Financial Management Fundamentals

Cash and Accounts Receivable Management


Cash is the most liquid of a company’s assets.  Cash is the sum of currency and checking account deposits a company has. The cash management function involves:


(1) determining the optimal liquid asset balance to maintain,

(2) efficient collection and disbursement of cash.


a)     Objectives.


·      To keep this non-earning asset to the minimum

Holding of excess liquid assets results in an opportunity cost resulting from the income that the firm could earn if these funds were invested in other productive assets.


·      However not to run out of cash.

Inadequate liquid balances result in "shortage" costs such as missing cash discounts, deterioration of the firm's credit rating, higher interest costs on borrowed funds, and the risk of insolvency.



b)     Reasons for holding Cash.


·      Cash required for expenses, supplies, taxes, payroll, acquiring fixed assets etc. (also what is known as Business Transactions.)

·      Minimum Balance to be kept in the Bank.

·      Precautionary balances (for emergency purposes) where inflows are not certain.









Cash inflows and outflows are seldom synchronized.

The first step in cash management is development of a cash budget

showing the forecasted receipts and disbursement as well as a forecast of any cumulative shortages or surpluses expected during the budget period.


The processes of cash collection and disbursement provide the firm with opportunities to increase the available cash balance without additional total investment.


A.      Float is the difference between the checking account balances shown

          in the firm's books and those of the bank.


1.       Positive or disbursement float occurs when the balance on the bank's books exceeds that on the firm's books.  This occurs because of the delays caused by mailing disbursement checks and the clearing process.


2.       Negative or collection float occurs when the firm shows a higher balance than the bank.  This depends on the time it takes for deposited checks to clear.


Example of Float :

The beginning balance of Cash on Dec 1 ,1998 was AED 100,000.

During the month the company received AED 1,000,000 in cheques from its customers. The company also paid its suppliers AED 900,000 by cheques during the month. As on Dec 31, 1998; AED 800,000 received by the company was cleared in the bank and AED 400,000 of the cheques paid had cleared the banking system.



Company's books

Bank's books

Beginning balance, Dec 1, 1998









Ending balance, Dec 31, 1998




Float = 500,000 - 200,000 = AED 300,000 (positive float)

The company has extra AED 300,000 as short-term funds.

Practice exercise

A Company’s beginning cash balance as per its books on January 1, 1997 was AED 200,000.  Cash receipts during 1997 totaled AED 750,000.  Cash payments amounted to AED 550,000.  If the cash balance as per the Bank’s records on December 31, 1997 is AED 250,000, then how much was the company’s float on that day?













Managing the Cash Flow Cycle depends on a few things.


·      Faster Collections

·      Delayed Disbursements


1)       Faster Collections.


·      Collection centers through out the marketing area through regional Banks.

·      Lockbox arrangements

·      Daily wire transfers to the corporate headquarters.


2)      Extending Disbursements.

         ( Not very ethical but you could do within limits.)


·        Give a cheque from a Bank Location that will take a long time to clear.

·        Stretching  payables



Accounts Receivable Management


Accounts receivable exist whenever businesses extend credit to their customers. Trade credit is credit extended by a company to another company while consumer credit is credit extended by a company to its ultimate consumers.


Accounts receivable management consists of:

 (1) evaluating individual credit applicants.

 (2) establishing credit and collection policies and



Extension of credit is essentially an investment decision as it results in an

investment in accounts receivable, a current asset.


A.                Shareholder wealth is maximized by investing in accounts receivable as long as expected marginal returns from the investment exceed expected marginal cost of funds invested.


B.         Marginal returns consist of gross profits from additional sales.


C.       Marginal costs include opportunity cost of capital tied in

accounts receivable, bad debt losses, cost of checking new

credit accounts, and collection expenses.



Credit policy administration


A credit policy includes as its major variables the firm's

          a) credit standards

          b) credit terms, and

          c) collection policy.








Credit standards

Credit standards are the criteria the firm uses to screen credit applications to determine whether and in what amount credit should be extended.


The "five C's of credit" provide a useful framework for organizing information about an applicant.


1.       Character concerns the applicant's willingness to meet credit


2.       Capacity refers to the applicant's ability to meet obligations based on

          his liquidity and projected cash flows.

3.       Capital refers to the applicant's overall financial strength based on

          net worth.

4.       Collateral refers to assets that may be pledged as security.  In trade

          credit decisions, collateral is seldom a major consideration since

          foreclosing on the pledged assets is often an expensive and time‑

          consuming process which does not adequately substitute for prompt

          receipt of cash.

5.       Conditions refer to the general economic climate and outlook which

          may affect the customer's willingness and ability to pay.



Credit terms


Credit terms specify the conditions under which credit extended must be repaid.


1.       The credit period is the time allowed for payment.


2.       Cash discounts are discounts allowed if payment is made within a

          specified period of time.  Cash discounts are usually specified as a

          percentage of the invoiced amount and are granted to speed up

          collection of accounts receivable.





Collection policy


The collection effort consists of the methods employed to attempt to collect payment on past due accounts.


1.       The collection effort must be a balance between excessive leniency

          and the risk of alienating customers.


2.       An important part of managing accounts receivable is monitoring their

          status.  Some measures used are


          a.       Average collection period


          b.       Ratio of bad debts to credit sales


          c.       Aging of accounts receivable

                   An aging analysis consists of classifying accounts into

                   categories according to the number of days they are past due.