BUSINESS

FINANCE

Let’s start
the lesson!
 06
Managing Cash,
Receivables, and
Inventory
Debt & Equity
Financing
Objectives:
At the end of the lesson, the student should be able to:

a. Explain tools in managing cash,

receivables, and inventory; and
b. Distinguish debt and equity financing..
 Reasons for holding
cash
 Cash Budget and its
purpose
 Debt and equity
financing
 Banks and non-bank
institutions
 Cash
the liquidity,
● Being the most and solvency of a
liquid asset, company. It is
cash is an also the most
important account vulnerable when
in the balance it comes to
sheet that will theft.
affect
 A good internal control must be
properly implemented to safeguard
this asset:
 A basic internal control system entails the
assignment of custodial function and
recording function to separate individuals,
unless you are the owner. Why is this so?
Imagine a cashier of a company who is also
the chief accountant. If tempted, this person
can steal cash from the company and can
manipulate the records so that nobody can
discover that he is stealing. If you are the
owner, you probably will not steal from
yourself and adjust the records?
 Cash collections should be
supported by official
receipts which are
summarized in a
daily collection report. The
daily collection report is
going to useful for the next
control measure for cash –
depositing collections.
 A good internal control
over cash is by depositing
all collections intact.
The daily collection
reports are now compared
with the deposit slips to
find out if all
collections are indeed
deposited.
 If all collections need to
be deposited, then payments
must be made through a check
voucher system. There must
also be two signatories in
the check to provide a check
and balance. If the business
is small then the
entrepreneur’s signature may
suffice.
 For small payments like the fare
given to a messenger, a petty
cash fund is used. A petty cash
fund which should be minimal in
amount will be issued to a petty
cash fund custodian, say the
office administrator. The petty
cash fund may be PHP10,000 or
PHP20,000. Disbursements from
this petty cash funds must be
supported by a petty cash voucher
signed by the recipient of the
petty cash. When the petty cash fund
is almost depleted, the petty cash
fund custodian will
get reimbursements. This
reimbursement will go through the
check voucher system where
the custodian gets a check with the
petty cash vouchers as supporting
documents.
 The check must also be cross-
checked by drawing two lines on
the payee section of the
check. This cross-checking
requires depositing of a check.
It cannot be encashed. This
makes it more difficult for
somebody who stole a check to
get the money.
Motives For Holding Cash
• The following are the reasons
for holding cash:
Primary Reasons
a. Transactional. This is the
cash used for paying expenses
such as salaries, utilities,
rent and taxes, among others.
b. Compensating balance. This
is the cash held to meet bank
requirements such as the
minimum cash balance you
maintain for checking
accounts and if you have
existing loans, banks may
also require a minimum amount
of deposit with them.
Secondary Reasons
a. Precautionary. This is the cash
maintained for emergencies such as the
additional cash you keep during
political and economic uncertainties.
For example, if your business requires
a substantial amount of importation, a
relatively higher amount of cash has
to be maintained when the exchange
rate becomes highly volatile due to
political instability such as
what happened during EDSA II.
b. Speculative. This refers to the
cash held by the company to take
advantage of opportunities (e.g.
buying stocks during major
corrections such as what happened
at the height of the
global financial crisis in 2008
and 2009 where stock valuations
went down by as much as 80% for
some companies).
Budgeting Cash
 The Cash Budget
 The cash budget provides
information regarding the
company’s expected cash receipts
and disbursements over a given
period.
 It is useful for identifying
future funding requirements
or excess cash within a given
period. This allows managers
to find possible sources of
financing if the cash budget
shows cash shortage
or identify appropriate
tenors for money market
placements for excess cash.
 Normally, a cash budget is
prepared for a one year
period broken down into
smaller intervals
like months. This allows
managers to see the
seasonality of the
business which affects the
cash flows.
 B. BUGAY INDUSTRIES
Cash Budget
For the months of October, November, and December 2015
OCTOBE NOVEMB DECEMB
R ER ER
Cash Receipts XXX XXX XXX
Less: Cash Disbursements (XXX) (XXX) (XXX)
Net Cash Flows XXX XXX XXX
Add: Beginning Cash Balance XXX XXX XXX
Ending Cash XXX XXX XXX
Less: Minimum cash balance (XXX) (XXX) (XXX)
Cumulative financing requirement (if
negative)
XXX XXX XXX
Or Cumulative excess cash balance (if
positive)
Basically, cash budget has the
following parts:
 Cash Receipts include all of a
firm’s inflows of cash in a
given financial period. The
most common components of cash
receipts are cash sales,
collections of accounts
receivable, and other cash
receipts.
Illustrative Example:
Source: Gitman, L. (1976). Principles of
managerial finance. New York: Harper &
Row.

