Chapter 9

Addressing Working Capital Policies and Management of Short-term Assets and

Liabilities

Working Capital: The Lifeblood of the Business

Imagine a business as a living organism with working capital as its lifeblood. It’s
the fuel that keeps day-to-day operations running smoothly. But what exactly is working
capital and how do you manage it effectively?
The term working capital originated from the practices of traveling salespeople
(peddlers) who carried goods to sell. These represents merchandise (inventory) that the
peddler sold to generate profits. This is similar to a company's current assets used in day-
to-day operations. The wagon and horse are owned by the peddler’s which is similar to a
company's investment using its own funds. Then, the peddler often takes short-term loans
from banks to purchase merchandise (similar to a company using short-term financing for
current assets). Banks lend based on the peddler's successful repayment history,
demonstrating creditworthiness (similar to how banks assess a company's financial
health before granting loans). The number of trips a peddler made per year serves as
basis for performance evaluation. This relates to a company's inventory turnover ratio,
which indicates how efficiently it sells and replenishes its inventory.
This historical context effectively illustrates the core concept of working capital as
the essential assets used to generate revenue, highlighting the importance of managing
them efficiently.
According to the definition of Mead, Baker and Malott, “Working Capital means
current assets.
According to the definition of Weston and Brigham, "Working Capital refers to a
firm's investment in short-term assets, cash, short-term securities, accounts receivables
and inventories".
According to the definition of Bonneville, "Any acquisition of funds which increases
the current assets, increase working capital also for they are one and the same".
According to the definition of Shubin, "Working Capital is the amount of funds
necessary to cover the cost of operating the enterprises".
According to the definition of Genestenberg, "Circulating capital means current
assets of a company that are changed in the ordinary course of business from one form
to another, for example, from cash to inventories, inventories to receivables, receivables
to cash".
Working capital is the difference between a company’s current assets and its
current liabilities. Current assets represent resources that can be. Meanwhile, current
liabilities are short-term debts that must be paid within the year. Simply put, working
capital reflects a company’s ability to meet its short-term obligations.
Concept of Working Capital
1. Gross Working Capital (GWC):
o Represents the total investment in current assets of a business.
o It's a broad measure, simply reflecting the value of all current assets on the
balance sheet.
o Formula: GWC = CA (Current Assets)
2. Net Working Capital (NWC):
o A more specific measure that considers both current assets and current
liabilities.
o It reflects the company's ability to meet its short-term obligations using its
current assets.
o A positive NWC indicates the company has sufficient current assets to cover
its current liabilities.
o A negative NWC suggests potential challenges in meeting short-term
obligations.
o Formula: NWC = CA - CL (Current Assets - Current Liabilities)
Components of Working Capital
Working capital constitutes various current assets and current liabilities such as:
Current Assets:
 Cash and Cash Equivalents
 Marketable Securities
 Accounts Receivable
 Inventory (Raw Materials, Work in Progress, Finished Goods)
 Prepaid Expenses
Current Liabilities:
 Accounts Payable
 Short-Term Loans
 Accrued Expenses
 Customer Advances
Working capital management is all about finding the perfect balance for your
company's short-term financial resources. It involves optimizing the levels of cash,
marketable securities, customer debts (accounts receivable), leftover inventory, and any
short-term financing you use. The goal? To have enough cash on hand to cover your daily
operations at the lowest possible cost. By doing this effectively, you can free up significant
amounts of cash that would otherwise be tied up in various areas
Importance of Working Capital Management
Effective working capital management is crucial for several reasons:
1. It's a Big Part of Your Assets: Especially in manufacturing and trading businesses,
a significant portion (often more than half!) of a company's total assets are
considered current assets. This means your financial managers have a lot of
responsibility in managing these current assets and liabilities effectively.
2. Growth and Survival: As your company grows in production and sales, you'll need
more current assets to support that growth. Working capital management directly
impacts your long-term success.
3. Balancing Act: Liquidity vs. Profitability: How you manage working capital directly
affects both your company's ability to pay its bills (liquidity) and its profitability.
Key Players in Working Capital Management
1. Cash: Optimizing cash flow is essential. This involves collecting receivables
promptly, managing inventory efficiently and negotiating favorable payment terms
with suppliers.
2. Accounts receivable: Collecting payments from customers quickly minimizes the
amount of money tied up in outstanding invoices.
3. Inventory: Finding the right balance between having enough stock to meet demand
and avoiding excessive inventory holding costs is crucial.
Factors to Consider When Managing Working Capital
Several factors influence the ideal working capital strategy for your company:
1. Nature of Operations: Manufacturing, retail, and service businesses all have
different working capital needs.
2. Sales Volume: Higher sales mean you'll need more current assets like inventory
and customer receivables to keep up.
3. Cash Flow Fluctuations: The more unpredictable your cash flow is; the more
working capital you might need to have a buffer.
4. Operating Cycle Period: This refers to how long it takes to convert cash into
inventory, then into sales, and finally back to cash. Shortening this cycle reduces
the amount of cash you need to have tied up at any one time.
Operating Cycle
The operating cycle represents the average time it takes a company to convert its
raw materials into cash from customer sales. It highlights how efficiently a business
manages its working capital.
The operating cycle is calculated by adding two key components:
1. Inventory Conversion Period (Inventory Period): This is the time it takes for a
company to sell its inventory after it's purchased. It reflects how long raw materials
sit in storage before becoming finished goods and being sold.
 2. Average Collection Period (Accounts Receivable Period): This represents the
average time it takes a company to collect cash from customers after a sale is
made on credit.
By understanding the operating cycle and its components, businesses can identify
areas for improvement. For example, they might aim to:
 Reduce inventory levels to shorten the inventory conversion period.
 Encourage faster payments from customers to shorten the average collection
period.
Both of these strategies can lead to a shorter operating cycle, freeing up cash that
can be used for other purposes.

