ABV-INDIAN INSTITUTE OF INFORMATION TECHNOLOGY &

MANAGEMENT, GWALIOR

Cash Flow Control

Self-Study
NIKHIL GARG (2004IPG44)
12/8/2008
 Cash Flow Control

Contents
Statement of Cash Flows.................................................................................................. ...............3
Informations from the statement of cash flows............................................................................3
Sources of Items on the cash flow statement:..............................................................................5
Cash Flow Statement Construction..............................................................................................5
Classifying Cash Flows................................................................................ .................................5
1) Operating cash flows (CFO):...............................................................................................6
2) Investing cash flows (CFI):..................................................................................................6
3) Financing cash flows (CFF):...................................................................................... ...........6
Cash Flow Control................................................................................................................... .........9
Objective for cash flow control.................................................................................. ...................9
Organizing for cash flow control.................................................................................... ...............9
A Framework of Responsibilities................................................................................. ..................9
Operational Cash Flows.................................................................................................... .........9
Financing and investment cash flows:.............................................................................. .......11
Currency Risk Management....................................................................................................12
Internal Controls of Cash Management...................................................................................13
Change in Cash............................................................................................. ................................13
Cash Flow Cycle........................................................................................................................... ..14
Measuring cash cycle time...................................................................................... ...................14
1) Sampling................................................................................................................. ..........14
2) Ratio Measurement............................................................................................... ............14
Just in Time.............................................................................................................................. ...16
Cash Flow Time Line.......................................................................................................... .........16
Working Capital:....................................................................................................... ..................16
Liquidity:................................................................................................................................ .....17
Cash Management Audit................................................................................. ..............................17
Influences for Change:................................................................................ ...............................17
Stages in the Audit Process:........................................................................................ ...............18

Statement of Cash Flows

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The statement of cash flows provides information beyond that available from earnings and other financial
data. This is because cash flow is essential to the continued operation of a business. The statement of cash
flows provides information on cash flows from operations, investing activities, and financing activities.
Information on noncash activities must also be reported along with the statement. The statement of cash
flows relates the firm's income statement to changes between the firm's beginning-of-period and end-of-
period balance sheets. The objective of the statement of cash flows is to show the sources of cash and all the
uses of cash during the accounting period.

Informations from the statement of cash flows:

• Information about a company's cash receipts and cash payments during an accounting period.
• Information about a company's operating, investing, and financing activities.
• Operating cash flow tells an analyst how much cash is being generated by the sales activity of the
company. It is the most important component of cash flow analysis.
• Cash flows can indicate problems with liquidity and solvency. Negative operating cash flows indicate
that the company will have to rely on external sources of financing to fund operations.
• Trends in cash flows can be extrapolated to estimate how the company will be performing over the next
few years. Trend analysis is particularly useful when compared to the trend of income over lime.
Discrepancies between the trends in income and cash flow can suggest that earnings trends are not
reliable.
• Interrelationships between cash flow components, such as cash inputs and cash collections, can give
insight similar to ratio analysis with income statement.

The statement of cash flows has this format:

Statement of Cash Flows for the Period 1/1/xx to 1/1/xx+l

Cash flow from operations (CFO) + /— xx

Cash flow from investing (CFI) + /- yy
Cash flow from financing (CFF) + /- zz
Change in the cash account ∆cash
Beginning of period cash + Beginning cash
Ending cash balance Ending cash

Cash flow from operations represents changes in the working capital accounts (e.g., accounts receivable,
inventory, and accounts payable) and all items that flow through the income statement (e.g., cash receipts
from customers, payments for good sold, wages)
• Net cash flow from operations focuses on the liquidity of the company rather than on profitability.
• Interest, dividend revenue and interest expense are considered operating activities, but dividends paid
are considered financing activities.
• All income taxes are considered operating activities, even if some arise from financing or investing.

Cash flow from investing represents the purchase or sale of productive assets (physical assets and
investments) for cash;
• Investing cash flow essentially deals with the items appearing on the lower left-hand portion of the
balance sheet (fixed assets).
• Investing cash flow includes:
➢ Capital expenditures for long-term assets.
➢ Proceeds from the sales of assets.
➢ Cash flow from investments in joint ventures and affiliates and long-term investment in securities.

