Chapter 16 WORKING CAPITAL, FUNDING REQUIREMENTS, AND THE

CURRENT ACCOUNTS
The Management of Working Capital The asset associated with short – term operating activities in most
Working Capital consists of balance sheet accounts arising from companies are cash, accounts receivables, and inventory.
routine activities or day-to-day activities of the company. Together they’re gross working capital. Current Accounts.

Working Capital Management is controlling the balances in the “Capital” refers to the idea that funds have to be committed to
accounts to the way the underlying functions are run. support these short–term assets.

➢ Arises from day-to-day operations, run with little money “Working” emphasizes the fact that they’re associated with the
tied up in current accounts and controlling these balances day–to–day operation of the business.
according to the way underlying functions run. Run with ➢ Working capital means funds committed for short-term
little money tied up in current accounts (current assets and assets associated with day-to-day operations.
current liabilities).
Working capital is an absolute necessity for the operation of
WORKING CAPITAL BASICS companies. Firms cannot do business without working capital
Working Capital accounts arise from day-to-day operations than they can without buildings or equipment.
including cash, receivables, inventory, payables, and accruals. It ➢ Working capital or short-term assets are more important
refers to the assets and liabilities required to operate the business than long-term assets because the former turn over
on a day-to-day basis. regularly; they are liquidated on a day-to-day basis. They
Long–term assets are held for an extended period (at least a help produce income on a day-to-day basis.
year) and are financed or supported with (long-term)liabilities Working Capital Requires Funds – Maintaining a working capital
that don’t have to be paid off for long periods. balance requires a permanent commitment of funds. Providing
➢ Dito na napasok yung matching principle; match short term working capital takes a permanent investment of funds.
assets to short term liabilities and long term assets to long a. Even though individual inventory items are constantly being
term liabilities. Current accounts are short term. bought and sold, approximately $XX amount is required to
Working Capital items are short-term. The assets and liabilities in maintain a level to support the operations. Related to net
the working capital accounts are turned over regularly. Turnover working capital.
items are held for only a little while, such as inventory. Firms b. When a product is sold on credit, receivables are created
always have inventory on hand, individual pieces are purchased that won’t be realized in cash until the customer pays the
and sold quickly. The important point is that normal operating bill. In the meantime, the receivables represent money
activities create and liquidate the elements of working capital the company has recognized from the sale but doesn’t
regularly.
 have. Yung nabenta na ng company (sale) pero hindi pa They spontaneously reduce the need for funds to support gross
nakakacollect (receivable) sale on credit. working capital (cash, receivables, and inventory).
c. Keeping cash in the bank also takes funding. Even
WHAT IS SPONTANEOUS FINANCING?
though money is constantly flowing in and out of a
company’s bank account, an average balance has to be It refers to financing that arises out of regular, day-to-day
maintained to pay bills and conduct business. The operations. Generated naturally/automatically from normal
money has to come from somewhere and represents a business activities such as goods and services availed at credit,
funding requirement just like inventory or receivables. In trade credit from suppliers & creditors, accrued expenses, etc.
effect, the company buys a cash balance in its bank
Working Capital and Current Accounts
account.
➢ Pagnagtatabi ka ng cash sa bank, kailangan may “Net Working Capital” refers to the difference between gross
maintaining balance kasi diba babayaran mo rin ung working capital and spontaneous financing. A firm’s net working
bank pagmaghandle sila ng pera mo, alangan gawin capital reflects the net amount of funds required to support
nila un for free. routine operations.
The Short – Term Liabilities (Spontaneous Financing) – Operating In practice, working capital is the net of current assets less
activities also create payable and accrual liabilities. When current liabilities.
inventory is purchased on credit, the payable represents material
gross working capital = current assets
that can be used (temporarily) without payment. Similarly, labor
that’s been received but not yet paid is reflected in an accrual. net working capital = current assets – current liabilities
The liabilities created by operations spontaneously offset the Gross Working Capital – Spontaneous Financing
funding required to support the assets. They come automatically
OBJECTIVE OF WORKING CAPITAL MANAGEMENT
with the associated assets and operating activities. The acts of
buying inventory and building products lead directly to the related Primary Objective: Good working capital management means
payables and accruals. running the company as effectively with as little money tied up in
the current accounts as possible which also involves a series of
➢ (Spontaneous Financing) Pag nagkaroon ng short
cost/ benefit trade–offs. The trade-offs arise because it’s easier
term current assets sa operations ng company,
to run a business with more working capital than with less, but
automatically may liabilities associated doon
it’s also more expensive.
(payables and accruals). Kasi need ng utang para
magfund ng business. If there is a current asset, more working capital = more expensive
there is a current liability.
Because of the automatic nature of liabilities arising from
operating activities is referred to as spontaneous financing.
 INVENTORY Working capital management involves trade-offs between easier
: operation and the cost of carrying short – term assets.
PROS: CONS:
Large inventories keep Larger inventories cost more to Using more working capital increases sales and improves
customers happy because finance, incur bigger losses from relations with customers and vendors, but costs extra money.
suppliers always have what they obsolescence, breakage and No right way for a right working capital level. The choice is a matter
want right away. theft, and take more storage of policy and involves tradeoffs that are often hard to quantify.
space than smaller inventories. Therefore, working capital management requires judgment,
Also, production delays due to
experience, and an ability to work with others in the organization.
running out of materials are
minimized by carrying big stocks Operations – The Cash Conversion Cycle
of parts.
RECEIVABLES
PROS: CONS:
A large receivables balance Relatively large bad debt losses
means the firm grants credit to and big interest charges to
customers easily and is willing finance the receivables balance.
to wait a long time to be paid,
which makes customers happy
and tends to increase sales.

