Working capital management

Cash as a medium of exchange

Motives for maintaining a minimum cash
balance
Managing the cash balance
The optimal cash transfer
The effective borrowing rate
Cash float management
Internal controls for cash

 In narrow sense: currency and generally accepted

equivalents of cash like cheques, drafts etc.
In broad sense: includes near-cash assets, such as
marketable securities and time deposits in banks.
They can be readily sold and converted into cash.
Can serve as a reserve pool of liquidity.
Also provide short term investment outlet for excess cash.

Economic Cycle

Business Cycle

1. Increase/quicken collection or reduce/

defer cash expenses
2. Dispose excess, non- performing long
term assets
3. Finance money
1. (if short term debt then effective borrowing cost )

 Formula:
EBR = Net Borrowing Costs/Net Proceeds
Interest paid
xx
Principal amount
xx
Processing costs
xx
Less: Discounted interest
(xx)
Other transaction costs xx
Expenses deducted in advance
(xx)
Less: Income derived from
Incremental compensating
money borrowed (xx)
cash balance
Net Borrowing Costs
xx
Net Proceeds xx

(xx)

 Simple annual borrowing rate

Formula :
APR=EBR x n
n = No. of periods = (365/periodic term)

Bank 1

Bank 2

Bank 3

Principal

P5
million

P 5 million

P5
million

Interest rate

10%

10%
discounted

10%
stated

Term

1 year

1 year

1 year

Present compensating
balance

P
400,000

none

P
700,000

Required compensating
balance

P
600,000

P 600,000

P
600,000

Interest
rate earned by the
6%
none
6%
Required:
compensating
balance
1. Arbitrage pricing
rate(ie, simple annual borrowing rate). Which bank
offers the cheapest source of financing short term?
2.What is the compounded effective borrowing rate if bank 1s period of
borrowing is quarterly and is done in a continuing basis?

Bank 1
Interest expense

Income from incremental

compensating balance
Net Borrowing Costs

Bank 2

P
500,000

Bank 3

P
500,000

12,000

P
500,000
0

0
488,000

500,000
500,000

Principal
Discounted interest
Incremental compensating
balance
Net Proceeds

5,000,000

5,000,00 5,000,000
0

500,000

200,000

600,000

4,800,000

3,900,00 5,000,000
0

Effective Borrowing rate

10.17%
12.82%
Bank 3 offers the cheapest source of financing ; APR=10%

10.00%

 Operating cash inflows.. speed it up!

High standard on credit approval
Shorter trade discount and credit period
Efficient and effective billing system

 Cost-Effective collection system

Frequency of collection follow-up

Visibility of collection personnel
Use of specialized postal system
Electronic fund transfer
Concentration banking

 Operating cash outflows . . . slow

down

Use of checks and drafts

Voucher system
The 3:00 o'clock habit
T.G.I.F. Syndrome
Payroll management

 Cash department should be under the

supervision of the treasurer.
Cash department should be separated from
accounting and other departments that
keeps records of transactions and events.
All cash transactions must be supported by
available proof of accuracy.
All cash receipts must be deposited intact
in the designated depository on the day of
collection or in the following business day.
Banks deposits slips must always be on file,
complete and available.

 Periodic reconciliation of bank and book records

must be done.
Cash cout should always be done and with an
element of surprise.
All checks must be properly signed and approved
by at least two signatories.
Cash personnel must be properly selected and
trained.
Cashiers must be bonded.

 Cashiers should be rotated, periodically or

surprisingly.
A cashier's manual must be made available.
Use of mechanical or electronic equipment in
issuing checks and officials receipts.
Preparation and verification of daily cash report.