Cash flow from financing represents acquiring and dispensing ownership funds and borrowings:

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Financing cash flow deals with the lower right-hand portion of the balance sheet (long-term debt and
equity). It includes cash flows from additional debt and equity financing.
• Debt financing includes both short- and long-term financing.
• Dividends paid are a financing cash flow because dividends flow through the retained earnings
statement.

Noncash investing and financing activities do not flow through the statement of cash flows because they do
not require the use of cash. Examples are:
• Retiring debt securities by issuing equity securities to the lender.
• Converting preferred stock to common stock.
• Acquiring assets through a capital lease (only the initial purchase entries).
• Obtaining long-term assets by issuing notes payable to the seller.
• Exchanging one noncash asset for another noncash asset.
• The purchase of noncash assets by issuing equity or debt securities.

While these activities do not flow through the statement of cash flows, they should be disclosed in either the
footnotes or on a separate schedule as investing or financing events that did not affect cash. The calculation
of cash flow from operations using the indirect method starts with income after taxes (the bottom of the
income statement) and adjusts backwards for noncash and other items. Changes in balance sheet items are
used to adjust net income under the indirect method. Changes in balance sheet accounts as either sources of
cash (added to net income) or uses of cash (subtracted from net income).

Balance Sheet Items in the Cash Flow Statement

Increase Decrease

Current assets use of cash source of

cash
Current liabilities source of use of cash
cash

Net Income
Adjusted for:
+ Noncash expenses or losses
– Noncash revenues or gains
Adjust for changes in working capital:
+/- Changes in operating asset accounts
+/- Changes in operating liability accounts
= Cash flow from operations

Sources of Items on the cash flow statement:

• Income statement items
• Changes in balance sheet accounts.

Cash Flow Statement Construction:

• Calculate the change in cash
• Calculate the change in all other balance sheet items
• Identify changes as potential adjustments for operating, investing, and financing activities
• Determine net cash flow from operating activities
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• Determine financing cash flows

• Determine investing cash flows
• Compare cash flow from operating, investing, and financing activities with the change in cash

Classifying Cash Flows

In most cases the classification of cash flows is straightforward. Items that affect cash flow are either an
income statement account or a change in a balance sheet account. As a general rule, an increase in an asset
account or a decrease in a liability account requires the use of cash and, therefore, decreases the cash flow to
the firm. For example, purchasing more inventory (increase in an asset account) or retiring trade credit
(decrease in a liability) results in the use of cash and a decrease in cash flow. Likewise, a decrease in an
asset account or an increase in a liability account represent a source of cash or an increase in the firm's cash
flow. For example, collecting accounts receivable (decrease in an asset account) or an increase in notes
payable (increase in a liability) both result in cash inflows for the firm.

1) Operating cash flows (CFO): All items affecting income are included as a component of operating
cash flow. Changes in asset or liability accounts that are a result of the sales or production process also
are classified as operating cash flows.
• Balance sheet items that are classified as operating cash flows include changes in:
➢ Receivables.
➢ Inventories.
➢ Prepaid expenses.
➢ Taxes, interest, and miscellaneous payables.
➢ Deferred taxes.
• Income statement items that are classified as operating cash flows include:
➢ Cash sales.
➢ Cash cost of sales.
➢ Cash general and administrative expenses.
➢ Cash taxes.
➢ Interest paid and received.
➢ Dividends received.

2) Investing cash flows (CFI): Changes in asset accounts, typically long-term assets (and potentially
corresponding liability accounts), that reflect capital investment in the company are classified as
investing cash flows.
Investing cash flows include changes in:
➢ Purchases of property, plant, and equipment.
➢ Investments in joint ventures and affiliates.
➢ Payments for businesses acquired,
➢ Proceeds from sales of assets.
➢ Investments (or sales of investments) in marketable securities.