CASH Current assets can be thought of as going through a series of

More rather than less cash in the bank makes it easier to conduct transformations as a business operates. Cash “becomes”
business and minimizes the chance of running short, but it also inventory and labor, which combine to become a product. When a
increases financing cost. product is sold, a receivable is created, which becomes cash when
collected.
PAYABLES AND ACCRUALS
The transformation process is conceptually important. In
PROS: CONS:
essence, the firm begins with cash, which turns into things that
On the liabilities side, more net Reduces spontaneous financing eventually turn back into cash. This enables it to buy more
working capital means smaller and thus increases the need for
inventory, which starts the cycle all over again.
payables and accruals balances costly external funding.
which comes from paying The Cash Conversion Time Line:
vendors and employees quickly,
which keeps them happy. ✓ A business’s operating cycle is the period from the
acquisition of inventory to the realization/collection of cash
from the sale of product.
 ✓ The cash conversion cycle is shorter by the period during Seasonally variable businesses give rise to the ideas of permanent
which the firm holds a payable for the inventory. Mas and temporary working capital.
shorter ang cash conversion cycle kasi may payables
✓ Permanent working capital to the extent that it supports a
deferral period na involved. Cash conversion is the time
constant or minimum level of sales. Usual businesses.
from disbursement of cash to pay for materials to the
✓ Working capital that supports operations above the
receipt of cash for product sold. Mula sa pag release ng
minimum level doesn’t need to be maintained year-round
cash pambili hanggang sa pagbenta ng product; Yung cash
and can be viewed as temporary. Temporary working
icoconvert mo, hence, cash lang ang involved.
capital can be thought of as supporting peak sales
Production labor is continuously added to inventory during the levels.
conversion to product process and is paid relatively quickly.
FINANCING NET WORKING CAPITAL
Administrative labor is being performed and paid all the time.
Working capital tends to be financed separately with short-term
The cash conversion concept is important because it
debt. Working capital differs from other assets because of its
contributes to our understanding of just how an ongoing
short-term nature leads to the idea that it may be appropriate to
business works.
support it separately with short-term financing rather than using
PERMANENT AND TEMPORARY WORKING CAPITAL the firm’s general pool of debt and equity capital.
A firm’s need for working capital varies directly with its sales Self–liquidating debt must be paid off when the item financed
level. The more it produces and sells, the larger its inventories becomes cash in the borrower’s hands.
have to be and generally the more receivables and cash it has to
WHAT IS A SELF-LIQUIDATING LOAN?
carry.
A self-liquidating loan (or self-liquidating offer) is a form of short-
➢ Approximate lang ang need na net working capital na dapat
or intermediate-term credit instrument that is repaid with money
sakto sa pagsupport ng business operations, ngayon para
generated by the assets it is used to purchase.
madeterming ung approximate na need, nakadepende sa
sales. No formula. ➢ In other terms, yung utang mo is babayaran gamit ng
income from the asset, which is the reason bakit ka
Temporary working capital supports seasonal peaks in business.
nangutang. Example, need mo ng capital for your sari-sari
Example of seasonal: Flower sellers during undas. store, so ang gagawin mo is mangutang money as start-up,
yung income from sari-sari store you will use to pay the
Some businesses operate at relatively even (pantay, constant)
utang. Short-term ung utang kasi mabayaran moa gad
sales levels year-round and therefore have more or less constant
pagnakabenta. Self-liquidating, bayaran niya sarili niya.
needs for working capital. In seasonal businesses, sales vary
throughout the year, as do working capital needs.Sales are The repayment schedule and maturity of a self-liquidating loan are
directly proportional to working capital. timed to coincide with when the assets are expected to produce
income. These loans are intended to finance purchases that will The Options Available to Most Companies – Most companies have
quickly and reliably generate cash. the option of financing at least some of their working capital needs
on a short-term basis. Loans aren’t always tied to specific assets,
Example: A merchant who has a store but no money for inventory
but they’re always short-term.
approaches a bank for a loan to buy products for his store. He
promises to pay as soon as his goods are sold. Firms CAN just about always use some of their long–term debt/
equity capital to finance working capital. Management has a
1. The loan is short-term because it will be paid off as soon as choice between using long-term and short-term funds.
the merchandise sells. Banks consider short-term loans
safer than those made for longer periods because they Maturity Matching Principle – The maturity matching principle
don’t allow much time for business conditions to advises that the term of financing MATCH the duration of the item
deteriorate before repayment is made. supported. The maturity matching concept says that the maturity
2. The bank can see exactly where the money to pay off the date of financing should be roughly matched to the duration of
loan will come from – the proceeds of the sale of the the asset or project being financed. A loan taken out to finance a
inventory purchased with the borrowed money. This is an project should be repayable at roughly the time of the project’s
important point; the loan is self–liquidating. The merchant completion. This makes the loan/project combination a self-
is not at liberty to do anything else with the sale proceeds liquidating proposition.
(di pwede galawin unless makabayad ka, reserved) until a
Short to Short (STS)
portion is used to pay off the loan. Such an arrangement is
Long to Long (LTL)
more secure than depending on the business’s general
profitability for repayment. For example, suppose a project requires a $1 million investment
Self–liquidating debt MUST be paid off when the item today and is expected to pay off $1.2 million in six months.
financed becomes cash in the borrower’s hands. Maturity matching implies that a firm should borrow the $1
3. The bank can demand that the merchant pledge the million for about six months and use the project’s proceeds to
inventory itself as security for the loan. Then if the product pay off the loan. Borrowing for a longer period will leave unused
isn’t sold and payment isn’t made, it can repossess and funds drawing interest after the project’s end. Borrowing for a
sell inventory. A similar case can be made for a loan based shorter period can result in default.
on receivables. • Default – failure to meet obligations/failure to pay.
Example: Danger of borrowing short, imagine that a firm borrows
These features enable banks to make working capital loans to $1 million for just three months with the intention of refinancing
businesses that wouldn’t qualify for general unsecured loans. The for the second three months. But suppose conditions change and
point is that working capital lends itself to short-term financing the lender refuses to refinance after the first three-month period.
by offering lenders elements of security that aren’t available The firm won’t be able to pay off the loan at that time because the
with loans for other purposes. project will not yet have generated the expected cash, which can
lead to default and potential bankruptcy.
 working capital assets remains constant. In the context of
In principle, it’s a good idea to match the duration of short- and maturity matching, the situation can be interpreted as appropriate
intermediate-term projects with the maturity of the financing for either short – or long-term financing.
supporting them. Very long-term projects should be financed
with equity, which has an indefinite duration, or with long-term Temporary working capital is more clearly of limited duration
debt lasting 20 to 40 years. (kasi seasonal) and therefore calls for short–term financing.
They can support it very largely with long–term sources using little
It’s also not a good idea to over finance a project. Example: or no short–term borrowing, or they can use short–term money
imagine that a new venture requires $6 million to get started, but extensively.
the owner manages to raise $10 million. Investors will expect a
high return on the entire $10 million, but will probably be Financing with long-term funds is safe but expensive. It’s safe
disappointed because earning opportunities are available for only because enough money is raised at the outset to cover anticipated
$6 million. Kasi akala nila may $10 million ka na nagegenerate working capital needs for a long time (naka-raise na ng enough
kaya sila nag invest, andon yong expectation. money from the start para ma-cover ung working capital needs,
hence walang fear na kulangin ng funds) and the firm is unlikely to
These guidelines shouldn’t be interpreted too literally. Modest ever to run short. It’s expensive because long-term rates of return
overfunding in both time and amount provides conservatism. In are generally higher than short-term rates (long-term have higher
our first example, if the $1.2 million is late coming in, borrowing a interest rates kasi volatile ang market, short-term naman fixed na
little long avoids missing (extend) the six month loan repayment kaya usually lower), and raising long-term money usually involves
date. In the second example, if the start-up is more expensive than paying flotation costs.
anticipated, a slightly larger initial loan might save the trouble and • Flotation – cost incurred when issuing new securities fees.
embarrassment of going back to investors a second time. Long-term financing is safe but expensive, while short-term
money is cheap but risky.
Short – and Long – Term Working Capital Financing Permanent
working capital can be financed long or short-term, but Short-term funds is cheap but risky. It’s cheap because [short
temporary needs should be supported with short-term funds. rates are generally lower than long rates], and the transaction
costs of raising money are relatively small (kasi mababa nga ang
Permanent working capital CAN BE long or short term have interest rate). Borrowing short-term is risky because every time a
constant sales. new loan is required, the firm has to face a new set of market
Temporary needs should be supported with ONLY short-term conditions (bagong utang, bagong contract).
funds.
Example: If interest rates rise over time, a company borrowing
It’s easy to see that maturity matching doesn’t give us a clear short-term will have to pay increasing market rates (kasi ang loan
prescription in the case of permanent working capital. and interest need mag equate sa market rate, therefore need mag
Although the inventories and receivables financed are clearly adjust). These may turn out to be higher than the long-term rate
short-term, they’re continuously replaced so the level of the that was available initially.
 b.) Short- term funds support all of temporary and much of
There’s also a possibility that money can become so tight that permanent working capital. The policy is aggressive in that
financing isn’t available at any rate. If that happens, the firm may some risk is being taken to reduce cost. A drying up of short-
not be able to finance working capital at all, which can seriously term funds could make normal business operations very
affect its survival. difficult.
Aggressive – short-term funding
Alternative Policies The result of all this is that the degree to
which a firm uses short-term financing to support working WORKING CAPITAL POLICY
capital is an issue of policy. Working capital policy refers to the firm’s policies on four sub
issues.
Conservative –working capital is conservative if long-term funding 1. How much working capital is used?
is used predominantly (mainly). The mix of short or long-term 2. How long/ the extent to which working capital is supported
working capital financing is a matter of policy. The use of longer- by short versus long term financing?
term funds reflects conservatism. 3. The nature/source of any short-term financing used.
4. How each component of working capital is managed.
Finance all permanent and half of temporary working capital long-
term and half of temporary working capital short-term. SOURCES OF SHORT-TERM FINANCING
Working capital is the major reason most firms seek short-
a.) Short-term funding supports only the peaks of temporary term loans. It’s worth noting explicitly that short-term financing
working capital. When temporary working capital is low and is ALWAYS debt of one form or another.
the total funding requirement is below the long-term level, the Sources of short-term financing into the following four categories
excess funds are invested in short-term marketable securities and review each in some detail:
(typical investor mindset). Conservative in that there’s very 1. Spontaneous financing consisting of accounts payable and
little risk of being unable to fund ups and downs in working accruals (current liabilities).
capital. Its costs tends to be fairly high. 2. Unsecured bank loans
3. Commercial paper
Conservative – expensive long-term funding and the excess is 4. Secured loans, which may be from banks or other sources.
invested in short-term securities.
SPONTANEOUS FINANCING
Aggressive – working capital is aggressive if relatively more short- Accruals arise because firms receive services continually but
term funding is used. make payments at fixed intervals. Accruals are made for any
number of other services and obligations such as property taxes,
Finance only half of permanent working capital long-term and the insurance, and rents. Effectively, they’re interest-free loans from
other half of permanent along with all of temporary working capital whoever provides the service.
short-term.
Payables and accruals arise in the normal course of business and 2/10, net 30
represent spontaneous financing (automatic).
The net amount of the invoice is due within 30 days, but a 2%
Accruals, especially for labor, tend to be very short-term. They’re prompt payment discount may be taken if payment is made in 10
liquidated every week or two on payday and are also not days or less. Any combination of discount period, net period, and
controllable. Labor market practices and tax laws dictate when discount is possible.
payments have to be made with little or no flexibility. Accruals
provide a modest financing advantage, but they’re not a policy Trade credit is implicitly costless only during the prompt
issue. payment discount period. Because you still have the chance to
take the discount, and after the expiration of the discount period,
➢ Accruals are incurred expenses that is yet to be paid. the discount rate becomes the interest rate of the spontaneous
They’re interest-free and short-term. Provides a modest financing.
financing advantage and is not a policy issue. Interval
magbayad. Preferred Interpretation: You can also interpret it as the true price
of goods is 98% of the invoiced amount and 2% is a penalty for
Accounts Payable – Trade Credit Most sales between companies not paying quickly.
are made on credit. The buying firm receives the goods and is
expected to pay for them at a specified later date. Effectively, The Prompt Payment Discount The early payment discount is
the selling company lends the buyer the purchase price, typically a very generous offer on the part of the vendor (seller).
without interest, from the time the goods are shipped until the
payment is made. The practice is called extending trade credit to Passing prompt payment discounts is generally a very expensive
the customer. source of financing. Kasi imbis na discounted ung purchase, di mo
tinake edi magbabayad ka ng buo, di ka naka-save.
There’s typically no security and very little contractual support
for trade credit. The contract between the parties is limited to Abuse of Trade Credit Terms On its face, trade credit is purely a
the terms written on the buyer’s purchase order and the customer accommodation, and it is already expected. Vendors
seller’s invoice. offer credit because they HAVE TO rather than they want to.