Cash Conversion Cycle

The cash conversion cycle (CCC) is a crucial metric used to assess a company's
efficiency in managing its working capital. It represents the average time it takes for a
company to convert its cash into inventory, then into finished goods, sell them, and finally
collect payment from customers. A shorter CCC indicates better working capital
management as it means the company is tying up less cash in its operating activities.
Here's a breakdown of the components of the CCC:
1. Inventory Conversion Period (ICP): This represents the time it takes for a
company to sell its inventory after it's purchased. It's calculated as:
ICP = 365 days / Inventory Turnover
o Inventory Turnover = Cost of Goods Sold (COGS) / Average Inventory
2. Average Collection Period (ACP): This represents the average time it takes a
company to collect cash from customers after a sale is made on credit. It's
calculated as:
ACP = 365 days / Receivable Turnover
o Receivable Turnover = Credit Sales / Average Receivable
Calculating the Cash Conversion Cycle (CCC):
The CCC is calculated by subtracting the Average Payment Period (APP) from the
Operating Cycle (OC). The APP represents the average time a company takes to pay its
suppliers.
CCC = OC - APP
* OC = ICP + ACP
Benefits of a Shorter Cash Conversion Cycle:
 Reduced financing needs: A shorter CCC means less cash gets tied up in
operations, freeing up resources for other purposes, potentially reducing the need
for short-term borrowing.
  Improved profitability: Faster cash collection can lead to better cash flow and
potentially reduced interest expenses.
 Increased efficiency: A shorter CCC indicates a company is managing its working
capital effectively, potentially leading to improved overall operational efficiency.
Strategies to Shorten the Cash Conversion Cycle:
 Reduce inventory levels: Implement better inventory management practices to
minimize stockouts without holding excessive inventory.
 Improve sales collections: Tighten credit policies, offer discounts for early
payments, and implement efficient collection procedures.
 Negotiate better payment terms with suppliers: Aim for longer payment terms with
suppliers to extend the APP (although this should be balanced with maintaining
good supplier relationships).
Illustrative Problem 9.1
A company has the following information:
Credit Sales P1,200,000
Cost of Goods Sold (COGS 1,000,000
Average Inventory 250,000
Average Receivables 300,000
Average Payment Period (APP) 30 days
Calculate the Cash Conversion Cycle (CCC) for this company.