3) Financing cash flows (CFF): Changes in equity accounts, including dividends, and changes in
liabilities that are part of the capital structure are classified as financing cash flows.
Financing cash flows include:
➢ Cash dividends paid.
➢ Increases or decreases in short-term borrowings.
➢ Long-term borrowings and repayment of long-term borrowings.
➢ Stock sales and repurchases.

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Noncash transactions: Some transactions do not result in immediate cash inflows or cash outflows. These
transactions are disclosed in footnotes. However, these transactions typically involve an investing and/or
financing decision. For example, if a firm acquires a building and real estate by assuming a mortgage, the
firm has made an investment and financing decision. Economically, this is equivalent to borrowing the
purchase amount. Another example of a noncash transaction is an exchange of debt for equity. It should be
considered of the firm's noncash transactions and incorporate them into analysis of past and current
performance, and include their effects in projections of the future.

The CFO can be presented two ways

• The direct method
• The indirect method.

The direct method presents more information (and requires more information to prepare) and is better for
analysis. However, most firms use the indirect method for financial reporting.
The following is the format of the basic statement of cash flows:

Statement of Cash Flows (SCF)

for the period 1/1/2006 to 12/31/2006_________
Cash flow from operations (CFO)
+Cash flow from investing (CFI)
+Cash flow from financing (CFF)
Change in the cash account
+Beginning of period cash
Ending cash balance

Direct method. The direct method presents operating cash flow by taking each item from the income
statement and converting it to its cash equivalent by adding or subtracting the changes in the corresponding
balance sheet accounts. Footnotes are often helpful in learning how inflows and outflows have affected the
balance sheet accounts. The following are some common examples of operating cash flow components:
• Cash collections is the principle component of CFO. The actual amount of cash received during the
period is measured with: net sales (a source), adjusted for changes in accounts receivable, and cash
advances from customers.
• Cash outflows consist of cash inputs, cash operating expenses, cash interest, and cash taxes. One
component of cash operating expenses is the cash used in the production of goods and services, which is
measured with: cost of goods sold (COGS) adjusted for changes in inventory, changes in accounts
payables, and changes in other liabilities for inputs. Other cash operating expenses are cash expenses
related to selling, administration, and research and development, adjusted for changes in related
operating liabilities.
• The cash interest component only recognizes interest expense paid in cash. Accrued interest expense is
not included. Cash interest is computed using interest expense (which includes noncash interest
components) and removing the affect of changes in noncash interest components (such as accrued
interest, the amortization of bond discounts and premium, and accretion).
• Finally, the cash tax component only recognizes taxes paid in cash. Total taxes paid are netted against
changes in deferred tax accounts. Cash taxes are computed using: tax expense, changes in taxes payable,
and changes in deferred taxes. Similar to our discussion of interest expense above, tax expense on the
income statement includes noncash items such as taxes payable and deferred taxes.

Investing cash flows (CFI) are calculated by finding the changes in the appropriate gross fixed-asset
account. Changes in noncash fixed-asset accounts, such as accumulated depreciation and goodwill, are not
included since they do not represent a cash transaction. Any gains or losses from the disposal of an asset
must also be reflected in cash flow.

cash from asset disposal = decrease in asset + gain from sale

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Financing cash flows are determined by measuring the cash flows occurring between the firm and its
suppliers of capital. Cash flows between the firm and creditors result from new borrowings and debt
repayments. Note, interest paid is technically a cash flow to the creditors but it is already accounted for in
CFO. Cash flows between the firm and the shareholders or owners occur as equity issued, share
repurchases, and dividends. CFF is the sum of these two measures:
net cash flows from creditors = new borrowings - principal repaid
net cash flows from owners = new equity issued - share repurchases - cash dividends
where:
cash dividends are measured using dividends paid and changes in dividends payable
CFF = net cash flows from creditors + net cash flows from owners

Finally, total cash flow is equal to the sum of cash flow from operations, cash flow from investments, and
cash flow from financing. If done correctly, the total cash flow will equal the change in the cash balance
from the beginning-of-period balance sheet to the end-of-period balance sheet.

