inv & cash mngt

7/30/2019 Inv & Cash Mngt

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CASHMANAGEMENT & INVENTORY

MANAGEMENT

Prepared by:

Mohan Avinash

Panchanan Sahoo

Neel Jain

Riddhima TripathiHarish M.

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Inventory Management


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NATUREOF INVENTORY

Stocks of manufactured products and the materialthat make up the product.

Components:

raw materials work-in-process

finished goods

stores and spares (supplies)

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NEEDFOR INVENTORIES

Transaction motive

Precautionary motive

Speculative motive

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OBJECTIVESOF INVENTORY MANAGEMENT Ensure a continuous supply of raw materials to

facilitate uninterrupted production

Maintain sufficient stock of raw materials inperiods of short supply and anticipate price

changes Maintain sufficient finished goods inventory for

smooth sales operations and efficient customerservice

Minimise the inventory costs Control inventory investment by maintaining

optimum inventory

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INVENTORY MANAGEMENT TECHNIQUES

Economic order quantity (EOQ)

ordering costs: call for, order placing, transportation,

receiving, inspecting and storing, administration

carrying costs: warehousing, handling, clerical and staff,

insurance, depreciation and obsolescence

ordering and carrying costs trade-off:

Economic order quantity:

Where A=quantity required , O=ordering cost , c=carrying cost

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2EOQ =

AO

c


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INVENTORY MANAGEMENT TECHNIQUES

Reorder point under certainty lead time:Lead time is the time that elapses between the placing

of an order and actually receiving the goods ordered.

average usage

Reorder point = Lead time x average usage Reorder point under uncertainty

safety stock

Reorder point = (Lead time x average usage)+

safety stock

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INVENTORY INVESTMENT ANALYSIS

Estimation of incremental operating profit

Estimation of incremental investment in inventory

Estimation of the incremental rate of return (IRR)

Comparison of the incremental rate of return withthe required rate of return (RRR)

Optimum inventory:

IRR = RRR

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SELECTIVE INVENTORY CONTROL

ABC analysisclassify inventory into three categories according to valuecontrol by importance and exception: maximum attention to A items

Just-in-time systemIn a JIT system , material or the manufactured components & parts arrive to the

manufacturing sites just few hours before they put to use. Out sourcing

Out sourcing is a system of buying parts & components from outside rather thanmanufacturing them internally.

Computerised inventory control system9


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INVENTORY MANAGEMENT PROCESS

Explicitly state the inventory policy

Create an inventory monitoring cell

Management group for controlling purchases

Periodic meetings between purchase, materialsplanning and production executives

Monthly reviews of total inventory at plant/corporatelevel

Identify critical inventory items for closer scrutiny

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Cash Management


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FOUR FACETSOF CASH MANAGEMENT

Cash planning

Managing the cash flows

Optimum cash level

Investing surplus cash


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CASH MANAGEMENT

Cash management is concerned with themanaging of:

cash flows into and out of the firm,

cash flows within the firm, and cash balances held by the firm at a point of

time by financing deficit or investing surpluscash


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MOTIVESFOR HOLDING CASH

The transactions motive

The precautionary motive

The speculative motive


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CASH PLANNING

Cash planning is a technique to plan and controlthe use of cash.

Cash Forecasting and Budgeting

Cash budgetis the most significant device toplan for and control cash receipts andpayments.

Cash forecastsare needed to prepare cashbudgets.


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SHORT

-TERM

CASH

FORECASTS

The important functions of short-termcash forecasts

To determine operating cash requirements

To anticipate short-term financingTo manage investment of surplus cash.

Short-term Forecasting Methods

The receipt and disbursements method

The adjusted net income method.


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THE RECEIPTAND DISBURSEMENTS METHOD

The virtues of the receipt and payment methodsare:

It gives a complete picture of all the items ofexpected cash flows.

It is a sound tool of managing daily cashoperations.

This method, however, suffers from the followinglimitations:

Its reliability is reduced because of theuncertainty of cash forecasts. For example,collections may be delayed, or unanticipateddemands may cause large disbursements.

It fails to highlight the significant movements in

the working capital items.

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THE ADJUSTED NET INCOME METHOD

The benefits of the adjusted net income methodare:

It highlights the movements in the working capitalitems, and thus helps to keep a control on a firms

working capital. It helps in anticipating a firms financial

requirements.

The major limitation of this method is:

It fails to trace cash flows, and therefore, its utility

in controlling daily cash operations is limited.


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LONG-TERM CASH FORECASTING

The major uses of the long-term cash forecastsare:

It indicates as companys future financial needs,especially for its working capital requirements.

It helps to evaluate proposed capital projects. Itpinpoints the cash required to finance these projectsas well as the cash to be generated by the companyto support them.

