Tools in Managing Cash, Receivables and Inventory

Learning Competency & Module Expectations

Competency code: ABM_BF12-IIIc-d-12
Learners must be able to explain the tools in managing cash, receivables and inventory.
Focus of Week 4: working-capital tools (cash, receivables, inventory).

Key Definitions & Concepts

Current Assets – liquid assets expected to be converted into cash within 1 year (cash, savings, A/R, inventory).
Net Working Capital (NWC) – $\text{NWC}=\text{Current Assets}-\text{Current Liabilities}$ .
Working Capital Management (WCM) – administration & control of working-capital accounts with the objective of balancing profitability vs. risk.
Operating Cycle (OC) – $\text{OC}=\text{Days of Inventory}+\text{Days of Receivables}$ .
Cash Conversion Cycle (CCC) – $\text{CCC}=\text{OC}-\text{Days of Payables}$ .
Days of Inventory (DSI) – average days to sell inventory.
• Formula 1: $\text{DSI}=\frac{\text{Average Inventory}}{\text{COGS}/365}$
• Formula 2: $\text{DSI}=\frac{365}{\text{Inventory Turnover}}$
Days Sales Outstanding (DSO) – $\text{DSO}=\frac{\text{Average Accounts Receivable}}{\text{Credit Sales}/365}$ .
Days Payables Outstanding (DPO) – $\text{DPO}=\frac{\text{Average Accounts Payable}}{\text{Credit Purchases}/365}$ .
Permanent WC – minimum current-asset base required given capacity.
Temporary WC – portion of CA that fluctuates above the permanent level.

Working-Capital Financing Policies

Maturity-Matching (Hedging)
• Permanent WC ⇒ long-term sources (long-term debt, equity).
• Temporary WC ⇒ short-term sources (bank working-capital loans).
Aggressive Policy
• Some permanent WC financed by short-term debt.
• Pros: lower financing cost; Cons: higher liquidity risk.
Conservative Policy
• Some temporary WC financed by long-term funds.
• Pros: low liquidity risk; Cons: higher cost, lower profitability.

Cash Management

Cash is most liquid & theft-prone; strong internal control required.
Segregate custodial vs. recording functions.
Controls & tools:
• Official receipts + daily collection report.
• Mandatory bank deposit of collections; disbursements via check-voucher system (two signatories, cross-checking).
• Petty-Cash Fund (e.g., Php 10 000–20 000) for small expenses; replenished via reimbursement supported by petty-cash vouchers.

Motives for Holding Cash

Primary:

Transactional – meet day-to-day expenses (salaries, utilities, rent, taxes).
Compensating Balance – satisfy bank minimum-balance requirements or loan covenants.
Secondary:
Precautionary – cushion for emergencies (e.g., FX volatility, political crisis).
Speculative – exploit opportunities (e.g., buy undervalued stocks during a market crash).

Costs & Objective

Cost of holding cash: opportunity cost (foregone interest).
Objective: keep cash investment as low as possible while operating efficiently.

Cash Budgeting

Time horizon: usually 1-year, broken into months to expose seasonality.
Sections:

Cash Receipts – cash sales, A/R collections, other inflows.
Cash Disbursements – cash purchases, fixed-asset buys, A/P payments, interest, rent/lease, dividends, wages, loan principals, taxes.

Non-cash charges (depreciation, amortization) excluded.
Calculations per period:

$\text{Net Cash Flow}=\text{Cash Receipts}-\text{Cash Disbursements}$
$\text{Ending Cash}=\text{Beginning Cash}+\text{Net Cash Flow}$
$\text{Surplus / (Financing Need)}=\text{Ending Cash}-\text{Desired Minimum Balance}$ (negative ⇒ funding required).

Uses: foresee shortages (arrange financing early) or invest excess cash (choose tenor & instrument).

Accounts-Receivable Management

Credit sales expand market but create collection risk.
5 C’s of Credit Evaluation:
• Character – willingness to pay.
• Capacity – cash-flow ability.
• Collateral – pledged security.
• Capital – financial strength.
• Condition – macro/business environment.
Good billing & collection system: timely SOA, aging schedule.
Aging of Receivables monitors current, 30-, 60-, 90-day buckets; >90 days ⇒ higher default likelihood; informs allowance for doubtful accounts.