Trade credit is an attractive source of financing because it’s Stretching payables or leaning on trade is a common abuse of
free. However, it is typically extended for very long periods. trade credit. The trade-credit relationship can become somewhat
adversarial, with customers abusing credit privileges when they
Credit Terms A vendor’s terms of sale specify the number of can. Paying late, beyond the net date specified in a vendor’s
days after delivery that payment is expected (pagkadeliver, ilang invoice (Gusto nila late magbayad kasi gusto nilang may pera pa
days na palugit para magbayad ka; deadline ng payment mo). In silang hawak). Most firms, however, do at least a little stretching if
most cases, a discount is offered for earlier payment. they can. Prompt payment discount after the specified period has
elapsed.
Vendors will tolerate a limited amount of abuse because they want can use promissory notes to confirm the agreed terms of a loan. In
to keep the customer’s business (customer retention). But if the short, a promissory note allows anyone to act as a lender.
practice becomes excessive, the customer is labeled a slow payer
and can find itself with problems. Slow – paying customers can be Line of Credit is an informal revocable borrowing limit offered
cut off from further shipments until debts are caught up or can be by banks. It is a relatively informal, nonbinding agreement
refused product unless payment is made in advance. between the bank and the borrowing firm that specifies the
maximum amount that can be borrowed during a particular
Slow-paying companies receive poor credit ratings in credit period. A line of credit is a revolving loan that allows you to access
reports issued by credit agencies. money as you need it up to a certain limit. You can borrow up to
that limit again as the money is repaid.
Vendors usually report slow payers to a credit agency (credit
bureau). Credit agencies prepare credit reports on all companies. Example: A firm with a $100,000 line of credit could have up to
When new customers approach vendors asking for trade credit, $20,000 promissory notes outstanding at any time during a year,
it’s customary to consult an agency about applicant’s record. A but because it is nonbinding, the bank could reduce the line at any
bad credit rating from a credit agency generally prevents a firm time. However, it could not shorten the term of any note that had
from getting trade credit. already been signed. An amount borrowed under a line of credit is
said to take down the line by that amount.
UNSECURED BANK LOANS
Bank loans are the primary source of short-term financing for Under a line of credit agreement, the borrower pays interest
most companies, and are primary business of commercial banks, only on amounts borrowed.
which can be secured or unsecured.
Credit lines are generally unsecured, meaning the loans are not
Promissory Note is a traditional bank lending arrangement. A backed by specific assets (no collateral) and the bank relies only
note (contract) is signed promising to repay the amount borrowed on the general creditworthiness of the borrower for repayment.
at a definite future date along with a specified amount of
interest. Sometimes a schedule of repayment is stipulated. The REVOLVING CREDIT AGREEMENT
note also stipulates the nature of supporting collateral and other A revolving credit agreement is an irrevocable borrowing limit
terms and conditions. Secured because of collateral. requiring a commitment fee on the unused amount.

When the agreement is signed, the bank generally credits the A revolving credit agreement is similar to a line of credit except
amount borrowed directly into the borrowing firm’s checking that the guarantees the availability of funds up to a maximum
account. amount during the specified period. A revolver is essentially a
binding line of credit. It is generally unsecured.
A promissory note is a written promise by one party to make a
payment of money at a date in the future. Although potentially The bank’s commitment to advance funds up to a maximum in a
issued by financial institutions, other organizations or individuals revolver isn’t free. The borrower is required to pay a commitment
fee on the unborrowed balance of the agreement whether it’s used Firms typically maintain positive cash balances in their checking
or not. Commitment fees are in the neighborhood of one quarter accounts most of the time anyway, so an average balance
of 1% per year. requirement may not present much of a problem. If that’s the
case, the effective interest rate on the loan isn’t necessarily raised
The interest rates on revolving credit agreements are generally very much. Compensating balances are typically between 10%
variable (paiba-iba). They’re usually specified relative to the bank’s and 20% of amounts loaned.
prime rate, which is the rate it charges its largest and most
creditworthy corporate customers. The interest rate on a smaller Clean- Up Requirements Most banks require that borrowers
firm’s revolving debt is likely to be stated as prime plus 2 or 3 clean up short-term loans once a year. Theoretically, a firm can
%. maintain a balance of short-term debt all the time by borrowing on
a new note to pay off each old one as it comes due (utang lang ng
Compensating Balances short-term bank loans come with a utang ng short-term pagkatapos bayaran. Pagkabayad ng short-
feature that seems outrageously unfair to the borrower but is just a term, utang ulit ng another short-term). Doing that makes it
roundabout way of compensating the bank for its services. A possible to fund long-term projects with short-term money (kung
compensating balance is a minimum percentage of the loan uutang ka ng uutang paulit-ulit g short-term, pwede ka makatapos
amount that has to be left in the borrower’s account and is ng long-term na project; example, para magtayo ng building
therefore unavailable for use. Restricted. kelangan mo pera so uutang ka ng uutang ng short-term/
babayaran mo agad, hanggang sa matapos yong building),
For example, if a firm borrows $100,000 subject to 20% refinancing the debt again and again throughout the life of the
compensating balance, the bank will deposit $100,000 in the project.
company’s account, but only $80,000 can be drawn out and used.
It is risky because:
Compensating balances increase the effective interest rate on the 1. Short-term rates rise, and interest expense can increase
loan. quickly, putting a strain on the firm’s profitability.
2. If refinancing funds become unavailable, a default on the
A compensating balance requires leaving a portion of the loan on short-term notes is likely as they come due.
deposit raising the effective interest rate.
• Default- failure to meet legal obligations of a loan
There are two kinds of compensating balance. • Foreclose- repossession, liens, security/assurance
1. Minimum balance requirement
2. Average balance requirement which may not have as This kind of risk for a borrowing company is also risk for the bank,
severe an effect. The average daily balance over a month because a defaulted customer is likely to mean a lending loss.
cannot fall below a specified level. That means the entire Banks try to keep customers from falling (help them avoid) into
loan can be used but not all the time. the trap of using short-term funds to support long-term projects.
The banks’ approach is the clean-up requirement. They simply organizations. It pays low-interest rates, typically about half a
require that borrowers pay off all unsecured short-term debt point above the three-month Treasury bill rate. Rather than bearing
periodically and remain out of debt for a specified period an interest, the notes are discounted like T-bills. This means that
(bayad ng short-term tapos for a period wag muna magkautang). the interest is taken out of the price when the note is sold.
Most clean-up requirements stipulate that borrowers be out of
short-term debt for 30 to 45 days once a year. Example: A six-month, $1 million note paying an annual rate of 6%
would sell for ($1M/1.03) $970, 874.
COMMERCIAL PAPER
Commercial paper is short-term borrowing done by the largest CONS: Commercial paper has one drawback even for the large,
corporations. Commercial paper refers to notes issued by large, strong companies that issue it. The commercial paper market is
strong companies to borrow money from investors for very rigid and formal. If a company is a little short of cash when a
relatively short periods. The paper itself is simply a promise to note is due, there’s no flexibility in repayment terms. Banks, on the
repay the money borrowed on a given date. Conceptually, other hand, are generally willing to bend a little to accommodate
commercial paper is simply a very short-term corporate bond, business ups and downs. Hindi kasi banks ang nagpapautang sa
but there are administrative differences. kanila, kundi insurance companies, money market mutual funds,
banks, and pension funds.
Buyers and Sellers commercial paper is unsecured debt issued
by a limited number of nation’s largest and strongest company. It SHORT–TERM CREDIT SECURED BY CURRENT ASSETS
tends to be purchased by other large organizations that have Several short-term financing arrangements are available in which
excess funds to invest for short periods (ang lending way is debt is secured by the current asset financed.
ibebenta ng entity ung commercial paper nila sa other companies,
so ang ending is parang investment type siya sa creditors). Several common arrangements enable firms to borrow to fund
Typically, buyers are insurance companies, money market mutual working capital using the value of the current assets
funds, banks, and pension funds. The notes are generally placed themselves to guarantee the loan. The assets that provide such
with buyers by dealers for a fee. credit security are accounts receivables and inventories. The
funding sources are often banks but can also be other financial
[Short-term = low-interest rate] institutions.

