CASH AND MARKETABLE SECURITIES MANAGEMENT

CASH are currency or cash items on hand (such as awaiting deposit and cash in working funds) as well as deposit in banks, which are unrestricted as to withdrawal or use for current operations. CASH MANAGEMENT refers to planning, controlling and accounting for cash transactions and cash balances OBJECTIVES OF CASH MANAGEMENT: 1.) Provide accurate accounting for cash receipts and cash disbursements 2.) Prevent or minimize losses from theft or fraud 3.) Anticipate the need for borrowings and assure the availability of adequate cash for conducting business operations 4.) Prevent unnecessarily large amount of cash from sitting idle in bank accounts which produce no revenue FUNCTION OF CASH MANAGEMENT involves the managing the monies of the firm in order to maximize cash availability and interest income on any idle funds. CASH MANAGEMENT EFFICIENCY collect accounts receivable as soon as possible but pay accounts payable as late as is consistent with maintaining the firms credit standing with suppliers REASONS FOR HOLDING CASH: 1.) Transactional Purposes It is used to meet expected payments of purchases, salaries, operating expenses, taxes and dividends. 2.) Compensating Balance Requirements Compensating balance is a set amount of cash that a firm must leave in its checking account at all times as part of a loan agreement. These balances give banks additional compensation because they can be relent or used to satisfy reserve requirements. 3.) Precautionary Reserves It is used to handle unexpected problem or contingencies due to the uncertain pattern of cash inflow and outflow like unexpected slow-down in accounts receivable collection or increase in disbursement due to inflation. 4.) Potential Investment Opportunities It can be used to take advantage of unusual investment opportunities that requires cash outlay like acquisition of another firm or high yielding securities and fixed assets at highly advantageous prices to the

company. 5.) Speculation It can be used to take advantage of probable change in prices of raw materials, equipment or currency exchange rate. SOURCES OF CASH 1.) Operations 2.) New borrowings USES OF CASH 1.) Payment of cash dividend 2.) Repayment of borrowings and stocks 3.) Payment of property, plant and equipment 4.) Purchase of noncurrent assets 5.) Payment of inventory, salaries, taxes and operating expenses 6.) Purchase of debt or equity security

3.) New stock issues 4.) Sale of property, plant and equipment 4.) Sale of noncurrent assets 5.) Return on loan (interest income) and equity security (dividend income)

SALE OF GOODS AND SERVICES CASH SALES CREDIT SALES Credit Policy - a set of decisions that includes a firms credit period, credit standards, collection procedures and discounts offered Four Variables of Credit Policy : 1.) Credit Period - the length of time buyers are given to pay for their purchases. 2.) Credit Standards - refer to the strength and creditworthiness a customer must exhibit in order to qualify for credit Five(5) Cs of Credit : 1.) Character - refers to the customers willingness to meet credit obligation. This information can be sought from the firms bank, suppliers, customers and even competitors. 2.) Capacity the ability to pay when a debt is due or meet credit obligation out of operative cash flow. It is gauged in part by the customers past record and business method, supplemented by physical observation of their plants and stores. 3.) Capital refers to the customers financial reserves or resources needed to produce profit 4.) Collateral - represented by assets that customers may offer as security in order to obtain credit. 5.) Conditions - refers to both general economic trends and to special developments in certain geographic regions or

sectors of the economy that might affect customers abilities to meet their obligations. 3.)Collection Policy - refers to the procedures the firm follows to collect accounts receivable. 4.) Discounts given for early payment (cash discount) INTERNAL CONTROL OVER CASH : 1.) Separate the function of handling cash from the maintenance of accounting records 2.) Prepare for each department a cash budget 3.) Prepare a control listing of each cash receipt 4.) Require that all cash receipts be deposited daily 5.) Make all payments by check except for small expenses which will be paid out of petty cash fund 6.) Separate the function of approving expenditures from the function of signing checks 7.) Promptly reconcile bank statement with accounting records CASH BUDGET - a forecast of the future cash receipts and disbursements of a firm over various intervals of time. The purpose of cash budget is to determine the future cash needs, plan for the financing of these needs and exercise control over the cash and liquidity of the firm. SECTIONS OF THE CASH BUDGET: 1.) Receipt section 2.) Disbursement section 3.) Cash excess or deficiency section 4.) Financing section

ABC COMPANY Cash Budget For the Quarter Ended 2002 Quarter 1 Cash Balance, beginning Add: Collection from Customers Total cash available Before current Financing Less: Disbursements: Direct Materials P16,000 99,000 2 15,486 134,400 3 15,229 171,600 4 15,788 176,400