Inventory Management

Aim: satisfy production/merchandising needs at minimum total cost.
High inventory ⇒ carrying cost, spoilage/obsolescence; Low inventory ⇒ stock-outs & lost sales.
Special attention for perishable, fragile, toxic items.
Manufacturing inventories:

Raw Materials – purchased inputs not yet used.
Work-in-Process (WIP) – in production but unfinished.
Finished Goods – completed, ready for sale.

Formula Reference Sheet

$\text{Working Capital}=\text{CA}-\text{CL}$
$\text{Inventory Turnover}=\frac{\text{COGS}}{\text{Average Inventory}}$
$\text{DSI}=\frac{365}{\text{Inventory Turnover}}$
$\text{DSO}=\frac{\text{Average A/R}}{\text{Credit Sales}/365}$
$\text{DPO}=\frac{\text{Average A/P}}{\text{Credit Purchases}/365}$
$\text{CCC}=\text{DSI}+\text{DSO}-\text{DPO}$
Production Budget: $\text{Expected Sales (units)}+\text{Planned Ending Inv. (units)}-\text{Beginning Inv. (units)}$

Illustrative Corporate Example – Jollibee Foods Corp. (Dec 31, 2019)

Current Assets (Php M):
• Cash & CE 7 618
• A/R 7 621
• Inventories 5 972
• Other CA 2 810
• Total CA 24 021
Current Liabilities (Php M):
• Trade Payables 6 576
• Other CL 12 515
• Total CL 19 091
Derived Metrics:
• $\text{NWC}=24 021-19 091=4 930\ \text{M}$
• Assets needed daily: cash, receivables, inventories (as above).

Multiple-Choice & True/False Highlights (Study Guide)

Cash mgmt primary goal: minimize investment in cash yet remain liquid (MC pre-test #1 – d).
Speculative motive: hold cash for future investment opportunities (MC #2 – c).
Current Assets are liquid assets (MC #3 – c).
Inventory mgmt: control of inventory (MC #5 – a).
Budgeting = advance income-based spending plan (previous-lesson recall #1 – d).
Financial planning ensures solvency & positive cash flow (#2 – a).
Sales Forecasting provides future sales trend predictions (#4 – a).

Sample Computational Exercises (with Answers)

WC: $530\ 000-300\ 000=230\ 000$ .
Credit sales = $0.90\times600 000=540 000$ ; Receivable turnover 5 ⇒ $\text{DSO}=\frac{365}{5}=73\text{ days}$ .
Year-end A/R: $\frac{540 000}{5}=108 000$ .
Paula’s NWC:
• CA = 10 000 + 5 000 + 15 000 = 30 000
• CL = 7 500 + 2 500 + 5 000 = 15 000
• $\text{NWC}=30 000-15 000=15 000$ .
Days’ sales in inventory (73 days) used to solve ending inventory.
• $\text{DSI}=73=\frac{\text{Avg Inv.}}{720 000/365}$ ⇒ Avg Inv ≈ \$144 000.
• Beg Inv 82 000 ⇒ End Inv ≈ 206 000 (using $\text{Avg}=(82 000+\text{End})/2$ ).

Real-World Reflection – Piolo Pascual on Frugality

Worked 16-hour shifts abroad at 19; endorses BDO Remit.
Practices saving since school days; lives below means; maintains emergency fund.
Invests in farming (self-produced food, cost saving, sharing with friends).
Lesson: importance of disciplined saving, avoiding lifestyle inflation, investing in self-sustaining assets.

Ethical & Practical Implications

Good internal controls protect stakeholders’ interests & deter fraud.
Credit policies affect customer access & economic growth but must balance default risk.
Inventory over-accumulation wastes resources; under-stocking damages customer relations.
Choosing aggressive vs. conservative WC policies reflects management’s risk appetite and ethical responsibility toward creditors & employees.

Connections to Prior Lectures

Builds on previous topics: planning, forecasting, budgeting (sales forecasts feed production budgets which influence inventory levels & cash-flow timing).
Reinforces financial-statement relationships: SOFP provides point-in-time data; SOCI provides flow data necessary for turnover ratios.

Quick-Look Checklist for Exam Preparation

Memorize formulas (WC, DSI, DSO, DPO, CCC).
Understand three WC financing policies & their risk/return trade-offs.
Be able to draft a monthly cash budget and interpret surplus/deficit.
Apply 5 C’s to evaluate customer creditworthiness.
Distinguish raw materials, WIP, finished goods.
Know motives for holding cash and related real-world examples.
Practice classifying items as CA/CL and computing NWC from a balance sheet.