B. Bugay Industries, a defense contractor, is

developing a cash budget for October,
November, and December. Jungaya’s sales in
August and September were PHP100,000 and
PHP200,000 respectively. Sales of PHP400,000,
PHP300,000, and PHP200,000 have been
forecast for October, November, and December
respectively.
Historically, 20% of the firm’s
sales have been for cash, 50% have
generated accounts receivable
collected after 1 month, and
the remaining 30% have generated
accounts receivable collected
after 2 months. In December, the
firm will receive a PHP30,000
dividend from stock in a
subsidiary.
Required: Prepare the cash receipts
section of the cash budget.
Forecasted sales 100,000 200,000 400,000 300,000 200,000
August September October November December

Cash Sales (20%) P20,000 P40,000 P80,000 P60,000 P40,000

Collection of AR
1st month (50%) P50,000 P100,000 P200,000 P150,000
2nd month (30%) P30,000 P60,000 P120,000
Other cash receipts P30,000
TOTAL CASH
P210,000 P320,000 P340,000
RECEIPTS
Cash Disbursements include all outlays of
cash by the firm during a given financial
period. The most common cash disbursements
are:
 Cash purchases
 Purchasing fixed assets
 Payments of accounts payable
 Interest payments
 Rent (and lease) payments
 Cash dividend payments
 Wages and salaries
 Principal payments (loans)
 Tax
• It is important to
recognize that depreciation
and other noncash charges
are not included in the cash
budget, because they
merely represent a scheduled
write-off of an earlier cash
outflow.
• Illustrative Example:

Jungaya Industries has gathered the

following data needed for the preparation
of a cash disbursements schedule for
October, November, and December.
Purchases - The firm’s purchases represent
70% of sales. Of this amount, 10% is paid
in cash, 70% is paid in the month
immediately following the month of
purchase, and the remaining 20% is paid 2
months following the month of purchase.
Rent Payments - Rent of PHP5,000 will
be paid each month.
Wages and Salaries - Fixed salary cost
for the year is PHP96,000, or
PHP8,000 per month. In addition,
wages are estimated as 10%
of monthly sales.
Tax Payments - Taxes of PHP25,000 must
be paid in December.
Fixed Assets - New machinery costing
PHP130,000 will be purchased and
paid for in November.
Interest Payments - An interest payment
of PHP10,000 is due in December.
Forecasted purchases (70%) 70,000 140,000 280,000 210,000 140,000

AUGUST SEPTEMBER OCTOBER NOVEMBER DECEMBER

Cash Purchases (10%) P 7,000 P 14,000 P 28,000 P 21,000 P 14,000

Payment of AP

1st month (70%) 49,000 98,000 196,000 147,000

2nd month (20%) 14,000 28,000 56,000

Total Cash Purchases P 7,000 P 63,000 P 140,000 P 245,000 P 217,000

Rent 5,000 5,000 5,000

Wages and Salaries 48,000 38,000 28,000

Tax 25,000

Machinery purchase 130,000

Interest 10,000
TOTAL CASH
P 193,000 P 418,000 P 285,000
DISBURSEMENT
Net Cash Flow, Ending Cash, Financing,
and Excess Cash
• The firm’s net cash flow is found by
subtracting the cash disbursements from
cash receipts in each period. Then we add
beginning cash to the net cash flow to
determine the ending cash for each
period. Finally, we subtract the desired
minimum cash balance from ending cash
to find the required total financing or
the excess cash balance. If the computed
amount is negative, the company needs
financing. Otherwise, the company has
excess cash.
The cash budget is part of planning.
It helps managers anticipate future
funding requirements in order to
obtain proper financing even before
the need arises. This will help them
avoid usurious rates. On the other
hand, if the company has excess cash,
managers are able identify the
investment instruments that will
maximize the returns on the excess
cash.
Illustrative Example: Given the two
illustrative examples, generate a cash
budget showing the net cash flow,
ending cash flow, financing, and excess
cash. At the end of September,Jungaya’s
cash balance was PHP50,000,and its
notes payable and marketable securities
equaled PHP0. The company wishes to
maintain as a reserve for unexpected
needs, a minimum cash balance of
PHP25,000.
 B. BUGAY INDUSTRIES
Cash Budget
For the months of October, November, and December 2015

