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• Module overview
• 1. Introduction to budgets
  • 1.1 Introduction to the Budget Process
  • 1.2 Budget types
    • 1.2.1 The Budget Guidelines
    • 1.2.2 The Sales Budget
    • 1.2.3 Budget for Operating Expenses
    • 1.2.4 Profit Budget
    • 1.2.5 Cash-Flow Budget
    • 1.2.6 The Financial Position Budget
    • 1.2.7 Additional Types of Budgets
    • 1.2.8 Additional Budgeting Techniques
  • 1.3 The budget process and its objectives
  • 1.4 Budgets for performance management
    • 1.4.1 Master budget

• 2. Planning the budget

  • 2.1 Planning the Budget
    • 2.1.1 Business income
    • 2.1.2 Visual representation of sales and budgets
    • 2.1.3 The break-even point
    • 2.1.4 Contribution margin

• 3. Controlling the budget

  • 3.1 Controlling budgets
    • 3.1.1 Variance analysis
    • 3.1.2 Taking action to achieve the objectives of the budget
    • 3.1.3 Resource acquisition and usage

• 4. Introduction to Financial Management

  • 4.1 Business Objectives
    • 4.1.1 Maximising profit
    • 4.1.2 Maximising wealth
  • 4.2 Ethics and conflicts in business
    • 4.2.1 The dilemma of ethics in finance, investment and accounting
  • 4.3 Financial Managers
    • 4.3.1 Financial information and objectives
    • 4.3.2 Accounting, the financial information system
  • 4.4 The finance function
    • 4.4.1 Business and financial calculations

• 5. Elements of Business and Financial Management

  • 5.1 Business Structures
    • 5.1.1 Sole proprietors
    • 5.1.2 Partnerships
    • 5.1.3 Corporations and companies
  • 5.2 Reporting financial data and information
  • 5.3 Financial reports
    • 5.3.1 Statement of financial performance (profit and loss statement)
  • 5.4 Capital Markets
    • 5.4.1 Capital Markets
  • 5.5 Regulation and financial institutions
    • 5.5.1 Interest rates, supply and demand and market efficiency
  • 5.6 An overview of taxation implications

• 6. Obtaining Funds: Sources of Long Term and Short Term Finance

  • 6.1 Finance from external sources
    • 6.1.1 Equity finance
  • 6.2 Debt
  • 6.3 Long-term debt
    • 6.3.1 Debentures and unsecured notes (bonds)
    • 6.3.2 Mortgage loans
  • 6.4 Hybrids of debt and equity
  • 6.5 Leasing
    • 6.5.1 Operating Lease
    • 6.5.2 Financial Lease
    • 6.5.3 Distinguishing between an operating lease and a financial lease
    • 6.5.4 Sale and Leaseback
    • 6.5.5 The issue of gearing
  • 6.6 Short-term debt
    • 6.6.1 Bank Overdrafts
    • 6.6.2 Fully drawn advance
  • 6.7 Retained Earnings, internal funds and depreciation

• 7. Managing Working Capital

  • 7.1 Managing current assets and current liabilities
    • 7.1.1 Appropriate level of working capital
  • 7.2 Managing inventories
    • 7.2.1 Reasons for holding inventories
    • 7.2.2 The economic order quantity (EOQ)
    • 7.2.3 Re-order point (ROP)
    • 7.3.4 Safety stock (SS)
    • 7.2.5 Quantity discounts
  • 7.3 Managing trade debtors (accounts receivable)
    • 7.3.1 Credit policies
    • 7.3.2 Collection period
    • 7.3.3 Managing cash and near-cash assets
    • 7.3.4 Managing trade creditors (accounts payable)

• 8. Job Costing

  • 8.1 Accounting information about product, service and project costs
    • 8.1.1 Full costing
    • 8.1.2 Single product/service line
    • 8.1.3 Multi product/service
    • 8.1.4 Direct and indirect costs
  • 8.2 How costs behave
    • 8.2.1 Allocating Overheads
  • 8.4 Cost drivers
    • 8.4.1 ABC and the service industry
  • 8.5 Conclusion

7.3.3 Managing cash and near-cash assets

Cash means actual cash and any cheque accounts with a bank. From a financial viewpoint (not an accounting one!) one might include any unused portion of bank overdraft facilities that could be called upon to fill a need for cash.

Other liquid assets include near-cash assets , such as marketable securities. Marketable securities are financial instruments that earn interest and are readily convertible into cash through the marketplace or can be redeemed 'at call' or on short notice. Usually, when a financial instrument is redeemed early there is an associated opportunity cost, such as losing part of the interest earnings.