Maturity and Terms Commercial paper is a debt security of the Borrowing against receivables and inventories tends to be more
issuing corporation. It can be sold without SEC registration if its popular in some industries than in others. It’s common in
maturity is under 270 days and the buyers are “sophisticated” seasonal businesses where temporary working capital needs are
investors. Maturities generally range from 1 – 9 months, averaging substantial.
five or six.
The commitment, rules, and procedures vary considerably
Commercial paper is considered a very safe investment because between different arrangements. We’ll consider receivables
of its short maturity and the strength of the borrowing financing first and then inventory financing.
 Pledging can be accomplished in (2) two ways with respect to the
Receivables Financing accounts receivable represent cash that receivables offered as security. (1) A lender can provide a general
is to be received in the near future. Lending institutions are line of credit tied to all of the firm's receivables without reviewing
generally willing to recognize the value of this about to receive individual accounts in detail (may limit). The lender is unlikely to
money and will extend credit backed by that value where advance more than 75% of the receivables balance because of the
otherwise would not. A key lending issue is the collectability of risk that some accounts may not pay.
the receivables, which relates to the creditworthiness of the
firm’s customers rather than to its own creditworthiness. (2) In another approach, the lender reviews each receivable
Pledging and factoring receivable arrangements are common. (review as in tignan kung pwede pautangin o indi) individually,
considering the creditworthiness of the customer owing the
Pledging Accounts Receivable A borrowing firm can pledge money. Then funds are advanced only on the basis of acceptable
receivables by agreeing to use the cash collected only to pay off accounts. The lender is likely to advance as much as 90% of the
the loan. Pledging receivables involves using their cash value as balance of accounts accepted.
collateral for a loan. The borrower signs a binding agreement
stating that the money collected from pledged receivables will Under a straight pledging of receivables, the borrowing company
be used to satisfy the loan. continues to do all its OWN credit and collection functions. The
The distinguishing feature of the arrangement is that the lender is relying on the borrower mostly for the quality of the
receivables continue to belong to the borrowing firm, which assets securing the loan. Some banks offer billing and collection
receives the cash directly from its customers as it would in the services that borrowers can use for an additional fee.
absence of the pledging agreement. The company’s customers are
generally unaware that their obligations have been pledged (non- Pledging receivables is a relatively EXPENSIVE form of financing.
notification). Financing sources generally charge interest at rates of 2% to 5%
over prime plus an admin fee of 1% or 2% of the face value of all
Under a pledging arrangement, if a particular receivable proves receivables pledged.
uncollectible, the borrowing firm is not relieved (need parin
magbayad ng entity) of its obligation to lender. This feature is ➢ Pledging is paggamit ng value ng receivable as collateral sa
known as recourse (may habol). The lender is said to have utang. “Oy may utang sakin si Y na $XX amount, ibayad ko
recourse to the borrowing firm for the value of a defaulted yun sa utang ko sayo”. Yung receivable ni Y, pagmamay-ari
receivable. (Pag hindi nakabayad ung receivable na parin nung company na nagpledge nung receivable tapos
pinangcollateral, under with recourse term, hindi pa “free” yung yung makukuha niyang bayad don ibabayad niya rin directly
entity sa lender, kaya need parin bayaran nung entity yung lender sa inutangan niya. Hindi alam ni Y yung arrangement. Ang
na inutangan niya equivalent sa pinangcollateral niya). parang nangyari is “pinangako” lang yung receivable kasi
hindi pa nmn fully owned nung binentahan (lender). Pero if
Uncollectible accounts remain the responsibility of the hindi nakabayad si Y, hindi parin makakatakas sa utang si
borrower if the pledging agreement is with recourse. company kasi need niya bayaran yung inutang niya. In this
kasi sila parin ang may hawak ng accounts receivable, sila parin nagcocollect eh.
 case, yung pinangako niyang receivable na pambayad their needs. The companies that use the other services of factors
sana, na hindi nabayaran ay siya yung magbabayad. do so because they save money.
➢ It’s either lalagyan ng limit ng lender yung amount ng A factor is willing to:
receivable na iaaccept nila as collateral or rereview yung 1. Perform credit checks on potential customers.
creditworthiness nung uutang. 2. Advance cash on accounts it accepts or remit cash after
➢ Yung company parin ang kikilos to collect and pay. collection.
3. Collect cash from customers.
Factoring Receivables Factoring means selling receivables to a 4. Assume the bad debt risk when customers don’t pay.
finance company, which then becomes responsible for collection.
Factoring differs from other financing because it doesn’t involve Advance cash on accounts it accepts or remit cash after
borrowing. Factoring receivables means selling them at a collection. Cash advances can be done in either of two ways. The
discount to a financial organization called a factor, which can be a factor can pay the selling firm for a receivable when it’s sold or
commercial bank or a finance company. The cash from the sale when the underlying cash is collected from the customer
of the receivable provides financing to the selling company. (babayaran nung factor (or ung binentahan ng receivable) yung
firm na nagbenta from proceeds, regular sale lang ng receivables
When a receivable is factored, the factor takes possession of the pinakumplika lang netong text). If payment is made when the
obligation and generally becomes responsible for its receivable is taken over, the factor is out the cash until it
collection. In most cases, the customer owing the money is collects from the customer. Its fee includes interest despite the
notified (notification) to make payment directly to the factor fact that the receivables have been purchased and there really
rather than to the selling company. The factor covers its expenses isn’t a loan outstanding. Meaning nabenta na yung receivable (no
*Yung interest is profit.
and makes a profit from the difference between the face value of recourse) so meaning technically wala na utang kasi binayaran na
the receivable and what it pays the selling company. yung utang with receivable (no outstanding) , yung fee may interest
parin.
Factors generally review the credit standing of the customers
whose receivables they buy and don’t accept everything offered Receivable taken over (Pagkabili e kinuha agad without collecting
by the selling firm. Rejected accounts have to be handled by the anything beforehand) = factor out of cash until collection from
selling firm on its own. customer. Wala pang pera unless makabayad yung may-ari ng
receivable.
Companies factoring their receivables do it as a routine, by which
incoming orders are submitted directly to the factor and funded on If payment to the selling firm is delayed until cash is received from
an ongoing basis. It is called the basic factoring function. In the customer, the factor doesn’t charge any interest. In this
practice, factors offer a wide range of services with respect to arrangement, the factor isn’t financing the receivable, but only
receivables. They are willing to take over a firm’s credit and administering collections. If the selling firm do not pass the bad
collection function (taga collect yung hired na firm), which firm’s debt risk to factor, the factoring arrangement is done with
can select a menu of services and tailor an arrangement suit to recourse. In that case, bad debts are charged back to the seller.
financing receivable lang if walang interest if cash advance is through collection.
However, factors charge substantially more when there’s no A basic problem is the marketability of the inventory in the
recourse to the selling firm. hands of a lender. Unlike receivables, inventory doesn’t turn to
• Customer – customer of the firm selling the receivable. The cash by itself, because it has to be sold, and lenders are not
party owing the money that gives the receivable value. The equipped to do that. They have to dispose (sell) defaulted
firm selling the receivable is called the selling firm. inventory at bargain prices, which reduces the amount they
➢ Factoring is selling nung receivable at a DISCOUNT sa can lend on it.
factor or lender. Yung makuhang cash sa pagbenta ng
receivable ung magfifinance sa company; literal na benta Specialized inventory (unique or unusual parts) have little
for a price. Aware yung customers na binenta na yung collateral value because they’re difficult for a lender to sell.
receivable (along with the obligation to collect) kay factor. Perishable goods share a similar problem because their value is
➢ Paano yun? Ano nagcoconvince sa kanila bilhin yung lost by the time lender can take possession.
receivable? Syempre irereview nila yung creditworthiness.
➢ If hindi agad nabayaran ni factor yung binili niyang ➢ Hard to sell inventory = difficult, a problem, causes
receivable kasi yung payment terms e ung proceeds from reduction in selling price/lending price.
collections, walang interest kasi lugi nmn yung seller non.
Pero this makes it collecting nalang instead of financing Other commodity-type inventories are quite marketable and make
kasi nakadepende sa timing ng collection ng customer good loan collateral. Canned goods are example.
yung pambayad, hindi sa act of “sale” kasi hindi binayaran
agad pagkabenta. If an inventory does have an acceptable collateral value, its
➢ If without recourse, meaning di mahahabol nung factor ung availability in the event of a default must somehow be
selling firm pag di nagbayad yung receivable na binenta, guaranteed to the lender. This makes it difficult because the
mas mataas yung singil na payment ni factor kasi nga borrowing firm is continuously using and replacing inventory in
naman kelangan ng safety net or compensation incase na running its business. Several methods that involve varying
bad debt ung nabili nila. amounts of admin attention and cost are used.