OCTOBER NOVEMBER DECEMBER

Cash Receipts 210,000 320,000 340,000

Less: Cash Disbursements (193,000) (418,000) (285,000)
Net Cash Flows 17,000 (98,000) 55,000

Add: Beginning Cash Balance 50,000 67,000 (31,000)

Ending Cash 67,000 (31,000) 24,000

Less: Minimum cash balance (25,000 ) (25,000) (25,000)

Cumulative financing requirement (if negative)

Or Cumulative excess cash balance (if positive)
42,000 (56,000) (1,000)
Comprehensive Illustrative
Example:
It was December 2014 and the
president of DCD Corporation wants
to find out if the company has
enough cash to pay the
principal balance of the company’s
loan worth PHP3 million by the end
of 2015. He asked the chief
accountant to prepare the cash
budget for 2015.
The following assumptions which will be
used for the preparation of the cash
budget for 2015 are as follows:
Projected quarterly sales for 2015 are
as follows:
First quarter - Php 5 million
Second quarter - -Php 7.5 million
Third quarter - Php 8.5 million
Fourth quarter - Php 10 million

Fourth quarter sales in 2014 was Php 8

million.
Sales are collected 90% in the
quarter the sales are made. The
remaining 10% is collected the
following quarter.

The cost of sales is 75% of sales.

Merchandise inventories are
purchased in the quarter these are
sold. All merchandise purchased
in the quarter are paid in the same
quarter.
Operating expenses for each quarter
paid in cash are as follows:
First quarter - PHP500,000
Second quarter - -PHP750,000
Third quarter - PHP850,000
Fourth quarter - PHP1,000,000

On top of these cash operating

expenses, depreciation expenses that
should be charged to operations is
PHP150,000 per quarter.
Interest expense paid every quarter
is PHP75,000.

Income tax rate is 30%. The income

taxes to be paid every quarter will
be as follows:
First quarter - PHP157,500
Second quarter - PHP270,000
Third quarter - PHP315,000
Fourth quarter - PHP382,500
Expected cash balance at the end
of 2014 is about PHP350,000. For
2015, target cash balance is
raised to PHP500,000 because
of expected increase in sales.

Given the above assumptions, a

cash budget can now be prepared
for 2015.
 DCD Corporation
Cash Budget
For the Year Ending December 31, 2015
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
Collections
Quarter of Sale 4,500,000 6,750,000 7,650,000 9,000,000
A quarter after sale 800,000 500,000 750,000 850,000
5,300,000 7,250,000 8,400,000 9,850,000
Payments
Purchases 3,750,000 5,625,000 6,375,000 7,500,000
Cash operating expenses 500,000 750,000 850,000 1,000,000
Income taxes 225,000 157,500 270,000 315,000
Loan payment 3,000,000
Interest expense 75,000 75,000 75,000 75,000
Total payments 4,550,000 6,607,500 7,570,000 11,890,000
Net cash flow for the period 750,000 642,5000 830,000 (2,040,000)
Cash balance, beginning 350,000 1,100,000 1,742,500 2,572,500
Cash balance without financing 1,100,000 1,742,500 2,572,500 532,500
Target cash balance 500,000 500,000 500,000 500,000
Cumulative excess cash
600,000 1,242,500 2,072,500 32,500
(funding requirements)
Accounts Receivable
• Accounts receivables spring out of
the need to sell merchandise.

• An excellent business proposition

is to generate sales without
offering a credit facility to
customers. However, this concept is
theoretically sound, but not
sustainable.
 Consider a real estate company
which sells condominium units
at PHP5 million per unit. How
many units can the property
developer sell if he sells the
units only on cash basis? Do
you think he can sell a lot?
Probably not as many as
compared to providing
installment payments.
• Credit management strategically
defines the quality of accounts
receivables collection.

