Inv & Cash Mngt
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Transcript of Inv & Cash Mngt
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CASHMANAGEMENT & INVENTORY
MANAGEMENT
Prepared by:
Mohan Avinash
Panchanan Sahoo
Neel Jain
Riddhima TripathiHarish M.
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Inventory Management
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NATUREOF INVENTORY
Stocks of manufactured products and the materialthat make up the product.
Components:
raw materials work-in-process
finished goods
stores and spares (supplies)
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NEEDFOR INVENTORIES
Transaction motive
Precautionary motive
Speculative motive
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OBJECTIVESOF INVENTORY MANAGEMENT Ensure a continuous supply of raw materials to
facilitate uninterrupted production
Maintain sufficient stock of raw materials inperiods of short supply and anticipate price
changes Maintain sufficient finished goods inventory for
smooth sales operations and efficient customerservice
Minimise the inventory costs Control inventory investment by maintaining
optimum inventory
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INVENTORY MANAGEMENT TECHNIQUES
Economic order quantity (EOQ)
ordering costs: call for, order placing, transportation,
receiving, inspecting and storing, administration
carrying costs: warehousing, handling, clerical and staff,
insurance, depreciation and obsolescence
ordering and carrying costs trade-off:
Economic order quantity:
Where A=quantity required , O=ordering cost , c=carrying cost
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2EOQ =
AO
c
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INVENTORY MANAGEMENT TECHNIQUES
Reorder point under certainty lead time:Lead time is the time that elapses between the placing
of an order and actually receiving the goods ordered.
average usage
Reorder point = Lead time x average usage Reorder point under uncertainty
safety stock
Reorder point = (Lead time x average usage)+
safety stock
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INVENTORY INVESTMENT ANALYSIS
Estimation of incremental operating profit
Estimation of incremental investment in inventory
Estimation of the incremental rate of return (IRR)
Comparison of the incremental rate of return withthe required rate of return (RRR)
Optimum inventory:
IRR = RRR
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SELECTIVE INVENTORY CONTROL
ABC analysisclassify inventory into three categories according to valuecontrol by importance and exception: maximum attention to A items
Just-in-time systemIn a JIT system , material or the manufactured components & parts arrive to the
manufacturing sites just few hours before they put to use. Out sourcing
Out sourcing is a system of buying parts & components from outside rather thanmanufacturing them internally.
Computerised inventory control system9
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INVENTORY MANAGEMENT PROCESS
Explicitly state the inventory policy
Create an inventory monitoring cell
Management group for controlling purchases
Periodic meetings between purchase, materialsplanning and production executives
Monthly reviews of total inventory at plant/corporatelevel
Identify critical inventory items for closer scrutiny
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Cash Management
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FOUR FACETSOF CASH MANAGEMENT
Cash planning
Managing the cash flows
Optimum cash level
Investing surplus cash
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CASH MANAGEMENT
Cash management is concerned with themanaging of:
cash flows into and out of the firm,
cash flows within the firm, and cash balances held by the firm at a point of
time by financing deficit or investing surpluscash
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MOTIVESFOR HOLDING CASH
The transactions motive
The precautionary motive
The speculative motive
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CASH PLANNING
Cash planning is a technique to plan and controlthe use of cash.
Cash Forecasting and Budgeting
Cash budgetis the most significant device toplan for and control cash receipts andpayments.
Cash forecastsare needed to prepare cashbudgets.
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SHORT
-TERM
CASH
FORECASTS
The important functions of short-termcash forecasts
To determine operating cash requirements
To anticipate short-term financingTo manage investment of surplus cash.
Short-term Forecasting Methods
The receipt and disbursements method
The adjusted net income method.
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THE RECEIPTAND DISBURSEMENTS METHOD
The virtues of the receipt and payment methodsare:
It gives a complete picture of all the items ofexpected cash flows.
It is a sound tool of managing daily cashoperations.
This method, however, suffers from the followinglimitations:
Its reliability is reduced because of theuncertainty of cash forecasts. For example,collections may be delayed, or unanticipateddemands may cause large disbursements.
It fails to highlight the significant movements in
the working capital items.
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THE ADJUSTED NET INCOME METHOD
The benefits of the adjusted net income methodare:
It highlights the movements in the working capitalitems, and thus helps to keep a control on a firms
working capital. It helps in anticipating a firms financial
requirements.
The major limitation of this method is:
It fails to trace cash flows, and therefore, its utility
in controlling daily cash operations is limited.
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LONG-TERM CASH FORECASTING
The major uses of the long-term cash forecastsare:
It indicates as companys future financial needs,especially for its working capital requirements.
It helps to evaluate proposed capital projects. Itpinpoints the cash required to finance these projectsas well as the cash to be generated by the companyto support them.