Inventory Financing Inventory financing uses a firm’s inventory ➢ If yun nga mahirap itinda, kelangan may guarantee or other
as security for short-term loans. Financing secured by inventory collateral para di lugi.
is DIFFICULT because specialized or perishable items are hard
to sell. This method is popular but subject to several problems Blanket Liens A blanket lien gives the lender a lien against all
that can make it expensive and difficult to administer. inventories held by the borrower. The borrower remains in
complete physical control of the inventory, and can draw it down
➢ Challenging, problematic, difficult dahil sa nature nung to any level without the consulting the lender. May control parin
ititinda. Kung perishable ba yun, rare na mahirap itinda, etc yung borrower nung inventory tapos pwede niya kuhaan/bawasan
etc. yun without approval nung lender/hiniraman niya
 • Lien is a legal money claim attached to the specific signals the lender to look for repayment of the money lent to
property. The proceeds of the sale of the property must be finance that inventory. Warehousing companies specialize in
used to satisfy the lien. administering such arrangements. Safest kasi may proof na may
binawas.
Example: a firm borrows $600,000 collateralized by a blanket lien
on an inventory of $1 million verified by a bank representative on There are two kinds of warehousing arrangements:
the date the loan is disbursed. If the lender does not inspect the 1. Field warehouse –a secured area within the borrower’s own
operating facility, nothing prevents the borrower from suspending facility that’s accessible only to employees of the
inventory purchases while continuing to sell the existing stock warehousing firm. A floor-to-ceiling chain link fence can be
until its level has reached say $200,000. This can easily put the built to segregate open factory space for the purpose.
lender in an unsecured position unless it spends an inordinate Employees of the warehousing firm make themselves
amount of time and effort monitoring the borrower’s activities. available during designated hours each week.
Need iaudit or icheck ni lender yung inventory to make sure hindi 2. Public warehouse – is operated by the warehousing firm at
binawasan ni borrower. a site physically removed from the borrower’s facility. This
arrangement provides the lender with maximum security
Trust Receipt or Chattel Mortgage Agreement In this because the material is completely out of the borrower’s
arrangement, financed inventory is identified by serial number control.
and cannot be sold legally without the lender’s permission.
When items are sold, the proceeds must be used to repay the Warehousing gives lenders excellent security but tends to be
lender. The arrangement is legally binding, but the borrower is expensive because of the administrative cost of operating the
still in control of the inventory and might sell it without paying warehouse and tracking individual inventory items.
the lender. Guaranteeing that the borrower complies requires
inspection by the representatives of the lender. CASH MANAGEMENT
Good cash management can improve financial results, but it isn’t
➢ Yung inventory is may serial number, tapos legally owned ni likely to make a weak business strong. Bad cash management,
lender; hindi pwede basta basta ibenta ni borrower. Yung however, can make a strong company weak to the point of failure.
proceeds from selling that is ibabayad kay lender, kaso lang Among small firms, it isn’t uncommon for companies to be
control parin ni borrower yung inventories, so they might simultaneously profitable and bankrupt. In other words, a firm that
sell it tapos hindi ipambayad yung proceeds. Need parin doesn’t have the cash to pay its bills and meet its payroll goes out
iaudit or check ni lender. of business, regardless of how good its long-term prospects are.
For that reason, it pays to understand how cash oils the gears of
Warehousing Warehousing companies control secured business and how firms can get the most out of it.
inventories for the benefit of lenders. Under a warehousing
arrangement, financed inventory is placed in a warehouse and the
borrower’s access to it is controlled by a third party. When a
borrower draws a piece of inventory, paperwork is created that
 DEFINITIONS AND OBJECTIVES with respect to receipts. It’s therefore necessary to keep the
balance high enough to support routine operations. It’s especially
A firm’s cash is the money it has on hand in currency and in important to have enough cash on hand to take advantage of
bank checking accounts. The bulk of business cash is in prompt payment discounts offered by vendors.
checking accounts because very little commercial activity is
transacted in currency. Mahirap naman kasi na yung million mo e Precautionary Demand Emergencies arise with a little warning.
on cash parin, mas maganda na nakadeposit siya para hindi Example: unexpectedly damaging an order would require extra
susceptible sa theft and damages. labor and overtime rates. Firms keep cash on hand to pay for
• A bank checking account is known more formally as a such emergency needs.
demand deposit. The bank pays money out of the account
to third parties based on checks that represent the Speculative Demand Firms also keep cash available to take
demands of the account owner. In the normal course of advantage of unexpected opportunities. Suppose the price of a
business, when buyers and sellers know each other very particular input drops suddenly, but is expected to rise again
well checks are accepted as readily as currency. quickly. If cash is available, bargain can be had; if not, it has to
Therefore, the money available in the economy is defined to be passed up. Firms keep money on hand to take advantage of
include checking account balances. The financial such opportunities.
definition of cash follows the same (1) principle demand,
(2) precautionary demand, and (3) speculative demand. Compensating Balances Banks stay in business by investing the
The administrative reason for holding cash has to do with money individuals and companies deposit with them for a return.
compensating banks for the services they perform. It is customary for banks to require that depositors receiving
certain services maintain a minimum compensating balance to
Transactions Demand Firms need money in the bank to pay bills partially offset the cost of those services. It is equivalent to
for the goods and services they use. Payments are made to charging fees for services. Banks also require them for cashing
employees, vendors, utility companies, and taxing authorities. At checks and conducting a variety of transactions.
the same time, most receipts come in the form of checks that are
deposited in the bank. The constant flow of money in and out of The four reasons for holding cash aren’t entirely additive. Money
the bank gives rise to an average account balance that we available for transactions also provides some speculative and
associate with transactions. precautionary capability, and certainly contributes to meeting
compensating balance requirements.
Firms hold cash to make transactions as a precaution, for Summary:
speculative opportunities and to maintain compensating 1. Transactions Demand – for transactions, constant flow of money
balances. in and out. It’s especially important to have enough cash on
hand to take advantage of prompt payment discounts offered by
If firms had perfect knowledge of when cash would come in and vendors.
when it should go out, transactions balances could be kept very 2. Precautionary – for emergencies
low. However, we don’t generally have such knowledge, especially 3. Speculative – for opportunities
 4. Compensating Balance – Charging fees or minimum balance MARKETABLE SECURITIES
equal to a percentage of the loan. Precautionary and speculative motives call for having cash on hand
that isn’t used often. These demands can be largely satisfied by assets
The Objective of Cash Management Cash in bank doesn’t earn a that are only slightly less liquid than cash but earn a better return.
return. Banks don’t pay much interest on the balances in most
commercial checking accounts which means companies have to devote Marketable securities are liquid investments that can be held
a certain amount of their financial resources to maintaining cash in bank instead of cash and earn a modest return.
but receive little or no return on those resources. For this reason, it’s
desirable to operate with as little cash as possible. *financial resources such as compensating balances
Example: a firm invests its cash in short-term T-bills and has an
emergency need for funds. Because there’s a ready market for
Cash in bank have NO returns, and have no interest
kaya kailangan siya isupport ng other financial government debt, the securities can be sold within a day and the
resources. More cash in bank more financial proceeds used to satisfy the emergency need for funds. Since
resources expensed. Mas okay na onti lang cash in there’s a ready market for government debt, the securities can be
bank para not much financial resources expensed. sold within a day and the proceeds used to satisfy the emergency
need. T-bills pay a modest return on the invested funds. This
Good cash management implies maintaining adequate liquidity with compromise is known as investing in marketable securities. It
minimum cash in the bank. sacrifices a little liquidity for a modest but significant return.

It’s easier to run business with more cash than with less. A firm with a Marketable securities are short-term obligations of very strong
substantial bank balance will not be embarrassed by running out of
organizations, including T-bills and commercial paper. The fact
money. This is called liquidity. An adequately liquid firm will always be
that the securities are short-term is important because it insulates
able to pay its bills on time, take the appropriate discounts, and take
emergencies and opportunities in stride. them from changes in value due to interest rate fluctuations. The
word “marketable” implies that the issues can be sold quickly.
➢ Being liquid means away from financial insecurity kasi confident Marketable securities are also referred to as near cash or cash
na may pangbayad yung firm. equivalents.