• The collectability of accounts

receivables depends largely on the
quality of customers. The quality of
customers depends on the standards or
credit policies set up and used by an
organization.
Credit policies are an integral part of the
credit evaluation and there are 5C’s used
in credit evaluation. These are:
 Character –the willingness of the borrower
to repay the loan
 Capacity – a customer’s ability to generate
cash flows
 Collateral – security pledged for payment
of the loan
 Capital – a customer’s financial resources
 Condition – current economic or business
conditions
• Proper management of accounts
receivable entails having a
good billing and collection
system.

• A good system should lead to

the sending of statements of
account to customers on
time.
• Follow-ups through phone calls
or any form of gentle reminders
should be made if customers fail
to pay on time. These follow-ups
can also serve as the
management’s way of validating
if the contact details given by
customers are still valid and if
the customers still occupy
the same office.
• Aging of receivables is also a control
measure to determine the amount of
receivables that are still outstanding and
past due.

Current P 60 million
1 - 30 day past due 20 million
31 - 60 day past due 10 million
61 - 90 day past due 3 million
Over 90 days past due 7 million
Total Php 100 million
INVENTORY MANAGEMENT
Inventory management involves
the formulation and
administration of plans and
policies to efficiently and
satisfactorily meet production
and merchandising requirements
and minimize costs relative to
inventories.
• Effective inventory management
becomes critical when the nature of
the products are either perishable
(e.g. fruits, vegetables),
fragile (e.g. glasses), or toxic
(e.g. bleaching agent).
• Proper inventory management involves
the determination of reasonable
levels of inventories considering
the size and nature of business.
• Maintaining too much
inventories has costs such as
carrying or holding costs,
possible obsolescence or
spoilage.
• On the other hand, too low
inventory can result to stock
out, and eventually lost
sales.
Inventory in a Manufacturing
Company
 In a manufacturing company, there
are three types of inventory:

o Raw materials – these are purchased

materials not yet put into production.
o Work in process – these are
goods and labor put into
production but not yet
finished.
o Finished goods – these are
goods put into production
and finished. These are
ready to be sold.
The ABC Analysis
 One way to control inventory
is to classify inventory
into a classification system
called ABC Analysis.
 Inventories classified as
“A” are high valued items
which should be safeguarded
the most.
 B items, on the other hand,
are average-cost items that
should be safeguarded more
than C items but not as much
as A items.
 While C items have low cost
and is the least
safeguarded.
To summarize:

INVENTORY CLASS

A B C

Money value High Medium Low

Quality Control Very Strict Strict Not too Strict

Inventory Relatively
Slow Fast
movement (flows) fast
Debt Financing
- borrowing
money from
lenders and
not giving up
ownership.
Equity Financing - the
method of raising capital
by selling company stock
to investors
(stockholders) in exchange
of ownership interests in
the company.
Advantages and disadvantages of debt financing
and equity financing.
DEBT FINANCING EQUITY FINANCING
Advantage Disadvantage Advantage Disadvantage
It is limited to It does not require a It has the highest cost
Cost interest payments. fixed (see discussion on
dividend payment. risk).
Lender has no control over It may limit cash
Control operations and investment dividend declaration
decisions. by management.
There is a
specified maturity date
There is no maturity
Maturity or
date. It is perpetual.
periodic amortization
payments.
There is a risk of
Among the sources
not meeting the
Risk of financing, it is
obligation (default
the riskiest.
risk)
Interest expense is
Dividends are not
Tax tax deductible (it
tax deductible.
can minimize tax expense).
 Note that if debt is cheaper, why
doesn’t the company avail of 100% debt
financing?

 Possible answer: No bank/creditor

will provide 100% debt financing.
Creditors evaluate the paying capacity
of borrowers which means the amount of
loans they will tend depends on the
ability of the company to serve the
debt. Normally, this is based on the
projected cash flows of the
borrower.
Note that it is risky because:
 Stockholders are not guaranteed of returns
unlike creditors which have guaranteed
interest and principal payment.
 Under the corporation code, creditors have to
be paid first in case of liquidation before
anything is paid to the stockholders
 If the company is losing, it’s the stockholders
who bear the loss.
Review:
Short term financing is debt scheduled to
be paid within a year while long-term
financing is debt to be paid in more than
a year.