Solution:
1. Inventory Conversion Period (ICP):
ICP = 365 days / (COGS / Average Inventory)
ICP = 365 days / (P1,000,000 / P250,000)
ICP = 365 days / 4 = 91.25 days
2. Average Collection Period (ACP):
ACP = 365 days / (Credit Sales / Average Receivables)
ACP = 365 days / (P1,200,000 / P300,000)
ACP = 365 days / 4 = 91.25 days
3. Operating Cycle (OC):
OC = ICP + ACP
OC = 91.25 days + 91.25 days
OC = 182.5 days
 4. Cash Conversion Cycle (CCC):
CCC = OC - APP
CCC = 182.5 days - 30 days
CCC = 152.5 days
Interpretation:
This company's cash conversion cycle is 152.5 days. It takes an
average of 152.5 days for this company to convert its cash into inventory,
then into finished goods, sell them, and finally collect payment from
customers.
This information can be used by the company to assess the
effectiveness of their working capital management and identify areas for
improvement. They might consider strategies like lowering inventory levels
or improving their collections process to shorten the CCC and potentially
improve their financial health.

Reasons for a Longer Operating Cycle:

 Inefficient Purchasing: Overstocking, poor quality materials, lack of supplier credit,
or seasonal limitations can lengthen the cycle. (Purchasing Management can
address these)
 Production Issues: Outdated machinery, poor planning, or inadequate
maintenance can slow down production. (Production Management can improve
this)
 Inventory Management Problems: Excess inventory or stockouts can occur due to
deficient inventory policies. (Improved Inventory Management practices are
needed)
 Lax Credit Policy: Generous credit terms to customers can extend the collection
period. (Credit and Collection Period needs tightening)
 External Factors: Unforeseen events can disrupt the cycle, requiring mitigation
strategies.
Costs Associated with Working Capital:
 Carrying Costs: Costs of holding current assets, including:
o Opportunity Cost: Lost potential returns from investing elsewhere.
o Explicit Costs: Storage, insurance, and other maintenance expenses.
 Shortage Costs: Costs incurred due to insufficient current assets, including:
o Opportunity Cost: Lost sales due to stockouts.
o Explicit Costs: Expedited shipping fees or interest on short-term loans to cover
shortages.
Working Capital Management Strategies

Companies need efficient strategies to manage their current assets (cash,

inventory, receivables) – that's where Working Capital Management comes in. It involves
setting policies to optimize the relationship between sales and working capital. Here are
three main approaches companies can take:

1. Conservative Working Capital Policy:

 Goal: Minimize risk by maintaining a higher level of working capital.

 Benefits:
o Improved liquidity: Ensures enough cash and current assets to cover
unexpected expenses or shortfalls in sales.
o Enhanced supplier relationships: Ability to pay suppliers promptly,
potentially leading to better discounts or payment terms.
o Mitigates seasonal fluctuations: Buffer for companies with seasonal sales
variations, allowing them to maintain operations during slow periods.
 Drawbacks:
o Reduced profitability: Holding excess inventory or receivables can lead to
higher carrying costs (storage, insurance) and lost opportunity costs
(potential investment returns).
o Lower efficiency: May indicate inefficient inventory management or overly
generous credit terms to customers.

2. Moderate Working Capital Policy:

 Goal: Maintain a moderate level of working capital that aligns with sales
volume.
 Benefits:
o Balances risk and profitability: Aims for a balance between sufficient
liquidity and minimizing carrying costs.
o Improved efficiency: Encourages better management of inventory and
receivables to meet sales needs without holding excess stock.
 Drawbacks:
o Requires continuous monitoring: Needs ongoing adjustments to working
capital levels as sales fluctuate.
o May not be suitable for highly seasonal businesses: Might not provide
enough buffer during sales downturns.