Indirect method: The three components of cash flow are equal to the same values as they were under the
direct method. The only difference is that cash flow from operations is calculated in a different manner. The
indirect method calculates cash flow from operations in four steps:
Step 1: Begin with net income.
Step 2: Subtract gains or add losses that result from financing or investment cash flows (such as gains from
sale of land),
Step 3: Add back all noncash charges to income (such as depreciation and goodwill amortization) and
subtract all noncash revenue components.
Step 4: Add or subtract changes to operating accounts as follows:
• Increases in the balances of operating asset accounts are subtracted, while decreases in those
accounts are added.
• Increases in the balances of operating liability accounts are added, while decreases are subtracted.

Cash flow from investments and cash flow from financing are calculated the same way as under the direct
method. As was true for the direct method, total cash flow is equal to the sum of cash flow from operations,
cash flow from investments, and cash flow from financing. If done correctly, the total cash flow will be
equal to the increase in the cash balance over the period.

The only difference between the indirect and direct methods of presentation is in the cash flow from
operations (CFO) section. CFO under the direct method can be computed using a combination of the
income statement and a statement of cash flows prepared under the indirect method.

The general principal here is to begin with an income statement item and adjust the item for non-cash
transactions which have been included and cash transactions that have not been included.
Cash collections from customers:
1. Begin with net sales from the income statement.
2. Deduct (add) any increase (decrease) in the accounts receivable (AR) balance as disclosed in the indirect
method. If the company has sold more on credit than has been collected from customers on accounts
receivable, the AR balance will have increased, and cash collected will be less than net sales.
3. Add any advances from customers. Cash received from customers when the goods or services have yet
to be delivered is not included in net sales, so such advances must be added to net sales in calculating
cash collections.
Cash payments for inputs:
1. Begin with cost of goods sold (COGS), a negative number, as disclosed in the income statement.
2. If depreciation and/or amortization have been included in COGS, they must be added (they reduce
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COGS) in computing actual cash costs of inputs.

3. Add (subtract) any increase (decrease) in the accounts payable balance as disclosed in the indirect
method. If payables have increased, then more was spent on credit purchases of inputs during the period
than was paid on existing payables, so cash payments are reduced by the amount of the increase in
payables.
4. Subtract (add) any increase (decrease) in the inventory balance as disclosed in the indirect method.
Increases in inventory are not included in COGS for the period but still represent the purchase of inputs
so they increase cash payments for inputs.
5. Add any write-off of inventory value over the period. A decrease in inventory (for example from
applying lower of cost or market) will reduce the ending inventory and increase COGS for the period,
but no cash expenditure is associated with such a reduction in ending inventory.

Other items in a statement or cash flows under the direct method follow the same principles. Cash taxes
paid, for example, can be derived from income tax expense on the income statement. Adjustment must be
made for changes in related balance sheet accounts (deferred tax assets and liabilities, and income taxes
payable). Cash SG&A expense is SG&A from the income statement increased (decreased) by any increase
(decrease) in prepaid expenses. An increase in prepaid expenses is a cash outflow for expenses not included
in SG&A for the current period.

Cash Flow Control

Cash flow control is a technique used to regulate the flow of cash receipts into a business, cash transfers
between different parts of the business and cash payments by the business.

Objective for cash flow control

The objective of treasury management are mainly concerned with funding, liquidity and risk management in
order:
• To ensure that funds are available to support the company’s desired scale of operations.
• To maintain adequate liquidity.
• To keep credit risk, foreign currency risk and interest rate risk within acceptable limits.
• To contribute towards company profits from investment of surplus cash.

Organizing for cash flow control

Cash management, including cash flow control, must have an organizational framework that clearly defines
who is to be responsible for
• Collecting cash.
• Authorizing payments.
• Making payments.
• Bank accounts and transferring funds between accounts.
• Arranging overdraft facilities and loans.
• Investing cash surpluses.
• Foreign currency transactions.
In allocating authority and responsibility for cash management, it is useful to distinguish between
operational cash flows and cash flows for financing and investing activities.

