Chapter 5

Cash and Marketable Securities

Introduction

Cash The currency and coin the firm has on hand in petty cash drawers, in cash registers or in checking accounts at various commercial banks

Motives for Holding

Speculative Motive to hold sufficient liquid assets to enable the firm to take advantage of any unexpected bargain purchase that may arise anytime Precautionary motive act as a buffer to meet unforeseen events, which require immediate cash payment. This may arise due to risk and uncertainty.

Cont.

Transaction motive to meet cash needs that arise in the ordinary course of doing business. E.G. purchase materials, pay bills

Cash Management
GOAL - To minimize cash balance while maintaining certain level of liquidity HOW ? determine the optimal cash balance - decisions regarding investment in securities - Decision regarding short term borrowing from bank and other source

Management of cash receipts and cash payments

Float funds that have been paid for, but are as yet not usable. Mail float the length of time between the mailing of a payment and its receipt Processing float length of time between the receipt of a payment and its deposit into the firm account Clearing float the length of time between the deposit of payment into the firms account time for the cheque to be clear

Reducing collection time -reduce customer collection float shorten the average collection period and the cash conversion cycle Increasing payment time Concentration of cash -concentrate lockbox and other deposits into one bank Zero-balance accounts - disbursement accounts that always have a zero balance at the end of the day in order to eliminate non-earning cash balances in corporate checking accounts.

Operating Cycle
Te length of time between the purchase of raw material and time cash is collected from sales of finished goods or receivables Formula : OC = AAI + ACP

Where; *AAI (Average Age of Inventory) The average length of time goods is in inventory *ACP (Average Collection Period) the average number of days customers take to pay

Valuation

Minimum Operating Cash (MOC)

Amount of cash that need to be held at any given time to support operations MOC = Annual cash outlays / Cast Turnover

Cash Turnover (CTO)

The number of times the firms cash is actually turned over each year CTO = 360 / Cash Cycle

Cont.

Cash Cycle (CC)

The overall period between the time cash is paid out to suppliers & cash is received from customers. CC = Operating Cycle (OC) APP = AAI + ACP APP APP (Average Payment Period) The average numbers of days the firm take to pay for the purchase of raw material

Factors that influencing the choice of marketable securities

Liquidity risk the ability to transform securities into cash without experiencing a loss in value Purchasing power the risk that inflation will reduce the purchasing power of a given sum of money Interest rate risk the risk to which investors are exposed due to rising interest rate

Cont.
Default risk the risk that an issuer will be unable to make interest payment or repay the principal amount a schedule Return on securities Higher return is required on these securities, but the company must be brave enough to face a higher risk.

Marketable securities
Def : security investments that the firm can quickly converted into cash balance. 2 types of MS :

Private issue Government issue

Private Issue

Negotiable certificate of deposit (NCDs) A marketable receipts for funds that have been deposited in a bank for a fixed period Commercial Paper A short term, unsecured promissory notes sold by large business to raise cash Bankers Acceptance A draft (order to pay) drawn on a specific bank by an exporter in order to obtain payment for goods shipped to a customer, who maintains an account with specific bank.

Government Issue
Treasury Bills Lowest risk due to risk free Treasury notes US Treasury obligation with initial obligation with initial maturities between 1 to 7 years

Exercise
Cik Shasha is planning to determine the firms minimum operating cash to reduce the firms cost of investment. Currently the firm is holding RM110,000 cash on average continuously. The firm is selling on terms net 45. All customers normally pay on the last day. The firm pays all credit purchases on net 30. the firm takes 40 days to produce and 20 days to sell the products. The firms yearly cash outlay is RM500,000. (Use 360 days in a year)

a)

Calculate the cash cycle, cash turnover and the minimum operating cash. Is the current cash holding sufficient to meet its need ? Why?

b)

= AAI + ACP APP = 60 + 45 30 = 75 DAYS CTO = 360 / 75 = 4.8X MOC = 500 000 / 4.8 = RM104,166.67 b) yes, its sufficient since cash holding > MOC
a)

CC

Thank You!!!