Cash management involves striking a balance between these conflicting Investing excess cash in securities is a specialized function
objectives. Good cash management minimizes the amount of cash in carried out within the treasury department (investment). The
the bank, but at the same time ensures enough is available to concept of marketable securities and the fact that most large
operate efficiently. companies invest in them regularly are very important.
➢ Yun yung goal, pauntiin yung cash in bank kasi nga expensive
CHECK DISBURSEMENT AND COLLECTION PROCEDURE
siya since need ng financial resources.
The amount of cash companies need is related to the method by
which the financial system gets money from a paying organization
(the payer) to the receiving party (the payee). Understanding the
rudiments of this system is key to understanding cash
management.
The Basic Procedure for Transferring Cash
Check collection or clearing: Payees are interested in speeding the check-clearing process,
1. The payer writes a check on its bank and mails it to the while payers want to slow it down. Gusto nila mapabilis ung
payee (2-3 days) check-clearing process meaning gusto nilang mapabilis ung
2. The payee receives the check, records it, processes it delivery nung check papunta sa kanila/mareceive agad, parang
internally for deposit. parcel.
3. The payee then deposits the check in its own bank (2 days
item 2 and 3). Two important cash management:
4. The payee’s bank sends the check into the Federal 1. Perspective of a payee receiving money, speeding up the
Reserve’s interbank clearing system at a Federal Reserve collection of checks after they’ve been
Office. mailed gets cash in faster. Macollect agad
5. The clearing system processes the check. This transfers para may pera nako. LENDER
money from the payer’s account at its bank into the payee’s
account at is bank. The funds are now available for the
payee’s use. 2. Perspective of a payer, slowing down
the payment of checks after they’ve been
The length of time taken by each step is important. Float is money mailed gives a company use of its cash longer.
tied up in the check-clearing process. During the time checks are Mapabagal yung pagsend nung pera para may
in the mail they’re part of the mail float, and when they’re being pera pa ako. BORROWER
processed at the payee’s office they’re in processing float and
when they’re in the Federal Reserve System they’re in transit All companies are simultaneously payers and payees, so any firm
float. The money in the entire process is called check-cashing can use both ideas to reduce the funds that need to be committed
float or just float. to cash balances.

The farther the payer is located from the payee, the longer will be ACCELERATING CASH RECEIPTS
the mail float. If the payee’s bank is far from a Federal Reserve POV of the payee/LENDER, party
office, extra time may be required to get checks into the clearing receiving the money, and examine
system. approaches to accelerating the receipt of
cash.
Objectives in Managing the Check-Collection Process Check
collection-clearing process takes five or six days. The payee Lock Box Systems these are services
doesn’t have the use of the cash even though the payer has written provided by banks to accelerate the collection of cash once a
and mailed its check (kasi hindi pa hawak ni payee yung check has been mailed to a payee.
cash/check, in process or otw palang). Funds remain in a payer’s
account and are technically usable by the payer until the check
clears through the banking system.
The payment process involves the payer mailing a check which is
processed and deposited by the payee. Together, these steps take Concentration banks sweep excess balances in distant
four to five days. depository accounts into central locations daily. Concentration
banking is a system in which a single concentration bank manages
A lockbox system reduces this float period by moving the check the balances in remote accounts to target levels and sweeps
directly from the payer to the bank, eliminating the stop at the excess cash into its central location. Special documents called
payee’s office. Through this system, the payee rents a post office depository transfer checks are used to move funds from one
box near its bank and then orders payers to mail their checks to bank to another within a concentration network. Funds can also
the post office box rather than to its headquarters. The bank opens be moved electronically.
the box several times a day, collects the checks received, and
deposits them in the payee’s account which cuts an average of Wire Transfers move money electronically. The fastest way of
two or three days out of the whole process. moving money from one bank to another is electronic wire
transfer. Wire transfer is quick and secure, but the fees involved
Lock boxes are located near customers and shorten mail and make it too expensive for regular use with small sums.
processing float.
Preauthorized Checks When there’s a very good working
After the bank deposits the checks, copies are sent to the payee’s relationship between a payer and payee, preauthorized checks
office. Its internal processing is based on those copies after the can eliminate mail float. The payer (customer) gives the payee
deposit has been made and the clearing process has begun. (vendor) several signed check-like documents in advance.
Based on trust. When the payee (vendor) ships a product to the
Concentration Banking Large companies often have a great many payer (customer), it simply deposits a preauthorized check in its
depository results from multiple lockbox systems which also bank account which requires a certain amount of trust on the part
happens when firms have widespread retail outlets because each of the payer.
store has to deposit its receipts in a local bank every day. MANAGING CASH OUTFLOW
• Working banks usually have two kinds of admin purposes:
a.) Depository account which receives incoming cash POV of the payer/BORROWER. Goals:
b.) Outgoing checks are written on the disbursing maintain control of disbursements and
account. slow checks in the clearing process.

Holding cash in several small accounts tends to be Control Issues Most large companies are
administratively inefficient because of duplicated effort and decentralized (operating divisions in
lack of central control. It also makes it difficult to invest in locations remote from headquarters).
marketable securities, which tend to be traded in large sums.
When cash is separated into several small bundles under the Most agreements are done at the division level, and since cash
control of local divisions, no one has enough to take advantage of payments are a key element in processing the agreements, it
short-term investment opportunities. makes sense to place disbursing authority in the hands of
division management, which results in at least one disbursing EVALUATING THE COST OF CASH MANAGEMENT SERVICES
account at every division and leads to undesirable distribution To be effective, a cash management system must lower
of cash balances around the country. balances enough to save more in interest than it costs.

Zero Balance Accounts (ZBAs) Solve this control problem. They Cash management, especially the acceleration of receipts,
are empty disbursement accounts established at the firm’s reduces the financial resources firms have tied up in their cash
concentration bank for its various divisions. Divisions write accounts. The general implication is that firms can borrow less
checks on their ZBAs that are automatically funded as they’re money by the amount of the reduction in their cash balances
presented for payment. The funds come out of a master account and pay commensurately less interest. This saving has to be
at the concentration bank. ZBAs are subdivisions of the master measured against the cost of the cash management system to see
account; it never has a positive balance; it has a number and if it’s worthwhile.
receives statements that enable the division to use it to manage
its business just like any other checking account. Kapag Cash management systems are subject to significant economies
magrerelease lang sila ng check magkakaroon ng balance yung of scale, larger companies benefit more clearly from having
account. No balance, parang pag nagsulat na siya ng check with sophisticated systems than do smaller firms.
the amount needed, doon lang nila lalagyan ng laman yung
checking account enough/sakto sa sinulat sa check. CASH BUDGETING (FORECASTING)
An important part of cash management is planning cash flows in
Remote Disbursing Payers sometimes disburse checks from and out of the company on at least a monthly basis. Planning
remote banks to lengthen mail float and slow cash outflow. Sa cash is important because running out of money to pay bills and
malayo naglalabas ng pera para mas malayo at mas mabagal yung wages is at best embarrassing and at worst can lead to failure.
transaction. Payers would like to slow the check collection This process is called cash budgeting or cash forecasting and
process and expand float to prolong the time cash remains in their can be considered part of either financial planning or working
bank accounts. capital management.

Remote Disbursing is a way to keep checks in the bank clearing Cash budgeting begins with planning exactly when receipts and
system. If a check is written on a bank in a distant city or in a small disbursements will occur for each of the business functions that
city that isn’t the site of a Federal Reserve branch, it will take a day generate or require cash. Then inflows and outflows are summed
or two longer to leave the bank and get back to it. This delay has to arrive at net figures for each month of the planning period.
the effect of increasing transit float, keeping money in the payer’s
account longer. This makes it common for checks from large Monthly totals are accumulated into a running balance over the
companies to be drawn on small banks in out-of-the-way places. forecast period that can be either positive or negative.
a.) Positive figures – mean the company is building up cash in
the bank or paying down debt.
 b.) Negative figures – mean more cash is being paid out than credit. The management of receivables is a relatively unique
taken in, and the firm may have to borrow to meet its function in finance in that it involves interacting with customers,
obligations. something usually reserved for the sales department.

It’s that borrowing need that’s crucial. Firms need to know OBJECTIVES AND POLICY
approximately how much they’ll need to borrow in the near term
so loan arrangements can be made at a bank. Higher receivables improve sales and customer relations but lead
to more bad debts and interest expenses.
Forecasting with Time Lags
• Receipts (inflow) generally come from cash sales, Companies like to operate with as little tied up in receivables as
collecting receivables, borrowing, and selling stock. possible. Two reasons for that preference:
• Disbursement (outflow) includes paying for purchases, 1. Carrying fewer receivables minimizes the interest cost of
wages, taxes, and other expenses as well as dividends. supporting the receivable asset.
2. It minimizes bad debt losses because whenever money is
Receipts and disbursements follow sometime after a predictable owed, there’s a chance that it will never be collected.
event like a sale or purchase. The most problematic item is the
collection of accounts receivable – usually a firm’s largest There are trade-offs. A higher level of receivables generally
inflow. increases sales and leads to better customer relations.

It’s difficult to predict when cash from credit sales will be Managing accounts receivable means striking a balance
collected because we rarely know exactly when customers will between these effects. As receivables increase, sales tend to go
pay their bills. up, which increases profit. Interest cost and collection losses
increase which depresses profit.
As a result of that uncertainty, most planners base receipts
forecasts on the firm’s collections history, which shows the Interest Sales Profit
percentage of revenues usually collected in each month after a Interest cost Collection losses
sale. =
Profit
The firm collects revenues according to time-lagged pattern;
payables are handled similarly, however, disbursements are The focus of the trade-off is at the EBT (earnings before tax, after
easier to forecast because the date on which a check is written ebit) level. Managing receivables means finding the point at which
and mailed is under the firm’s control. profitability is maximized because of the opposing forces, NOT
MANAGING ACCOUNTS RECEIVABLE the point at which sales are maximized.

