AY 2008-9

CHAPTERS 3 & 4:
CASH & CREDIT MANAGEMENT

Managing Cash Flow

 Primary and fundamental goal

of financial planning
 The success of financial plans
depends on the ability to stick
to established cash budget

Role of Cash Management in

Financial Planning

Cash management deals with the

routine, day-
day-to
to--day use of liquid assets.
assets.

Liquid assets consist of cash and other

assets which can be readily converted to
cash with little or no loss in value.

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Examples of Liquid Assets:

Cash
Current Accounts
Savings Deposits
Time Deposit with short maturity
ACU deposits

• Low returns, high opportunity costs

• Risks and liquidity characteristics
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Purpose of Liquid Assets:

Assets:
 Meet recurring living expenses
 Make purchases
 Provide
P id reserve ffor unexpected
t d expenses
 Repay loans
 Use temporarily to accumulate funds for
longer--term financial goals
longer

Examples of Liquid Assets for:

Planned Expenditures
– Interest bearing current account or savings deposits
Emergency Fund
– 3-6 months of monthlyy income
– Savings or short term time deposits
Savings for future
– To diversify investment
– Time or ACU deposits
– Depend on risk aversion, need for liquidity etc..

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Key Objective of Cash

Management

Minimise the amount of liquid cash

without jeopadise your ability to
pay for essential goods and
services

How is the interest calculated?

Simple Interest—
Interest—interest paid only
on initial amount of deposit.
Compound Interest—
Interest—interest paid
at set intervals and added back to
principal.

Nominal rate - the named or stated rate of interest.

Effective rate – the annual rate of return actually
earned.

If interest is compounded more frequently than

once a year, the effective rate will be greater than
the nominal rate of interest.

r = (1+i(m)/i)m – 1

r = effective rate of interest

i(m) = nominal rates of interest compounded mthly,
e.g. m=12, monthly
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Q. If the nominal rate is 6% compounded

half yearly, what is the effective rate?

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How much interest will you earn?

It depends on:
• Frequency of compounding
• Balance on which interest is paid
• Interest rate paid

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Inflation Risk
Fisher’s equation, the real return, r ,
1 + r = (1+ i ) / (1 + e)
i = nominal interest rate
e = expected inflation rate

Risk of declining purchasing power

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Question
If the inflation rate is 2%, bank pays you
(a) 3% interest per annum, what is your
real rate of return?
(b) 1.5%
1 5% iinterest
t t per annum, what
h t iis
your real rate of return?

What would be your choice or

investment?
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Choosing a bank

 Credit standing
 Interest rate
 Convenience
 Quality of service
 Minimum balance requirements
 Bank charges

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Individual borrows money

at some point in life:
Make purchases such as house or car
Face cash flow problems because of
fi
financial
i l crisis
i i e.g. ill
illness or
retrenchment
Borrow to invest in assets such as
properties, stocks or options

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Credit Management
Credit or Debit is a financial tool
Uses of Credit
– convenient, e.g. credit card
– source off funds
f d ini an emergency,
unexpected expenses
Problems associated with Credit
– possibility of overspending
– cost, credit is not free

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Principles of Good Credit Management

Ascertain that the purchases financed by

borrowings are absolutely essential or profitable
– returns from investment exceeds interest costs
Verify that you have means to repay loan
Ensure that debts servicing < 40% of disposal
income
– Debt servicing are mortgage repayment, property
tax, insurance, car loan, credit card payment etc..

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Types of Credits:
Open Account Credit
Credit Card
Charge cards
Overdrafts
Loans
Housing loan
Car loan
Personal loan
Education loan
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Comparison:
Loan and Open Credit Account
Loan Open Credit Account
• Formal Agreement • Informal agreement
• Primarily for specific • For general purpose
purpose • Finance small
• Finance large purchases
purchases • Numerous transactions
• One
One--off transaction • No collateral for credit
• Collateral usually and charge cards and
required unsecured overdrafts
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Loans
Housing loan
Car loan
Personal loan
Education loan

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Amount to borrow depends on:

 Value of goods purchased
 Your ability to repay the loan

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How Much Debt is Acceptable?

 Total Debt Load =
Total Debt
Total Assets
= < 50% (Ideal)

Debt Service Ratio =

Loan Repayments
Gross Pay
= < 35%
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Example
If your monthly gross income is $3,000, what would be
your maximum mortgage payment if the lender’s
affordability ratios stipulated that your mortgage
payment not exceed 30% nor your total instalment
paymentst exceed d 40% off your monthly
thl gross income?
i ?
What will be your monthly mortgage repayments for a
$150,000, 30 years, 5.5% mortgage?
Would you meet the lenders’ guideline if you also have a
personal loan of $500 monthly payment.

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Major Providers of Credit

 Commercial banks

 Finance Companies

 Insurance Companies

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Choosing a loan:
 Interest rate – most important
 Margin of financing
 Repayment schedule
 Processing fee
 Maturity – duration of loan
 Collateral
 Penalty fees for prepayment and late
payment of instalments
 Administrative efficiency
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Interest rate
 Fixed Rate Mortgage
- Interest rate and periodic repayments
(monthly) are fixed
- Process of repayment called
amortization
ti ti

 Adjustable or Variable Loan

- Interest rate (fluctuates relative to
general economy) and
- Periodic repayments are not fixed
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Single--payment Loan
Single
 Simple interest method
- If you borrow $1,000 for 6 months at 10% per
annum, at maturity, what is your repayment at
the
t eeend
doof 6 months?
o t s
 Discount Method
- Finance charges are paid in advance
- A personal loan which charges 10% per
annum discounted, what is the amount lent to
the borrower?

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Instalment Loan
• Interest and principals are repaid with a
series of regular fixed payments
• Common types – monthly
monthly--rest, annual-
annual- rest
or flat rate
E
Examplel
A $10,000 loan is to be amortised by equal monthly
payments over the next 5 years. Which is the
cheapest option:
a) monthly
monthly--rest at 6%;
b) annual
annual--rest at 5%; or
c) flat rate at 4%?
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Example
A $10,000 loan at 7% interest rate is to be
amortised by equal monthly payments over
the next 2 years. What is the monthly
repayment if the interest charged is at:
(a) monthly rest;
(b) annual rest; or
(c) flat rate?

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The Mortgage Payment

($80,000 loan for 30 years at 9% per annum)
— Mostly Interest
700
600
Monthly
500 payment
400
INTEREST $643.70
($151,732 total)
300
200
PRINCIPAL
100 ($80,000)
0
Years
0 5 10 15 20 25 30
Note that most of the mortgage payment will go toward
interest until year 22!
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Buying or Leasing

Q. Would you buy a HDB flat or a private

condominium or rent one?
Q. Would you buy a a car or use the public
transport
– Costs comparison using market values
– Assumptions used

Costs and convenience are factors of

consideration
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A careful and well though

credit plan enables you to
enjoy the benefits of owning
assets without being
saddled with cash-
cash-flow
problem

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Thank You

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