A Framework of Responsibilities
Someone should be responsible for every aspect of cash management, and there should be no areas of uncertainty
where no one is willing to accept responsibility. Nor should there be scope for disputes over who has the

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authority for certain areas of cash management. Operational cash flows are receipts and payments for trading
activities.

Operational Cash Flows:

There may be three types of organization on the basis of cash flow structure
1. Partially Decentralized Cash Responsibilities in which head office responsible for all payments and cash
balances.

2. Partially Decentralized cash responsibilities in which head office responsible for large
payments and surplus cash balance.

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3. Centralized organization, all invoicing, receivables and payables would be a head-office

responsibility.

Financing and investment cash flows:

Controls over cash flows for investments and financing also can be shared between head
office and local business units, particularly when the business units are located in different
countries. A central treasury, should not be involved with day-to-day cash flow control.
Local payments, invoicing, collections, and customer credit decisions should be the
responsibility of the local financial controller. Central treasury should be used for policy
formation in these areas, and for overall cash flow and liquidity management within the
group banking arrangements are described more fully in cash collection and transmission.
Companies with several bank accounts might wish to control their combined cash balances,
or payments between the accounts. Two such arrangements are:
1) Pooling: Pooling is an arrangement whereby the cash balances in several different bank
accounts of the company or group are pooled together into a single account known as a
cash pool. Under a pooling arrangement, the current balances would be swept up into a
single account so that company can benefit from higher interest rates by investing a
larger amount, or by investing some of the surplus in a long-term deposit or money

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market instrument. minimizes or eliminates any overdraft that the company or

group would otherwise have in its various accounts.
2) Netting: Netting is another type of cash flow arrangement, It can be used in
situations where individual business units within a company trade regularly with
each or her. Instead of making separate payments for every invoice from one
business unit to another, only a net amount is paid or received by each unit.
Netting reduces the number of payments or receipts to one per business unit.

Ex.

The benefits of netting include greater predictability of cash flows within the group.
Netting payments occur at regular intervals. Each division must pay other divisions in
full for amounts due and can expect to receive payments in full. One division,
therefore, cannot ease its own cash flow problems by delaying payments to another
division.

Currency Risk Management:

Companies with cash flows in several currencies have exposures to currency risk. This is the risk of losses
from adverse movements in exchange rates. Currency exposures, can be reduced or eliminated in various
ways, such as by fixing an exchange rate with a forward exchange contract. Another method is to manage
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cash receipts and payments so that, so far as is possible, receipts in each currency ate used to make
payments in the same currency, i.e. receipt and payments in each currency are matched.

Reinvoicing Centre:
Some large multinationals have established reinvoicing centers. If a subsidiary
company sells goods to a customer in what is to the subsidiary a foreign currency, the
subsidiary invoices the reinvoicing center in its own currency and the reinvoicing
center invoices the customer in the Foreign currency- Similarly, if a subsidiary buys
goods in a Foreign currency, the invoice can be directed from the supplier to the
reinvoicing center, that will then invoice the subsidiary in its Own domestic currency.
The currency risk therefore is taken away from the subsidiaries and transferred to the
reinvoicing center that can manage the exposures centrally.

Internal Controls of Cash Management

Control over cash management can be achieved by applying eight long-established
principles of internal control. These are:
1) Organization and procedural controls
2) Authorization
3) Physical Controls
4) Segregation of duties
5) Personnel controls
6) Accounting and arithmetic controls
7) Supervision
8) Management controls

Change in Cash

Net income based on accrual accounting is not cash earnings. Therefore we need a statement of cash flows
to provide information about a company's sources and uses of cash. 'Cash and cash equivalents' includes
currency, coins, bank deposits, money market funds, and T-bills and other debt securities with maturities of
less than 90 days.
Some understanding of the basics of constructing a statement of cash flows can be gained by looking at
basic accounting relations. Since:

assets = liabilities + equity, it must be that:

∆assets =∆liabilities + ∆equity, and we can write:
∆cash +∆non-cash assets =∆liabilities + ∆equity
and ∆cash = ∆liabilities + ∆equity -∆non-cash assets.