A firm’s accounts receivable represents the obligations of The receivables policy involves credit standards, terms, and
customers for future payments that arise when sales are made on collection procedures.
The things firms do to influence profitability through receivables old customer wants to buy more on credit than it has previously,
management are collectively called receivables policy or credit the credit department has the responsibility of approving or
and collections policy. Issues involved: disapproving the request.
1. Credit Policy: How financially strong must a customer be
for the firm to sell to it on credit? The department investigates the creditworthiness of the customer
2. What terms of sale (due dates and discounts) should be using a number of information sources. These sources include the
offered to credit customers? reports of credit agencies (also called credit bureau), the
3. Collections policy: How should customers whose bills customer’s own financial statements, bank references, and the
aren’t paid on time be handled? customer’s reputation among other vendors.

Who Is Responsible for Receivables Policy? The receivables The primary source of information is usually the report of a credit
policy is under the control of financial management and has a agency, an organization that keeps files on the financial condition
major effect on sales, which is why most policy decisions are joint and bill paying records of vast numbers of companies. For a fee,
efforts between financial and sales/marketing management. It’s the credit agency will provide a vendor with a report on any
not unusual for this shared area of responsibility to create quite a customer or potential customer.
bit of conflict between the two organizations.
A firm’s credit policy is a statement of the minimum customer
DETERMINANTS OF THE RECEIVABLE BALANCE quality it will accept for credit sales. A company’s credit policy
The size of a firm’s receivables balance is determined primarily by revolves around how good a risk a customer has to be before it
the level of its credit sales. The more it sells for cash, the will extend credit. A typical policy might require that a customer:
smaller will be its receivables, and the fewer associated • Be in business at least three years.
problems it will have (inverse relationship). It is axiomatic that • Have a net worth of three times the amount of credit
everyone prefers to sell for cash when they can. Industrial custom requested.
doesn’t permit many interbusiness cash sales, and receivables • Have a current ratio of 2.5:1 or higher, and
are substantial for most firms. • Have no adverse comments on its credit report from other
• Industrial custom – the custom is reversed in consumer vendors.
markets where retailers usually demand cash at the time of
sale, either from the customer or from a credit card If the conditions aren’t met, the firm will sell to the customer only
company. on a cash basis. It’s important to understand that customers
whose credit applications are disapproved generally do not buy
Credit Policy is the most important decision variable available from the firm. They either can’t because they don’t have the cash,
for influencing the level of receivables. It determines the or they can find another vendor with a more liberal policy.
customers to whom a company is willing to make credit sales.
A tighter credit policy, meaning higher-quality requirements for
Most firms have credit departments staffed by credit credit customers, generally has the effect of reducing sales. On
specialists. When an order is received from a new customer, or an the other hand, a looser credit policy accepts lower-quality
customers and increases sales. However, some of the share the information with the credit department. Credit
incremental customers brought in by a looser policy generally personnel therefore may harbor some resentment toward
prove unable or unwilling to pay their bills which results in a salespeople when receivables go sour.
credit loss (bad debt loss) of the value of their receivables. The
frequency of bad debt losses tends to increase substantially as The Terms of Sale Credit sales are made on terms that specify the
credit policy is relaxed. number of days after which the net payment is due and a period
during which a prompt payment discount may be taken.
Setting credit policy requires striking a balance between these
effects. We want to maximize profit. Terms can affect receivables in two ways:
1. Shortening or extending the net period tends to affect the
The Conflict with Sales over Credit Policy There are often length of time a nondelinquent customer takes to pay its
conflicts between the sales and credit departments. The job of the bill. Shortening the term would reduce the receivables
sales department is generally to sell as much product as it can. balance. Companies don’t have a great deal of latitude in
When salespeople’s compensation is based on commissions, the making the net period shorter than whatever is customary
task becomes a personal challenge. The philosophy in most in the industry.
companies is that the salesperson delivers a willing buyer to the 2. The prompt payment discount tends to be a more
credit department, which then approves or disapproves a credit effective policy variable.
sale.
More on: Prompt Payment Discount – is usually an effective tool
If the sale is approved, the customer gets the product on credit, for managing receivables. A generous discount usually reduces
the salesperson gets their commission, and everyone is happy. If receivables balances because customers pay quickly to save
the credit sale is disapproved, it is lost which means that the money. Discounts are expensive for the firm giving them.
salesperson doesn’t get a commission and their efforts go down
the drain. Occasionally, prompt payment discounts don’t help to reduce
receivables at all. Hindi kinukuha yung discount kasi walang cash
However, if the credit sale is approved and the customer fails to pambayad since cash ang payment basis to avail discounts. That
pay, it is assumed that the salesperson will be charged back. That happens when a firm’s customers are too cash-poor to take the
isn’t the case, however. The credit decision is viewed as strictly the discount regardless of how attractive it is (which is often the case
responsibility of the credit department, so the blame for a bad for struggling businesses). In such situations, increasing the
debt loss is laid at its door alone and the salesperson gets to keep discount to reduce receivables can backfire and cost money
the commission. because only customers who are already paying promptly take the
increased discount.
This practice creates a counterproductive conflict of interest.
Salespeople are generally in close contact with customers and Collections Policy A firm’s credit department is usually closely
may be aware of things no one else knows about. But if those connected with its collections department. The function of the
things are negative, the commission system motivates them not to collections department is to follow up on overdue receivables to
get delinquent customers to pay their bills. This process is called collected. They use the same techniques as the selling firm but
dunning the debtor. Guilt-tripping, or harassing the debtor para tend to be more persistent, aggressive, and threatening.
matakot at magbayad na.
If the agency isn’t successful, a lawsuit can be filed against the
Dunning is the process of following up on overdue receivables. delinquent customer. The filing can be handled by either the
company or the collection agency. If the suit is successful, the
The normal procedure begins with mailing a polite reminder that firm is awarded by the court which still may not be collectible if
payment is overdue a few days after the net date on the invoice. If the customer is missing or bankrupt.
payment isn’t received, 2 or 3 additional dunning letters follow
using progressively stronger language. After this phone calls are Collection policy is the manner and aggressiveness with which a
made first to the customer’s payables department and then to firm pursues payment from delinquent customers.
responsible executives. If a customer is substantially in arrears,
further shipments are stopped until some payment is received. A company’s collections policy determines how quickly and
aggressively it pursues overdue accounts.
In the majority of cases, unpaid bills are the result of some
product or admin problem. An example is when a product Collections and Customer Relations Overly aggressive
purchased doesn’t work as expected, many firms don’t pay the collection efforts can damage customer relations.
bill. The collections department gets the customer together with
the firm’s sales and service personnel to try to straighten out the INVENTORY MANAGEMENT
problem. Inventory is a product held for sale to customers. In retailing
operations, inventory management is critically important but
Another common problem involves mismatches between the relatively simple, while in manufacturing it can be as complex as it
firm’s invoice and what the customer’s records show as having is crucial. Most service businesses carry only incidental
been ordered and received. If these don’t match exactly, many inventories, so the issue is minor. In any business in which
organizations don’t pay. The collections department works to inventory is significant, its mismanagement has the potential
reconcile the paperwork and get the bill paid. to ruin the company.