It helps to improve corporate planning. Long-term
cash forecasts compel each division to plan for futureand to formulate projects carefully.
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MANAGING CASH COLLECTIONSAND
DISBURSEMENTS
Accelerating Cash Collections
Decentralised Collections
Lock-box System
Controlling Disbursements Disbursement or Payment Float
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FEATURESOF INSTRUMENTSOF COLLECTION
IN INDIA
Instrument Pros Cons
1.Cheques No charge
Payable through clearing
Can be discounted after receipt
Low discounting charge
Requires customer limits which areinter-changeable with overdraft limits
Can bounce
Collection times can be long
Collection charge
2.Drafts Payable in local clearing
Chances of bouncing are less
Cost of collection
Buyers account debited on day one
3.Documentary bills Low discounting charge
Theoretically, goods are not releasedtill payments are made or the bill is
accepted
Not payable through clearing.
High collection cost
Long delays
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4.Trade bills No charge except stamp duty
Can be discounted.
Discipline of payment on due date.
Procedure is relatively cumbersome
Buyers are reluctant to accept the due
date discipline.
5.Letters of credit Good credit control as goods are
released on payment or acceptance of
bill.
Seller forced to meet deliveryschedule because of expiry date.
Opening charges
Transit period interest
Negotiation charges
Need bank lines to open LC.
Stamp duty on usance bills
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OPTIMUM CASH BALANCE
Optimum Cash Balance under Certainty:BaumolsModel
Optimum Cash Balance under Uncertainty: TheMillerOrr Model
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BAUMOLS MODELASSUMPTIONS:
The firm is able to forecast its cash needs withcertainty.
The firms cash payments occur uniformly over aperiod of time.
The opportunity cost of holding cash is known and itdoes not change over time.
The firm will incur the same transaction costwhenever it converts securities to cash.
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BAUMOLS MODEL The firm incurs a holding cost for keeping the cash balance. It is an
opportunity cost; that is, the return foregone on the marketablesecurities. If the opportunity cost is k, then the firms holding cost formaintaining an average cash balance is as follows:
The firm incurs a transaction cost whenever it converts itsmarketable securities to cash. Total number of transactions duringthe year will be total funds requirement, T, divided by the cashbalance, C, i.e., T/C. The per transaction cost is assumed to beconstant. If per transaction cost is c, then the total transaction costwill be:
The total annual cost of the demand for cash will be:
The optimum cash balance, C*, is obtained when the total cost isminimum. The formula for the optimum cash balance is as follows:
.
Holding cost = ( / 2)k C
Transaction cost = ( / )c T C
* 2cTC
k
Total cost = ( / 2) ( / )k C c T C
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ILLUSTRATIONBAUMOLS MODEL
Advani Chemical Limited estimates its total cash requirement as Rs 2 crore next year. The companys
opportunity cost of funds is 15% per annum. The company will have to incur Rs 150 per transaction whenit converts its short-term securities to cash. Determine the optimum cash balance. How much is the totalannual cost of the demand for the optimum cash balance? How many deposits will have to be made during
the year?
k/cT2C*
000,200Rs15.0
)000,000,20)(150(2C*
The annual cost will be:
30,000Rs=15,000+15,000=(1,00,000)0.15+(100)150=2)(2,00,000/0.15+2,00,000)(2,00,000/150=costTotal
During the year, the company will have to make 100 deposits, i.e. converting marketable securities to
cash.
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THE MILLERORR MODEL
The MO model provides for two control limitstheupper control limit and the lower control limit as wellas a return point.
If the firms cash flows fluctuate randomly and hit the
upper limit, then it buys sufficient marketablesecurities to come back to a normal level of cashbalance (the return point).
Similarly, when the firms cash flows wander and hitthe lower limit, it sells sufficient marketable securitiesto bring the cash balance back to the normal level(the return point).
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THE MILLER-ORR MODEL The difference between the upper limit and the lower limit
depends on the following factors:
the transaction cost (c)
the interest rate, (i)
the standard deviation (s) of net cash flows.
The formula for determining the distance between upper
and lower control limits (called Z) is as follows:
1/ 3(Upper Limit Lower Limit) = (3/ 4 Transaction Cost Cash Flow Variance / Interest Rate)Upper Limit = Lower Limit + 3
Return Point = Lower Limit +
The net effect is that the firms hold the average the cash balance equal to:
Average C
Z
Z
ash Balance = Lower Limit + 4/3Z
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INVESTING SURPLUS CASHIN MARKETABLE
SECURITIES
Selecting Investment Opportunities:
safety,
Maturity, and
marketability.
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SHORT-TERM INVESTMENT OPPORTUNITIES:
Treasury bills
Commercial papers
Certificates of deposits
Bank deposits Inter-corporate deposits
Money market mutual funds