3. Aggressive Working Capital Policy:

  Goal: Maximize profitability by maintaining a low level of working capital
relative to sales.
 Benefits:
o Increased profitability: Minimizes carrying costs associated with holding
excess inventory or receivables.
o Improved efficiency: Encourages lean operations and efficient cash flow
management.
 Drawbacks:
o Higher risk: Increased risk of stockouts or liquidity problems if sales
unexpectedly fall or unexpected expenses arise.
o Strained supplier relationships: May lead to late payments to suppliers,
potentially damaging relationships.
o Not suitable for all businesses: Risky strategy for companies with unpredictable
sales or those requiring significant inventory for production.

Choosing the right working capital management policy depends on a company's

specific circumstances, risk tolerance, and industry. Here are some additional factors to
consider:

 Predictability of Sales: Companies with predictable sales can afford a more

aggressive approach.
 Industry Norms: Some industries have higher working capital requirements due to
the nature of their business.
 Access to Financing: Companies with easy access to short-term financing may be
more comfortable with a lower working capital level.

Effective working capital management involves continuously monitoring and

adjusting these policies to optimize the balance between risk and profitability.
 Learning Assessment 9.1

Problem Solving (Provide what is asked in each problem. Show your solutions to
receive full credit.)

1. Bully Corporation purchases raw materials on July 1. It converts the raw materials into
inventory by September 30. However, Bully pays for the materials on July 20. On
October 31, it sells the finished goods inventory. Then, the firm collects cash from the
sale 1 month later on November 30. If this sequence accurately represents the
average working capital cycle, what is the firm's cash conversion cycle in days?
2. ABC Company has the following data:

Inventory conversion period 50 days

Average collection period 17 days
Payables deferral period 25 days

What is the firm’s cash conversion cycle?

3. Data on ABC Inc. for 2023 are shown below, along with the days sales outstanding of
the firms against which it benchmarks. The firm's new CFO believes that the company
could reduce its receivables enough to reduce its DSO to the benchmarks’ average.
If this were done, by how much would receivables decline? Use a 365-day year.
Sales P 110,000
Accounts receivable 16,000
Days sales outstanding (DSO) 53.09
Benchmark days sales outstanding (DSO) 20.00
4. In 2023, data for Shayne Inc. are shown below, along with the inventory conversion
period (ICP) of the firms against which it benchmarks. The firm's new CFO believes
that the company could reduce its inventory enough to reduce its ICP to the
benchmarks’ average. If this were done, by how much would inventories decline? Use
a 365-day year.
Cost of goods sold P85,000
Inventory 20,000
Inventory conversion period (ICP) 85.88
Benchmark inventory conversion period (ICP) 38.00

5. Assuming your consulting firm was recently hired to improve the performance of
Tonton’s Inc, which is highly profitable but has been experiencing cash shortages due
to its high growth rate. As one part of your analysis, you want to determine the firm’s
cash conversion cycle. Using the following information and a 365-day year, what is
the firm’s present cash conversion cycle?
Average inventory P 75,000
Annual sales 600,000
Annual cost of goods sold 360,000
Average accounts receivable 160,000
Average accounts payable 25,000
 Chapter 10

Cash and Marketable Securities Management

In the fast-paced world of business, having easy access to cash is vital. That's
where cash and marketable securities come in – the dynamic duo that ensures a company
can meet its short-term obligations and seize unexpected opportunities. Out of all a
company's assets, cash and marketable securities are the easiest to convert into ready
cash.

 Cash: The lifeblood of any organization, cash refers to the physical currency a
company has on hand and the readily available funds in its checking accounts.
This includes both physical currency the company has on hand and the money
readily available in checking accounts. Cash is the essential fuel for everyday
business operations. It allows companies to pay bills, purchase supplies, and meet
financial commitments on time. In fact, a company's ability to survive can depend
on having enough cash to keep the lights on, so to speak.
 Marketable Securities: These are short-term money market instruments made with
extra cash that isn't immediately needed such as treasury bills, money market
funds (pooled investments in highly liquid assets) and commercial paper (short-
term unsecured loans issued by corporations). These investments can be quickly
sold and turned back into cash whenever necessary. Unlike just sitting on cash,
marketable securities offer the advantage of generating some interest income for
the company. While cash is readily available, it doesn't earn any interest. But,
marketable securities provide a solution by offering:

1. Liquidity: They can be quickly sold and converted back into cash whenever
needed.
2. Return on Investment: Unlike idle cash, marketable securities generate some
interest income, increasing the company's overall financial health.