It helps to improve corporate planning. Long-term

cash forecasts compel each division to plan for futureand to formulate projects carefully.


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MANAGING CASH COLLECTIONSAND

DISBURSEMENTS

Accelerating Cash Collections

Decentralised Collections

Lock-box System

Controlling Disbursements Disbursement or Payment Float


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FEATURESOF INSTRUMENTSOF COLLECTION

IN INDIA

Instrument Pros Cons

1.Cheques No charge

Payable through clearing

Can be discounted after receipt

Low discounting charge

Requires customer limits which areinter-changeable with overdraft limits

Can bounce

Collection times can be long

Collection charge

2.Drafts Payable in local clearing

Chances of bouncing are less

Cost of collection

Buyers account debited on day one

3.Documentary bills Low discounting charge

Theoretically, goods are not releasedtill payments are made or the bill is

accepted

Not payable through clearing.

High collection cost

Long delays

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4.Trade bills No charge except stamp duty

Can be discounted.

Discipline of payment on due date.

Procedure is relatively cumbersome

Buyers are reluctant to accept the due

date discipline.

5.Letters of credit Good credit control as goods are

released on payment or acceptance of

bill.

Seller forced to meet deliveryschedule because of expiry date.

Opening charges

Transit period interest

Negotiation charges

Need bank lines to open LC.

Stamp duty on usance bills


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OPTIMUM CASH BALANCE

Optimum Cash Balance under Certainty:BaumolsModel

Optimum Cash Balance under Uncertainty: TheMillerOrr Model


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BAUMOLS MODELASSUMPTIONS:

The firm is able to forecast its cash needs withcertainty.

The firms cash payments occur uniformly over aperiod of time.

The opportunity cost of holding cash is known and itdoes not change over time.

The firm will incur the same transaction costwhenever it converts securities to cash.


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BAUMOLS MODEL The firm incurs a holding cost for keeping the cash balance. It is an

opportunity cost; that is, the return foregone on the marketablesecurities. If the opportunity cost is k, then the firms holding cost formaintaining an average cash balance is as follows:

The firm incurs a transaction cost whenever it converts itsmarketable securities to cash. Total number of transactions duringthe year will be total funds requirement, T, divided by the cashbalance, C, i.e., T/C. The per transaction cost is assumed to beconstant. If per transaction cost is c, then the total transaction costwill be:

The total annual cost of the demand for cash will be:

The optimum cash balance, C*, is obtained when the total cost isminimum. The formula for the optimum cash balance is as follows:

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Holding cost = ( / 2)k C

Transaction cost = ( / )c T C

* 2cTC

k

Total cost = ( / 2) ( / )k C c T C


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ILLUSTRATIONBAUMOLS MODEL

Advani Chemical Limited estimates its total cash requirement as Rs 2 crore next year. The companys

opportunity cost of funds is 15% per annum. The company will have to incur Rs 150 per transaction whenit converts its short-term securities to cash. Determine the optimum cash balance. How much is the totalannual cost of the demand for the optimum cash balance? How many deposits will have to be made during

the year?

k/cT2C*

000,200Rs15.0

)000,000,20)(150(2C*

The annual cost will be:

30,000Rs=15,000+15,000=(1,00,000)0.15+(100)150=2)(2,00,000/0.15+2,00,000)(2,00,000/150=costTotal

During the year, the company will have to make 100 deposits, i.e. converting marketable securities to

cash.


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THE MILLERORR MODEL

The MO model provides for two control limitstheupper control limit and the lower control limit as wellas a return point.

If the firms cash flows fluctuate randomly and hit the

upper limit, then it buys sufficient marketablesecurities to come back to a normal level of cashbalance (the return point).

Similarly, when the firms cash flows wander and hitthe lower limit, it sells sufficient marketable securitiesto bring the cash balance back to the normal level(the return point).

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THE MILLER-ORR MODEL The difference between the upper limit and the lower limit

depends on the following factors:

the transaction cost (c)

the interest rate, (i)

the standard deviation (s) of net cash flows.

The formula for determining the distance between upper

and lower control limits (called Z) is as follows:

1/ 3(Upper Limit Lower Limit) = (3/ 4 Transaction Cost Cash Flow Variance / Interest Rate)Upper Limit = Lower Limit + 3

Return Point = Lower Limit +

The net effect is that the firms hold the average the cash balance equal to:

Average C

Z

Z

ash Balance = Lower Limit + 4/3Z


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INVESTING SURPLUS CASHIN MARKETABLE

SECURITIES

Selecting Investment Opportunities:

safety,

Maturity, and

marketability.

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SHORT-TERM INVESTMENT OPPORTUNITIES:

Treasury bills

Commercial papers

Certificates of deposits

Bank deposits Inter-corporate deposits

Money market mutual funds

inv & cash mngt

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