If we buy a machine (a non-cash asset), cash goes down and non-cash assets go up. If we sell a machine or
building, non-cash assets go down and cash goes up. If we borrow money, both cash and assets go up. If we
issue stock or make cash profits, both cash and equity increase. If we pay dividends, retained earnings are
less, so both equity and cash are less.

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Important information for investment decision making presented in the statement of cash flows includes
whether:
• Regular operations generate enough cash to sustain the business.
• Enough cash is generated to pay off existing debts as they mature.
• The firm is likely to need additional financing.
• Unexpected obligations can be met.
• The firm can take advantage of new business opportunities as they arise.

Financial statements should include information about:

• How the firm obtains and spends cash.
• The firm's borrowing and debt repayment activities.
• The firm's sale and repurchase of its ownership securities.
• The firm's dividend payments and other cash distributions to owners.
• Other factors affecting the firm's liquidity and solvency.

Cash Flow Cycle

There is a continuing business cycle of buying and selling, and paying for purchases
and being paid for sales. The cash cycle starts with the payment for raw materials
and ends with the receipt of payments from customers.

Measuring cash cycle time: There are two methods of calculating cash cycle time:
1) Sampling: Sampling is a more laborious method of measurement, but is likely to
produce better information about payment times for debtors and creditors. By
sampling debtors, a profile can be built up of the typical time from issuing an
invoice to payment by the customer. An average time to pay can be established
from the sample, for all customers taken together, and also for different groups of
customers such as domestic corporate customers, domestic non-corporate
customers and export customers. Similarly, a sample of supplier payments can be
taken to establish the average time from receipt of invoice to making the payment.
The sample can be sub-divided into groups of suppliers withcommon
characteristics; for example, suppliers who ask for payment within 15 days of
invoice, those who allow 30 days, etc. Credit terms offered by the supplier and the
credit period taken are not necessarily the same. Employees are a form of
creditor, and the average time to pay will depend on the mix of weekly paid and
monthly paid staff.
2) Ratio Measurement: Ratio measurements are a quicker method of analyzing cash cycle times. The ratios art
derived from an analysis of the company's accounts. The measurements are only approximations, but could he
sufficiently accurate. An advantage of ratio measurements over sampling cash cycle times is that an estimate can
be obtained for stock turnover time as well as debtor and creditor payment periods. The measurements can be
obtained by ratio analysis from data in a company's balance sheet and profit and loss account are:
• stock turnover period
• debtor days, average time taken to pay by customers
• average time taken to pay creditors.
For a manufacturing company, the stock turnover period can be sub-divided into a turnover period for raw
material stock, a production cycle time, and a turnover period for finished goods stock.
Ratio measurements are derived from the accounts of a company for a given time period, typically one year.
Assuming a 365-day year and annual figures for sales and the cost of sales, these following ratio measurements
can be obtained:
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Stock Turnover period = (Average stock*365)/(Cost of Goods Sold in the year) days

Debtor days (debtors payment period) = (Average trade debtors ,*365)/(Sales in the year) days

Credit period from creditors = (Average trade Creditors*365)/(Sales in the year) days

Average figures for stocks, debtors and creditors can be estimated as the average of
the beginning of the year and end of the year amounts, both obtainable from the
company’s balance sheet. There will, of course, be seasonal peaks and troughs
throughout the year depending on the type or seasonality of the business.

The Stock turnover period for a manufacturing company can be sub-divided into three
ratios:
Raw material stock turnover period= (Average raw material stock*365)/(Cost of goods
sold in the year)
+Production Cycle=(Average work-in-progress*365)/(Cost of goods sold in the year)
+Finished goods Stocks Turnover Period = (Average finished goods stock*365)/(Cost
of goods sold in the year)

Raw material stock turnover

+ Production Cycle
+ Finished goods turnover
= Stock turnover
+ Debtor days
- Average time to pay suppliers
= cash cycle

Cash flow consists eight elements

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Just in Time:
Just in time is a technique used in manufacturing for organizing work flows to achieve rapid and flexible
production to a high-quality standard while minimizing waste and stock levels. Perhaps the most well known
feature of JIT is that it is a system for reducing inventory levels and work in progress.
• Just in time production is driven by demand, and items are manufactured only when they are needed.
• Just in time purchasing is the matching of purchases as closely as possibly with usage, so that stocks of
raw materials and components are reduced to almost zero.