Some of the common examples where an entity may invest its temporaly idle funds
are:

1. Certificate of deposits (CD) – savings deposits at financial institutions (e.g.,

time deposit)
2. Money market funds – shares in a fund that purchases higher-yielding bank
CDs, commercial paper and other large-denomination, higher-yielding
securities
3. Government securities
a. Treasury bills – debt instruments representing obligations of the National
Government issued by the central bank and usually sold at a discount
through competitive bidding
b. CB bills or Certificate of Indebtedness (CBCIs) – represent indebtedness by
the Central Bank
 4. Commercial paper – short-term, unsecured, material promissory notes issued
by private corporations of very high credit standing
5. Repurchase agreements (Repos) – investment in loans with a commitment ot
resell the security at the original contract price plus an agreed interest income
for the holding period
6. Banker’s acceptance – a draft drawn on a specific bank by a firm that has an
account with the bank, which if accepted by the bank becomes a negotiable
instrument and is available for investments

The following are factor5s to be considered in choosing marketable securities:

1. Risks which could either be default risk, inflation risk or interest rate risk. Default
risk refers to chances that issuer may not be able to pay interest or principal on
time. Inflation risk is the danger that inflation will reduce the investment’s real
value. Interest rate risk is the fluctuations in prices caused by changes in
market interest rates.
2. Marketability which refers to how quickly a security can be sold before maturity
date without a significant price concession.
3. Returns or the expected return on investment
4. Terms or maturity which should coincide, whenever possible, with the date at
which the firm needs cash or when the firm will no longer have cash to invest.
5. Taxes

The Importance of Managing Cash and Marketable Securities

Traditionally, companies invested liquid assets in very safe, low-risk options like
certificates of deposit, Treasury bills, and commercial paper. Recently, some treasurers
are willing to take on slightly more risk to potentially earn a higher return on these
investments. This reflects the constant challenge financial managers face: balancing risk
and potential rewards.

Managing cash and marketable securities goes beyond simply paying bills and
collecting revenue. It's a strategic process that involves:

 Determining the optimal cash balance: Finding the ideal amount of liquid assets to
hold, considering both needs and earning potential.
 Optimizing cash flow: Implementing efficient methods to control how cash is
collected and disbursed.
 Selecting suitable short-term investments: Choosing the right type and amount of
marketable securities to invest in.

These decisions require careful consideration of the risk-return trade-off. While

cash and marketable securities generally offer low returns compared to other assets,
minimizing them can increase overall returns. However, a company with too little cash
becomes vulnerable to running out of funds for operations or missing unexpected
investment opportunities.
Motives for Holding Cash

There are four main reasons companies hold cash and near-cash equivalents:

1. Transaction Motive

This refers to having enough cash readily available to cover everyday business
needs, such as buying supplies, paying bills, and managing payroll.

2. Precautionary Motive

Companies keep a cash cushion to handle unforeseen situations like emergencies

or economic downturns. This buffer ensures smooth operations during challenging
times.

3. Speculative Motive

This involves holding cash to seize unexpected opportunities that arise outside the
normal course of business. It might involve buying discounted raw materials or
taking advantage of favorable investment opportunities.

4. Contractual Motive or Compensating Motive

Companies may hold some cash as required by contract provisions in order to

maintain a good relationship with banks and ensure access to services or loans.
Banks often require businesses to maintain a minimum average balance
(compensating balance) in return for providing services like check clearing or fund
transfers.

By understanding these motives and managing cash effectively, companies can

strike a balance between liquidity and profitability.