Liquidity risks and liquidity ratios

Liquidity risk typically refers to the
inability of an investor to buy or sell an
asset to avoid financial loss. It can also
refer to the inability to meet obligations
since assets are tied up with investments
or inventory.
Ratios such as the current ratio and
quick ratio measure the institution’s
liquidity. There should be a balance
between liquid funds and investments.
Too high liquidity ratios will have
opportunity costs since these funds
could have been invested to yield
earnings. Too low liquidity ratios,
however, may cause the institution to
default on payments should emergency
situations arise. Enough liquid
assets should be available to meet
short term obligations.
Sources and uses of short-term
funds
Suppliers Credit – refers to the extension of payment due date
by suppliers. For example, the terms 2/10 (2% discount if paid
within 10 days) with the due date of 60 days will result in annual
interest of (2/98)*(360/50 days), or 14.69%. Therefore, by not
availing of the discount, the one who ordered the supplies from
the supplier in effect borrowed at 14.69%. It may also be viewed
as the opportunity cost forgone.
 Advances from stockholders or other owners
– personal funds advanced by a stockholder to
a company that usually requires interest. These
usually require little to no interest on
advances, especially if the owner is advancing funds
to assist the company in sudden liquidity crisis.
This source, however, is depended on the availability
of funds of an individual.
• Credit cooperatives – provided lending
services to its members. Members usually
pay contributions to the cooperative.

• Banks – provides several loan products

catering to different types of needs.
• Credit Cards – just take note of the high interest rates on
this source of funds.

• Lending Companies – companies that are dedicated to

lending. They usually charge higher interest than banks but
their credit requirements are more lenient compared to
banks.

• Pawnshops – provides funds in exchange for collateral,

usually jewellery, or other items of value.
• Informal lending sources (5/6)
Describe the actual interest paid for this type
of lending
Interest is usually paid per month, and monthly
interest is (6-5)/5 or 20%. Annual interest is
actually 20%*12 or 240%.
Factors considered in selecting
the source of short-term
financing

• Cost (Interest)
Informal lending sources like
5/6 may be the most expensive.
• Availability of short-term funds
Informal lending sources like 5/6 is
most available because there are no
formal requirements to avail of the
facility.
• Risk
Whatever the source of fund is, if the
company defaults, the lenders may
foreclose some of the company’s
properties or even the entire business
itself to settle the loan.
• Flexibility
 This pertains to the ability of the
company to access funds. or example, a
bank loan may be cheaper but the bank
may reject the loan application of
the borrower because he/she did not
pass the credit evaluation process of
the bank.
 This financial flexibility can be
influenced by:
o Nature of the Company’s business
o Leverage ratio
o Stability of operating cash flows
• Restrictions (Debt covenants)
 Some lenders like banks may
require a minimum deposit
balance with their branch for
as long as the loans remain
outstanding.
 The bank’s approval may also
be secured before cash
dividends can be declared.
 The sources and uses of long-term
funds
• Equity investors – these are the individuals/corporations
which are issued common stock. They share in the
ownership of the company. There are also equity investors
who do not have voting rights in the company but have a
share in dividends, usually a fixed percentage. These
investors are issued preferred stock. Holders of preferred
shares are first to receive dividends than common
stock holders.
• Internally generated funds – not all profits are
distributed to stockholders. Most of the profits
are re-invested and used by companies to
finance their needs.
• Banks – they provide long-term loans, depending
on the nature of the need. For example, a 5-
year to 10-year loan may be granted if the
purpose of the loan is construction of an office
building.
• Bonds – these are debt investments where an
investor loans money to an entity which borrows
the funds.

• Lending companies – they can also provide

long-term loans.
• The company’s capital structure is a
major consideration for deciding
which long-term sources of funds to
utilize. The target would be to balance
debt and equity and come up with the
minimum cost of capital.
LEARNING RESOURCES (References)
Agamata, F. (2014). Management Services.
Gitman, L. (1976). Principles of managerial finance. New York:
Harper & Row.
Gitman, L. & Joehnk, M. (1981). Fundamentals of investing. New York:
Harper & Row.
Horngren, C. (1972). Cost accounting; a managerial emphasis.
Englewood Cliffs, N.J.: Prentice-Hall.
Roque, R. (1990). Reviewer in Management Advisory Services. Roque
Press, Inc.