115,000 22,689

149,886 29,732

186,829 34,636

192,188 34,239

Direct Labor Manufacturing Overhead Selling and Administrative Income taxes Equipment Purchases Dividends Total Disbursements Excess(Deficiency) of cash Available over disbursements Financing: Borrowings (beginning) Repayments (ending) Interest (12% p.a.) Total Financing Cash balance, ending

31,200 42,300 32,000 32,000 19,625 19,625 9,000 9,000 10,000 3,000 3,000 117,514 145,657 (2,514) 18,000 4,299 11,000

44,700 32,000 19,625 9,000 15,000 3,000 157,961 28,868

41,550 32,000 19,625 9,000 3,000 139,414 52,774

18,000 15,486

11,000 15,229

(12,000) ( 1,080) (13,080) 15,788

(17,000) ( 1,740) (18,740) 34,034

CASH MANAGEMENT TECHNIQUES: Effective cash management encompasses proper management of both cash inflow and cash outflow of a firm. It entails: 1.) Synchronized Cash Flow It is a situation in which inflow coincide with outflow and can be done by establishing regular billing cycles. 2.) Using Float Float the difference between the balance shown in a firms (or individuals) checkbook and the balance on the banks record. It represents the net effect of the delays in the payment of checks a firm writes and the collection of checks a firm receives. Negative/Collection Float exists when the firms book balance exceeds the banks balance. It arises from the delay between the time the payee actually receive these funds as collected balances (which are actually spendable). There is more cash tied up in the collection cycle and it earns a 0% rate of return. Negative Float in relation to customers payment is undesirable and should be minimized, it consist of : a.) Mail Float amount of customer payments that have been mailed by the customer but not yet received by the seller. b.) Processing Float amount of customer payments that has been

received by seller but not yet deposited. c.) Clearing Float amount of customers checks that has been deposited but not yet cleared. Positive Float associated with the firms payments and exists when the firms bank balance exceeds its book balance. This type of float allows the firm to maintain control of its cash for a longer period of time, thus earning a larger return. Disbursement Float amount of checks written by the firm that have not yet cleared. 3.) Accelerating Collection It is an attempt to reduce the negative float associated with the time it takes from mailing a customers check until it becomes usable fund to the firm. Strategies for Accelerating Cash Collection: a.) Lockbox System the firm has its customers mail their payments to a post office box in a specific city. A local bank collects the check from this box and deposits them in the firms checking account. b.) Local Collection Office a firms own collection center set up to handle its customers remittances. This can be an existing branch office or entirely separate operations. This system reduces mail and processing float by locating these where customers tend to cluster. c.) Preauthorized Check Payments under a prearranged agreement, a firm is permitted to draw a specific amount from a customers checking account as specified intervals. It is used for periodic insurance premiums, lease payments and mortgage payments. Pre-authorized Debits allows the fund to be automatically transferred from customers account to the firms account on specified dates. d.) Giving cash discount 4.) Getting available funds to where they are needed Concentration Banking it is used to mobilize funds from decentralized receiving location, whether they be lockboxes or decentralized company locations into one or more central cash pool (concentration bank where the firm maintains major disbursing account.) Mechanism for Transferring Funds: a.) Sweeping Accounts allows the firm to reduce its checking account balance to a minimum level at the end of each day.

Any funds released by sweeping the account can be invested overnight to earn interest income or be transferred to a centralized disbursement bank. b.) Wire Transfer interbank transfer of usable funds using telegram/wire service system. c.) Depository Transfer Check (DTC) A local depository bank notifies the concentration bank of the amount of check collections. The concentration bank prepares a DTC for this amount, credits the amount to the firms account and transmit the DTC to the local depository bank for payment. 5.) Controlling Disbursements Strategies for Controlling Disbursements: a.) Payables Centralization It permits financial manager to evaluate payments coming due for the entire firm and schedule availability of funds to meet these needs on a companywide basis. It also permits more efficient monitoring of payables and float balances. b.) Stretching Payables the firm pays accounts payable or accruals only when they are due, paying as late as possible within the credit period. c.) Payable through Drafts it is a legal instrument that has a physical appearance of an ordinary check but is not drawn on a bank, instead they are drawn on and payment is authorized by the issuing firm against its demand deposit account. d.) Zero-Balance Accounts A special checking account of a firms operating entities that contains no funds which are all located at the concentration bank, so that at the end of each day, the negative balances created by the divisions check can be restored to zero by debiting a master account. e.) Remote or Controlled Disbursement Under this system, the firm does not give local operating Units payment authority, instead all payments are made from one disbursement bank. The firm does not fund the disbursement until the day the checks are presented for clearance. The checks are covered by a same-day transfer of funds by the firm and can be applied to many accounts all of which can be funded with a single fund transfer.