Motives for holding cash

There are three main motives for a firm to hold cash or liquid assets:

• A transaction motive
• A precautionary motive
• A speculative motive

Transaction motive. This is triggered by the perceived (and real) need to hold cash balances for ordinary business transactions. For example, a business needs cash to pay suppliers and to pay wages to its employees. The firm also receives cash from its customers. These receipts and payments form a continuous flow through the firm's working cash balance. Seasonal or trade cycle factors create cash surpluses, part of which will be held in near-cash form so as to earn interest.

Precautionary motive. Sometimes, cash is needed at short notice when unforseen situations arise. Precautionary cash balances are usually held as near-cash, on call assets earning interest.

Speculative Motive. From time to time investment or cost saving opportunities arise unexpectedly which can only be taken advantage of if cash or near-cash is available on call.

Cash management policy

Cash management policy involves three main areas:

• How to manage working cash balances, that is, managing the storage, payments and collections over the cash conversion cycle
• How to determine the optimum or appropriate level of cash balances
• How to invest temporarily surplus or idle cash in interest bearing assets

Managing payments and collections: The cash cycle is a series of events in which cash is used to buy materials for producing goods; pay workers wages and other expenses during production. The finished goods are sold to customers and, when the customers pay their bills cash is received, and the cycle is completed.

The longer it takes to complete this cycle, the more the firm needs to hold cash or liquid assets. Reducing the time period between cash payments and cash collections reduces the amount of inactive cash holdings required.

Speeding collections and banking: One way of speeding up the collection process is to offer incentives for prompt or early payment. A second method is to reduce the lag between customers paying and the time taken for cheques to be cleared through the banking system. Some firms make arrangements for customers to make deposits directly into the firm's bank account (for example, Eftpos, Bpay, telephone and on-line banking).

To further minimise any delay firms should bank all cash and cheques on the day they are received. Cash not banked increases the cash conversion cycle unnecessarily, and allows possibilities for theft or misuse. Daily banking is an important internal control procedure for cash.

Controlling payments : Slowing payment to creditors and suppliers is another way of conserving cash. On way of doing this is to delay payments to creditors for as long as possible , without losing settlement discounts or getting a poor credit rating.

Determining the appropriate levels of cash balances

How much money should a firm keep in its cheque account and as cash in hand?

The working cash balance is maintained for transaction purposes, such as paying bills as they fall due and collecting cash from debtors. If cash balances are too low, the firm may run out of cash, and it must liquidate some marketable securities or borrow the amount it needs. In both cases there are associated transaction costs. If cash balances are too high, the firm loses the opportunity to earn interest on the surplus cash.

Finding the optimal cash balance involves a trade-off between transaction costs (which are high for low working balances) and opportunity costs (which are high for high working balances). Under conditions of certainty determining optimal cash balances can be seen as an inventory problem.

Unfortunately, cash receipts and payments are not completely predictable. Past data about the pattern of cash receipts and payments will allow a firm to estimate maximum and minimum balances relevant to the business cycle. Where a business is seasonal, it needs a higher minimum balance in peak activity periods than in low activity periods.

Cash balances fluctuate in a semi-random manner in response to inflows and outflows of cash. When they reach the maximum levels x dollars will be invested in marketable securities. The fluctuations continue until the balance reaches the minimum control limit when y dollars of marketable securities are sold and banked in the working cash account. The minimum level z represents a safety level to satisfy, in part, the precautionary motive for holding cash.

Taking into account uncertainty, variability and the seasonal nature of cash inflows and outflows, it is not reasonable to expect that an optimal working cash balance can be calculated. However, appropriate working cash balances that are reasonable can be established by experience, statistical analysis and observation.

Investing surplus or idle cash

Surplus or idle cash balances are usually held in short-term interest-bearing investments. If surplus cash is greater than that needed for precautionary and speculative reasons, it will be invested in longer-term and even permanent revenue-producing assets.

Instead of holding excess cash in short-term investments, a firm can borrow to meet variable cash requirements as they occur. This is what many firms do when they obtain overdraft facilities on their working cash account. Under such a policy a firm will never have excess cash.

There are three main factors to consider when investing excess cash in interest bearing securities. These are:

• default risk
  The reasons for investing excess cash balances make it unlikely that investments will be made in assets that have a high chance of failing. In selecting securities in which to invest remember that default risk and interest return are related, which means that low risk securities will give the lowest return.
  
• Maturity
  Maturity is the period over which the investment is made. As the purpose of investing excess cash is short-term, the maturity period should be matched as closely as possible to the initial purpose of the investment. Consideration must be given to investments that can be redeemed before the end of their maturity period.
  
• Marketability
  This refers to how easily the investment can be converted into cash. This includes early redemption and possibility of selling the security in the marketplace. Marketability is measured by the ability to sell within a given timeframe at a fair price.

Text reading

Atrill, Mclaney, Harvey & Jenner, pages 420-424

Note that the statement of cash flows referred to is really a cash budget

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