Page 297 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 14: Management of Surplus & Dividend Policy

5.50 per share of retained capital produced 10 per share of increased market value. In other Notes
words, for every 1 retained by management, 1.82 ( 10 divided by 5.50) of market value was
created. Impressive market value gains mean that investors can trust management to extract
value from capital retained by the business.
Managing and improving your cash flow should result in a cash surplus for your business. A
cash surplus is the cash that exceeds the cash required for day-to-day operations. How you
handle your cash surplus is just as important as the management of money into and out of your
cash flow cycle.

Notes Two of the most common uses of extra cash are:
1. Paying down your debt
2. Investing the cash surplus

Like so many other things you do for your business, deciding where to use your cash surplus
requires some planning and your better judgment.
1. Paying Down Debt: Paying down any debt you may have is generally the first option
considered when deciding what to do with a cash surplus. Rightfully so because a short-
term investment of your cash surplus is not likely to yield a return equal to or greater than
the rate of interest on any of your debt. It doesn’t make any sense to invest a cash surplus
at 5 percent when you can pay down a bank loan that is charging interest at 12 percent.
However, the decision to automatically pay down debt may not be correct in all cases.
One of the key advantages of managing your cash flow is the ability to predict the future
cash requirements for your business. That is, it should help you determine when your
business may need to rely on external financing as a source of cash. The need for external
financing may be the result of expanding your business, purchasing new property or
equipment, or just getting you through a normal seasonal down period.
Whatever the reason, preparing a cash flow budget is the best way of predicting these
future needs for cash. With at least some indication of your future cash needs, you can then
make some decisions regarding the best way to finance those needs.

Example: You may feel that interest rates are relatively low at this time and that you
look for them to rise in the near future. Therefore, instead of using your cash surplus
to pay off a two-year loan at 10.5 percent, it may be beneficial to invest the surplus
temporarily, and avoid a much higher interest rate on a bank loan one year from now.
2. Investing the Cash Surplus: When investing a cash surplus, it’s only natural to seek the
highest rate of return for your investment. Four factors must be considered when making
your investment decisions:
(a) Risk
(b) Liquidity

(c) Maturity
(d) Yield
Each factor plays an important role in determining the rate of return you receive on your
invested cash surplus. These factors can also help you determine how much to invest and
when to invest your surplus.

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