Optimal Cash Balance or Target Cash Balance

The terms "optimal cash balance" and "target cash balance" are often used
interchangeably, but there's a subtle difference between them. Target Cash Balance is
the specific desired level of cash a company or individual aims to maintain readily
available. Determining the target cash balance involves considering factors like
transaction needs, precautionary buffer for unexpected expenses, potential investment
opportunities and ability to access credit

Optimal cash balance, also known as Economic Cash Quantity or Economic

Conversion Cycle, refers to the theoretical ideal amount of cash that would minimize all
the associated costs. It's a more abstract concept that considers opportunity cost or the
interest or returns you forgo by holding onto cash instead of investing it, the transaction
costs or the fees associated with activities like depositing or withdrawing cash and the
safety costs or the risk of running out of cash if emergencies arise.
Approaches in Determining Optimal or Target Cash Balance

There are several approaches to determining your target cash balance, each with
its own strengths and considerations. Here's a breakdown of some common methods:

1. Fixed Formula Approach

This is a simple method that uses a rule of thumb, like maintaining 1-3 months of
operating expenses as your target cash balance. It's easy to implement but might not
be suitable for all businesses.

2. Cash Flow Forecasting Approach

This method involves creating a detailed forecast of your future cash inflows and
outflows thru the cash budget. This helps identify periods where cash might be tight
and allows to set a target balance that covers the firm’s anticipated needs.

3. Cash Break-even Point

This is the level at which total cash inflows is equal to total cash outflows. The formula
is:
Fixed Payments
Cash BEP = Unit Contribution Margin
4. The Baumol Model

This model was proposed by William J. Baumol in 1952 similar to the EOQ for cash
management. This model helps in determining the cash conversion size which means
how much cash should be arranged by selling marketable securities in each
transaction. The Baumol model focuses on finding the optimal balance between two
key costs associated with cash management:

 Transactional Cash Requirements: The cost of holding cash to meet everyday

business needs (e.g., buying supplies, paying bills).
 Lost Opportunity Cost: The potential returns forgone by holding cash instead of
investing it in other assets that could generate a higher return.

The model assumes that a company's cash needs can be predicted with certainty. It
then helps determine the ideal "conversion size" – the optimal amount of cash to
convert between holdings and investments to minimize the total cost.

The purpose of the model to minimize the total cost of cash holding which is
summation of opportunity cost and transaction cost. Hence, to compute for the optimal
cash balance under the Baumol Model, the formula is:
𝑇 𝐶
Optimal Cash Balance =𝐶xD+2xO

2𝐷𝑇
=√ 𝑂

Where:
 C = amount of marketable securities converted into cash per transaction
(Economic cash holding size)

O = Opportunity cost of holding cash, net equal to the rate of return foregone on
marketable securities or the cost of borrowing to hold cash

T = projected cash requirements during the planning period or the total amount
of new cash needed for transactions during the period

D = conversion cost per transaction

S = sum of conversion and holding costs

In simpler terms, the Baumol model helps companies find the sweet spot where they
hold just enough cash to cover daily operations without sacrificing potential returns by
keeping too much cash idle.

5. Miller-Orr Model

This model used to determine the optimal level of cash balances for a firm was built
upon Baumol’s model by incorporating uncertainty in cash flows. It was developed by
economists Merton Miller and John Orr in the 1960s. It acknowledges that cash inflows
and outflows may not be perfectly predictable, so it aims to find a target cash balance
that minimizes the risk of running out of cash.

The model is based on the idea that there are two types of costs associated with
holding cash: transaction costs and opportunity costs. This model sets control limits
for cash balances, helping companies decide when to convert excess cash into
investments or replenish cash reserves by selling investments. this model bases its
computations where:
L= the lower control limit
F= the trading cost for marketable securities per transaction
Ó = the standard deviation in net daily cash flows
𝑖𝑑𝑎𝑦 = the daily interest rate on marketable securities
Z= optimal cash return point
H = upper control limit for cash balances

To compute for Z and H, the formula are:

3 FÓ2
Z = ∛4 i +L
day

H = 3Z – 2L

Cash Management Techniques

 Effective cash management involves various strategies to optimize cash flow:

 Speedy Cash Collections: Companies prioritize collecting payments from

customers quickly. This might involve offering incentives for early payments or
streamlining the collection process. Techniques include:
o Encouraging prompt payment through discounts or special offers.
o Using clear and efficient billing methods with self-addressed envelopes for
faster return.
 Concentration Banking: This system centralizes collections by directing payments
to regional collection centers. These centers deposit the funds in local banks for
faster clearing, offering a decentralized approach with multiple collection points.
 Lockbox System: This method involves having a designated post office box where
customers send payments. A designated bank collects the payments from the box
and deposits them into the company's account. This can save time compared to
traditional mail collection.
 Slowing Disbursements: While collecting cash quickly is important, managing cash
outflows is equally crucial. Slowing disbursements (payments) does not mean
delaying or avoiding legitimate obligations. To optimize disbursements, payment
can be made thru drafts or zero-balance accounts and playing the float. A zero-
balance account requires checks to be written from special disbursement accounts
having zero-peso balance with no minimum maintaining balance required. Hence,
funds are automatically transferred from a master account when a check is drawn
from a ZBA is presented.
 Avoiding Early Payments: Companies can optimize cash flow by paying bills on or
close to the due date, maximizing the time they hold onto the cash.
 Centralized Disbursement System: While a decentralized collection system can
accelerate cash inflow by having collection points, a centralized disbursement
system offers advantages for managing outgoing cash flow. Centralized
disbursement allows for tighter control over outgoing funds, ensuring payments
are made accurately and on time, but not ahead of schedule. By holding onto cash
until the due date for bills, a centralized system helps companies maximize their
cash flow and potentially earn interest on those funds for a longer period.
 Using Float: Float is the difference between cash balance per bank and cash
balance per book as of a certain period, primarily due to outstanding checks and
other similar reasons. Cash management float refers to the temporary difference
between when a payment is made or received and when the funds are actually
reflected in the account balance. There are two main types of float relevant to cash
management:

1. Negative or Collection float - is the time it takes for a customer’s check or

electronic payment to clear and become available in your account. This can
range from a few days for electronic payments to a week or more for checks.
Hence, this occurs when book balance is greater than bank balance. Mail float
 is the amount of customer’s payments that have been mailed by customers but
not yet received by the seller-company. Processing float refers to the amount of
customer’s payments that have been received by the seller but not yet
deposited.
2. Positive or Disbursement Float - is the time between when you issue a check or
make an electronic payment and when the funds are deducted from your
account. It's generally shorter than collection float, but there can still be a delay
depending on your bank's processing times.

Good management suggests that positive float should be maximized while

negative float be minimized or, if possible, eliminated.

By implementing these techniques, companies can achieve a healthy balance

between collecting cash efficiently and managing disbursements effectively.
 Learning Assessment 10.1

 Problem Solving (Provide what is asked in each problem. Show your solutions to
receive full credit.)

1. Jardine Company writes checks averaging P15,000 a day, and it takes five days for
these checks to clear. The firm also receives checks in the amount of P17,000 per
day, but the firm loses three days while its receipts are being deposited and cleared.
What is the firm’s net float in pesos?

2. What is the opportunity cost of keeping a cash balance of P2 million, if the daily interest
rate is 0.02% and the average transaction cost of investing money overnight is P50?

3. Shanshan Inc. is preparing its cash budget. It expects to have sales of P30,000 in
January, P35,000 in February, and P35,000 in March. If 20% of sales are for cash,
40% are credit sales paid in the month after the sale, and another 40% are credit sales
paid 2 months after the sale, what are the expected cash receipts for March?

4. Angel Inc. sells to customers all over the country., and all receipts come in to its
headquarters in New York City. The firm's average accounts receivable balance is
P2.5 million, and they are financed by a bank loan at an 11% annual interest rate. The
firm is considering setting up a regional lockbox system to speed up collections, and
it believes this would reduce receivables by 20%. If the annual cost of the system is
P15,000, what pre-tax net annual savings would be realized?

5. A company has a 10% cost of borrowing and incurs fixed costs of P500 for obtaining
a loan. It has stable, predictable cash flows, and the estimated total amount of net
new cash needed for transactions for the year is P175,000. The company does not
hold safety stocks of cash. If the average cash balance for the company during the
year is P20,916.50, the opportunity cost of holding cash for the year will be