Page 262 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 11: Management of Cash

Notes
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Caution Short-term funding exposes the firm to the risk that it may not be able to obtain
the funds need to cover its seasonal peaks.

Under the aggressive funding strategy, the firm funds its seasonal requirements with short-
term debt and its permanent requirements with the long-term debt. Under a conservative funding
strategy, the firm funds both its seasonal and its permanent requirement with long-term debt.

Clearly, the aggressive strategy's heavy reliance on the short-term financing makes it riskier
than the conservative strategy because of interest rate swings and possible difficulties in obtaining
needed short term financing quickly when seasonal peaks occur. The conservative strategy
avoids these risks through the locked-in interest rate and long-term financing, but it is more
costly because of the negative spread between the earnings rate on surplus fund, and the cost of
the long-term funds that create the surplus. Where the firm operates between the extremes of the
aggressive and conservative seasonal funding strategies depends on management's response
towards risk and the strength of its banking relationships.

Task In respect of a firm, on an average, accounts receivable are collected after 80 days,
inventories have an average of 100 days and accounts payable are paid approximately 60
days after they arise. Calculate the firm's cash cycle and cash turnover assuming a 360-day
year.
Strategies for managing the cash conversion cycle:
1. Turnover inventory as quickly as possible without stockouts that will result in lost sales.
2. Collect accounts receivable as quickly as possible without losing sales from high-pressure
collection techniques.
3. Manage mail, processing and clearing time to reduce them when collecting from customers
and to increase them when paying suppliers.
4. Pay accounts payable as slowly as possible without damaging the firm's credit rating.

Self Assessment

Fill in the blanks:
13. Accounts payable reduce the number of days a firm's resources are tied up in ……………
cycle.
14. Under a …………….. funding strategy, the firm funds both its seasonal and its permanent
requirement with long-term debt.

11.8 Management of Marketable Securities

Management of marketable securities is an integral part of investment in cash as this may serve
both the purposes of liquidity and cash provided choice of investment is made correctly. As the
working capital needs are fluctuating, it is possible to park excess funds in same short-term
securities, which can be liquidated when need for cash is felt. The selection of securities should
be guided by three principles:
1. Safety: Returns and risks go hand in hand. As the objective of this investment is ensuring
liquidity, minimum risk is the criterion for selection.

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