = 80,000 ÷65,000 = 1,230 Times

3) Debit Ratio

This ratio is used  to check how much of the Assets are funded from the Loans/debt

Debt Ratio = Total Liabilities = Total Assets

LIABILITIES       2017(RM)           2018(RM)
Accounts payable        48,000            50,000
Notes payable         16,000            10,000
Accruals         6,000            5,000
Long term debt        160,000            150,000
Total        230,000            215,000
ASSETS        2017 (RM)           2018  (RM)
Cash        15,000          30,000
Marketable securities        8,000           16,000
Accounts receivable      42,000          34,000
Inventories      50,000          60,000
Fixed assets      285,000          270,000
Total assets      400,000           410,000

This implies that :

Debt ratio 2017 = 230,000 ÷ 400,000 X 100 = 57.5%

Debt ratio 2018 = 215,000 ÷ 410,000 X 100 = 52.4%

4) Inventory turnover :

This is a ratio that is used to measure the turnaround time of stock that is the number of times the stock is replenished within a financial year.

             2017 (RM)       2018 ( RM)
Cost of goods sold             360,000       460,000
Inventories              50,000       60,000

Average Stock = ( 50,000 + 60,000) ÷ 2 = 55,000

2017= 360,000 ÷ 55,000 = 6.545 Times

2018 = 460,00 ÷ 55,000 = 8,363 Times

5) Times interest earned

This is approximate of internet income that in future can be used to take care of the interest expense or debt expense.

Times Interest  Earned =  Income before interest and tax  ÷ interest expense

         2017 (RM)            2018 (RM)
Net profit before taxes         34,000            72,000
          2017 (RM)           2018 (RM)
Internet expense         10,000           8,000

Times interest earned 2017 = 34,000 ÷ 10,000 = 3.4 Times

Times interest earned 2018 = 72,000 ÷ 8,000 = 9.0 Times

6) Fixed asset turnover

Fixed Assets Margin = Net Sales ÷ ( fixed asset – Accumilated depreciation)

          2017 (RM)               2018 (RM)
Sales (credit)           450,000                600,000
            2017 (RM)             2018 (RM)
Fixed assets            285,000             270,000

2017 = 450,000 ÷ 285,000 = 1.579 Times

2018 = 600,000 ÷ 270,000 = 2.222 Times

7) Net profit margin

Net profit margin shows the amount that is earned out business transactions within a financial year.

Net Profit Margin = Net profit ÷ sales X 100

       2017 (RM)       2018 (RM)
Net profit after taxes       25,000       54,000
    2017 (RM)      2018 (RM)
 Sales (credit)     450,000      600,000

This implies that :

Net profit margin 2017 = 25,000 ÷ 450,000 X 100 = 5.5%

Net profit margin 2018 =  54,000  ÷ 600,000 X 100 =9.0%

8) Return on equity :

This ratio is used to give the profitability of the members investments

Rate on equity ratio = Net income ÷ shareholders equity .

      2017 (RM)        2018 (RM)
 Net profit after tax      25,000         54,000
        2017 ( RM)       2018 (RM)
Common shares        120,000        120,000
Retained earnings        50,000        75,000
Total        170,000        195,000

2017 = 25,000÷ 170,000 X 100 = 14.7%

2018 = 54,000  ÷ 195,000 X 100 = 27.7%

b) Generally, from the profitability ratios it is clear that the firm improved in its profitability in 2018 as compared to the previous year 2017. this was also shown by the decrease in the debt ratios which should be able to convince any person or company that intends to invest in Jelita Berhad that the firm had chosen its investments well and was able to meet their obligation without difficulties. However, will still remain at the discreet of the investor to decide whether to invest in this firm or no. As per the bank that was to give a debt of 2 million they have an opportunity to look through the ration and determine whether it would be worth giving out the loan to Jelita Berhad or not.

c) Financial ratio analysis is one of the most popular financial analysis techniques for companies and particularly small companies. Ratio analysis provides business owners with information on trends within their own company, often called trend or time-series analysis, and trends within their industry, called industry or cross-sectional analysis.

Financial ratio analysis is useless without comparisons. In doing industry analysis, most businesses use ​benchmark companies. Benchmark companies are those considered most accurate and most important and are those used for comparison regarding ​industry average ratios. Companies even benchmark different divisions of their company against the same division of other benchmark companies.

There are other financial analysis techniques to determine the financial health of their company besides ratio analysis. One example is a common size financial statement analysis. . These techniques fill in the gaps left by the limitations of ratio analysis discussed below.

a) Companies’ Balance Sheets Are Distorted By Inflation

Ever wonder why you always hear that balance sheets only show historical data? A balance sheet is a statement of a firm’s financial condition at a point in time. So, looking back on a balance sheet, you see historical data. Inflation may have occurred since that data was gathered, and the figures may be distorted.

Reported values on balance sheets are often different from “real” values. Inflation affects inventory values and depreciation; profits are affected. If you try to compare ​balance sheet information from two different time periods and inflation has played a role, there may be distortion in your ratios.

b)  Ratio Analysis Just Gives You Numbers, Not Causation Factors

You can calculate all the ratios you can find from now until doomsday. Unless you try to find the cause of the numbers you come up with, you are playing a useless game. Ratios are meaningless without comparison against trend data or industry data. Ratios are also meaningless unless you take the limitations listed in this article into account.

c) Different Divisions May Need Comparison to Different Industry Averages

Very large companies may be composed of different divisions manufacturing different products or offering different services. different industry averages need to be used for each different division to make ratio analysis mean something. The ratio analysis, used in this way, will certainly be more accurate than if you tried to do a ratio analysis for this type of large company.

d)  Companies Choose Different Accounting Practices

Different companies may use different methods to value their inventory. If companies are compared that use different inventory valuation methods, the comparisons won’t be accurate. Another issue is depreciation. Different companies use different depreciation methods. The use of different depreciation methods affects companies’ financial statements differently and won’t lead to valid comparisons.

e)  Companies Can Use Window Dressing to Manipulate Their Financial Statements

Ratio analysis is based entirely on the data found in business firms’ financial statements. Some companies may try to use window dressing to manipulate the data in the financial statements if they are not quite as good as they should be. Bear in mind — this is completely against the concept of financial and business ethics and flies in the face of corporate governance.

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