JIT has implications for the cash flow cycle, its implementation is an operational management responsibility,
with important non-financial implications such as closer supplier relationships and high quality standards.
JIT manufacturing also provides financial benefits through a short stock turnover period and low stock
levels. My reporting these potential financial benefits, a cash manager might encourage operational
management to move towards JIT.

Cash Flow Time Line: The time line is a horizontal line divided into equal periods such as days, months, or
years. Each cash flow, such as a payment or receipt, is plotted along this line at the beginning or end of the period in
which it occurs. Funds that you pay out such as savings deposits or lease payments are negative cash flows that are
represented by arrows which extend downward from the time line with their bases at the appropriate positions along
the line. Funds that you receive such as proceeds from a mortgage or withdrawals from a saving account are positive
cash flows represented by arrows extending upward from the line.
There are three main elements in the cash cycle and time line
• Holding stocks, from their purchase from external suppliers, through the
production and warehousing of finished goods, up to the time of sale.
• Taking time to pay suppliers and other creditors
• Allowing customers (debtors) time to pay.

Working Capital:
Working capital, or circulating capital, is the amount of funds required to support the
day-to-day operations of a business. A simple definition of working capital normally
used in relation to the cash cycle is the value of stocks plus debtors and minus
creditors.
Working Capital = Stocks + Debtors - creditors

Changes in the length of the cash cycle have a direct effect on the amount of working
capital required. A longer cash cycle would result from holding stock for an extended
period before it is used or sold, a longer production cycle, customers taking longer to pay or
paying suppliers more quickly, I f stock is hold longer before use or sale, there will be an
increase in inventory. Similarly, if the production cycle slows down, there will be more costs,

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including materials and labour, etc., tied up in work-in-progress. The volume of debtors will
increase if customers take longer to pay, and there will be fewer creditors if suppliers
paid more quickly.

Liquidity:
• The degree to which an asset or security can be bought or sold in the market without affecting the
asset's price. Liquidity is characterized by a high level of trading activity.
• The ability to convert an asset to cash quickly. Also known as "marketability".
Evaluating internal liquidity. Liquidity ratios are employed by analysts to determine the firm's ability to
pay its short-term liabilities.

The current ratio is the best-known measure of liquidity:

Current Ratio=( current assets/ current liabilities);
The higher the current ratio, the more likely it is that the company will be able to pay its short-term bills. A
current ratio of less than one means that the company has negative working capital and is probably facing a
liquidity crisis. Working capital equals current assets minus the current liabilities.
The quick ratio is a more stringent measure of liquidity because it does not include inventories and other
assets that might not be very liquid:

Quick Ratio = (cash + marketable securities + receivables)/current liabilities;

The higher the quick ratio, the more likely it is that the company will be able to pay its short-term bills.

The most conservative liquidity measure is the cash ratio:

Cash Ratio = (cash + marketable securities)/current liabilities;

The higher the cash ratio, the more likely it is that the company will be able to pay its short-term bills.The
current, quick, and cash ratios differ only in the assumed liquidity of the current assets that the analyst
projects will be used to pay off current liabilities.
Cash Management Audit
Cash management audit is simply a term for a thorough and systematic investigation of the
systems and controls for cash management. The purpose of an audit should be to consider
whether the cash management system is efficient and whether it is suitable for current
conditions.

Influences for Change:

• Volatile interest rates
• Volatile exchange rates
• Deregulation of the financial markets
• New banking technology
• Business reorganization

Stages in the Audit Process:

The broad stages of cash management audit are:

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 Cash Flow Control

1. Fact-finding.
2. Analysis and identification of weaknesses.
3. Developing proposals for improvement.
4. Evaluating the benefits and estimating the costs of each proposal.
5. Recommending improvements.
6. Implementation.

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