MARKETABLE SECURITIES are short-term investments (maturity of less than 1 year) that can be quickly converted into cash in a short period of time. REASONS FOR HOLDING MARKETABLE SECURITIES: 1.) Serve as substitute for cash 2.) Use as Temporary Investment Temporary Investment investments held in the meantime and are usually a result of excess cash not needed in the regular business operations especially during slack season. CHARACETERISTICS OF MARKETABLE SECURITIES TO BE CONSIDERED: 1.) Risk the possibility of loss; the uncertainty of future returns Financial Risk the uncertainty of expected returns from a security attributable to possible changes in the financial capacity of the security issuer to make future payments to the security owner. Event Risk the probability that some event (ex. Recapitalization or leveraged buyout) will occur that suddenly increases a firms default risk. Default Risk the chances that the issuer may not be able to pay the interest or principal on time or at all. Interest Rate Risk the uncertainty of expected returns from a financial instrument attributable to changes in interest rates. Inflation Risk risk that inflation will reduce the purchasing power of a given sum of money. 2.) Marketability the ability of the owner to convert it into cash; how quickly a security can be sold before maturity without a significant price concession. The determinant of a securitys marketability is in the existence of an active secondary market for that security. 3.) Maturity the time period over which interest and principal payments are made Maturity dates of securities held should coincide when possible with the date at which the firm will no longer have excess cash to invest. 4.) Taxability 5.) Yield return on security related to the interest and or appreciation of principal provided by a security TYPES OF MARKETABLE SECURITIES: 1.) Government (Treasury) Securities unconditional default free obligations of the sovereign state backed by the full taxing power of the sovereignty. Treasury Bills government security that matures in less than one year with a tenor of 91-day, 182 day and 364-day. Cash Management Bills T-Bills that matures less than 91 days

2.) Bankers Acceptances are time drafts drawn on and accepted by a bank. It was designed to facilitate the import-export trade business. 3.) Negotiable Certificate of Deposit a certificate of deposit (CD) which entitle the holder to receive the amount deposited plus the accrued interest upon maturity that once they are issued they can be traded in the secondary market. 4.) Commercial Paper a short-term unsecured promissory notes issued by large corporations and finance companies with a high credit ratings. 5.) Repurchase Agreements or repo is a sale of a short-term securities by the dealer to the investor, whereby the dealer agrees to repurchase the securities at a specified future time at a slightly higher price. 6.) Eurodollar Loan Deposits an interest-bearing (time) deposit denominated in dollar rather than local currency deposited in European banks or foreign branches of U.S. commercial banks. 7.) Money Market Mutual Fund a mutual fund that pools the investment of many small investors and buy large-denominated money market instruments Call Money are overnight placements by banks with excess cash in other banks with temporary reserve deficiencies. This is the most actively traded instrument in the Phil. Money market.

REFERENCES: FINANCIAL MANAGEMENT AND POLICY 11ed c1998 James C. Van Horne FINANCIAL MANAGEMENT: CONCEPT AND APPLICATION 3ed c1997 Ramesh K.S. Rao BASIC FINANCIAL MANAGEMENT 6ed c1993 J. William Petty, David F. Scott Jr., Arthur J. Keown and John D. Martin CONTEMPORARY FINANCIAL MANAGEMENT 7ed c1998 R. Charles Moyer, James R. McGuican and William J. Kretlow ESSENTIALS OF MANAGERIAL FINANCE 10ed c1993 J. Fred Weston and Eugene F. Brigham CORPORATE FINANCE 5ed c1999 Stephen A. Ross, Randolph W. Westerfield and

Jeffrey Jaffe FINANCIAL MANAGEMENT IN PHIL. SETTING: TEXT AND CASES c1985 Cesar G. Saldana MANAGEMENT ACCOUNTING : AN INTRODUCTION c1979 Jose F. Peralta BASIC INFORMATION ON PHIL. TREASURY BILLS AND TREASURY BONDS c1997 http:// www.treasury.gov.ph FINANCIAL MARKET STRUCTURE (PHIL.) http://www.emeap.org:8084/RedBook/Ph/A1.htm