Collection agencies specialize in pursuing overdue accounts

and are usually very aggressive. WHO IS RESPONSIBLE FOR INVENTORIES
Unlike cash and receivables, inventory is virtually never the
In cases customers don’t pay because they don’t have the cash or direct responsibility of the finance department. It is usually
are disreputable and just don’t pay bills until they’re forced to. managed by a functional area such as manufacturing or
When that happens, letters and phone calls don’t work, and the operations. The executives in charge of those areas generally have
account is eventually turned over to a collection agency. a broad latitude in choosing inventory levels and management
Collection agencies are companies that specialize in dunning and methods.
collecting overdue accounts for a percentage of the amounts
Finance has an oversight responsibility for inventory
management. In manufacturing, stockouts disrupt operations and cause idle
time and missed schedules, which cost money. At the point of
Finance gets involved in an oversight or policing way. If inventory sale, stockouts mean customers don’t get what they want right
levels become too high, the financial management has to call away. That causes dissatisfaction and can drive customers to
attention to the fact that things might be run more efficiently. other suppliers which means lost sales. Too many stockouts can
Financial people generally monitor the level of lost or obsolete drive customers away permanently.
inventory that has to be written off and ensure that it doesn’t
become excessive. They also supervise periodic physical All in all, carrying more active, usable inventory makes operations
inventories (count) that reconcile quantities actually on hand. run more smoothly, improves customer relations, and increases
sales.
The finance department does not itself manage the typical • Carrying extra obsolete or damaged inventory doesn’t
firm’s inventory, but it has the responsibility to ensure that convey these benefits. We must look beyond the dollar
those who do manage it act cost-effectively. Supervise. inventory figure on the balance sheet to see whether the
firm has enough or too much.
BENEFITS AND COSTS OF CARRYING INVENTORY
For firms in which inventory is important, it’s easier to operate with The Cost of Carrying Inventory Keeping inventory on hand takes
more usable inventory than with less. However, carrying the extra money. More inventory means fewer lost sales and production
material costs money, so there’s a trade-off between the cost delays but more carrying costs. The reasons can be separated into
and benefit. Inventory management aims to find a level that’s traditional costs of inventory and potential losses in its value. Both
close too optimal in balancing the pluses against the minuses. increase with the amount of inventory carried.
Traditional costs associated with holding inventory:
The Benefits of Carrying Adequate Inventory In manufacturing, • Interest: Firms have to pay a return on the funds they used to
inventory separates and smooths out the work of different acquire inventory just as they do on any other asset.
production departments. Avoid idle time or delays by stocking • Storage and security: Inventory takes up space and is often
“backup” inventory in case of emergencies. subject to pilfering (theft). Storage space has to be provided
along with security to prevent theft.
• Insurance: Firms generally buy insurance to protect themselves
In any business, carrying more inventory rather than less reduces
against large inventory losses due to fire, theft, or natural
stockouts and backorders. disaster.
• Stockout – a stockout occurs when something the • Taxes: Many states and localities levy a tax on the value of
company doesn’t have on hand is needed in production inventory.
or by a customer. The firm is out of stock on the item and
places a backorder with its suppliers to get it. Several phenomena cause inventory to lose value. The more inventory
• Backorder – implies the order is remedial in the sense that a firm carries, the more it exposes to risk of loss from each of the
the item is currently needed, and usually implies a request following causes and the higher is its overall loss.
for expedited handling.
 • Shrinkage: In spite of security measures, some inventory problems, and then trying to achieve that level of efficiency with the
inevitably disappears. Such vanishing, presumably due to theft, minimum inventory cost.
is known as shrinkage.
• Spoilage: Many items have limited shelf life, after which they lose There’s no single, all-encompassing approach to managing inventory.
their value partially or entirely. Even when inventory monitored Success is achieved through frequent reviews, attention to detail, and
carefully, some spoilage of perishable items is expected. the use of a variety of mechanized and manual systems.
• Breakage: Inventory in stock can be run over, stepped on, leaked
on or into, or broken in any number of ways. Carrying cost = inventory held
• Obsolescence: New products often do jobs better, faster, or Ordering cost = number of orders placed
cheaper than their predecessors. When that happens, the old
products lose value rapidly because no one wants them unless
their prices are heavily discounted. ECONOMIC ORDER QUANTITY (EOQ)

The cost and losses together can be called the carrying cost of The EOQ attempts to minimize inventory costs. Carrying costs increase
inventory. with the amount of inventory held while ordering costs increase with
the number of orders placed to replenish depleted stocks. The total
Ordering Costs The process of ordering and receiving goods generates a cost of having inventory is the sum of the two.
different sort of inventory–related expense. The carrying costs we’ve
talked about so far depend on the amount of inventory on hand during a Carrying Cost + Ordering Cost = Total cost of having inventory
period. Ordering costs reflect the expenses of placing orders with
suppliers, receiving shipments, and processing materials into inventory. The EOQ model is an approach to minimize total inventory cost by
These costs are related to the number of orders placed RATHER than recognizing that under certain conditions there’s a trade-off between
to the amount of inventory held. carrying cost and ordering cost.

INVENTORY CONTROL AND MANAGEMENT The model assumes that carrying costs vary directly with the average
inventory balance (AIB) and that ordering costs are fixed on a per-
Companies develop systems for tracking and controlling inventories. order basis.
The cost of such systems and the people to run them are additional
expenses associated with inventory. This kind of cost does not increase Carrying cost = C(Q/2)
with incremental inventory or orders. It’s tied to the number of different
pieces carried and the way they’re used. The total carrying cost can be reduced by ordering more frequently in
smaller quantities. If Q were smaller, the graph would have more saw-
Inventory management refers to the overall way a firm controls toothed peaks but each would be lower and the average quantity on
inventory and its cost. hand (Q/2) would be lower.

Inventory management refers to the overall way a company oversees its Ordering more frequently will increase the number of orders placed
inventory and uses its control system to manage the benefits of carrying each year. Each order costs a fixed amount, this increases the total
inventory against cost. The process is defining an acceptable level of ordering cost.
operating efficiency in terms of stockouts, backorders, and production N = D/Q
If the fixed cost per order is F, the total ordering cost If the usage rate increases after an order is placed, the stock will
diminish faster than planned and the inventory balance will dip into
Ordering cost = FN = F (D/Q) safety stock range.

This expression increases as order size decreases as Q is in the Its also easy to see that a delay in delivery after a reorder will cause a dip
denominator. Total inventory cost TC is the sum of carrying cost and into safety stock. It will also result in a stockout if there were no safety
ordering cost. stock.

TC = C Q/2 + F D/Q Safety Stock and the EOQ The inclusion of safety stocks does not
change the EOQ. It just increases the total cost of inventory by
Carrying cost increases and ordering cost decreases with order size, Q. carrying cost of the safety stock. The EOQ model sits on top of a safety
The sum of these costs, TC, first decreases and then increases as Q gets stock model.
larger.
The Right Level of Safety Stock Choosing a safety stock level involves
It’s possible to choose an optimal order size that minimizes the cost of another cost trade-off. The extra inventory increases carrying cost but
inventory. The value of Q is known as EOQ. It is directly below the avoids losses from production delays and missed sales. These opposing
minimum point on the total cost line. effects have to be balanced in the choice of appropriate inventory. The
choice can be difficult because the savings aren’t visible. They’re the
SAFETY STOCKS, REORDER POINTS, AND LEAD TIMES result of problems that didn’t happen, so they don’t appear anywhere in
the FS. The carrying cost however, is very visible and measurable.
It assumes an instantaneous delivery of parts whenever needed. Usage
rates vary and restocking orders don’t always arrive on time. It’s rarely advisable to carry so much safety inventory that stockouts are
avoided entirely. It would require a huge amount of inventory at an
These factors cause firms to run out of inventory and suffer problems excessive cost. It is best to tolerate occasional outage to keep inventory
associated with stockouts. Safety stock provides a buffer against levels reasonable. In some businesses, backorders are filled quickly,
unexpectedly rapid use or delayed delivery. It also avoids emergency outages don’t cause a lot of trouble, and safety stocks can be
outages, because it is simply an additional supply of inventory that is minimal.
carried all the time to be used when normal working stocks run out.
TRACKING INVENTORIES – THE ABC SYSTEM
Lead Times and Reorder Points Restocking order has to be placed in
advance of the time at which it’s needed. The advance period (ordering The amount of attention that should be given to controlling inventories of
lead time) is estimated by the item’s supplier. particular items varies with the nature and cost of the item.

As time passes, the quantity on hand diminishes along the diagonal line An ABC system segregates items by value and places tighter control on
until the reorder point is reached. At that time, an order for resupply is higher–cost pieces. Items designated A are important because of their
placed with the supplier. The reorder point is calculated so that the value or the consequences of running out, and are carefully controlled.
expected usage during the ordering lead time will bring the stock to its They’re usually serialized, kept under lock and key, and signed out to
lowest planned level just as the new supply is delivered. responsible individuals. C items are cheap and plentiful, kept in a bin
accessible to anyone, and reordered when the bin gets low. B items are
between As and Cs.
Recognizing that inventory items differ in importance enables
companies to keep control costs low.

JUST IN TIME (JIT) INVENTORY SYSTEMS

JIT eliminates manufacturing inventory by pushing it back on suppliers. A

manufacturing inventory concept developed by the Japanese has
received a lot of publicity. In theory, JIT system virtually eliminates
factory inventory. Under JIT, suppliers deliver goods to manufacturers
just in time (within a few hours) to be used in production. This idea
requires a great deal of faith and cooperation between a manufacturer
and its suppliers because a late delivery can stop a factory’s entire
production line.

Under JIT, the manufacturer is essentially pushing the task of carrying

inventory back to suppliers. The suppliers will push their inventory back
onto its suppliers, which do the same to their suppliers. The entire
production chain works in a coordinated manner, largely eliminating
inventories.

The idea sounds good in theory and does not work under certain
conditions but hasn’t proven as successful as its proponents originally
hoped. In many situations, it doesn’t work at all.

JIT works best when the manufacturer is very large and powerful with
respect to the supplier and buys most of the suppliers output. The
supplier willing to do almost anything to keep the manufacturer’s
business, including orchestrating JIT deliveries. The concept works really
well only when the supplier is located near enough to the manufacturer
that shipping delays are not a problem.

The idea was originally developed by Toyota in Japan.

Smaller companies that don’t have any clout over suppliers that are
located far away may find this concept practical. Suppliers have little
incentive to go to the trouble and expense of making the precise and
timely deliveries that Jit requires.