Working

Capital
Management

Compiled by: Qassim Mushtaq

Premier DLC

Working capital management

Working capital is the amount of finance required for the day to day running of the
business e.g to pay bills, to purchase stocks, payment of wages and salaries.
Working capital is calculated as follows;

Working Capital = Current Assets Current Liabilities.

Where;
Current Assets = Stocks + Debtors + Cash.
Current Liabilities =Trade Creditors.
Working Capital Cycle/Operating Cycle/ Trade Cycle/Cash Cycle:

Working Capital Cycle is the time delay between payment of cash for raw materials and
eventual receipt of cash from the customers.
The business always intends to minimize the time period in which cash is blocked in
operating cycle.
Operating cycle is calculated as follows;
Operating Cycle = Stock days + Debtor Days Creditors Days.

Each business seeks to minimize the blockage or investment of cash in operating cycle
i.e. each business intends to minimize the operating cycle.

How to minimize or reduce the operating cycle:

Reduction in stock days.

Reduction in debtor days.

Working Capital Ratios:

Stock Turnover Period:
Stock Days =

Average Stock
Cost of Sales

X 365 days

Or
Stock Turnover =

Cost of Sales
Average Stock

Stock turnover period can be further classified as follows:

Stock Days (Finished Goods) =
Stock Days (Raw Materials) =

Average Production (W.I.P) Period =

Average Stock
Cost of Sales

X 365 days

Average Raw Material Stock

Annual Purchases

X 365 Days

Average WIP x Degree of WIP

Completion
Cost of Sales

X 365 Days

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Optimum period of stock days will vary industry by industry, and will vary for different
types of stocks held by a firm.
High stock days or low stock turnover may arise due to:

The firm is being excessively prudent in its stockholding policies

Obsolete or slow-moving stock.

Low stock days or high stock turnover may arise due to:
Supply difficulties, which might result in stock-out and loss of sales.

Debtors Days:
Debtors Days/Debtors Payment Period =

Trade Debtors
Credit Sales
Turnover

X 365 Days

Creditors Days:
Creditors Days/Creditors payment Period =

Average Trade
Creditors
Purchase or Cost
of Sales

X 365 Days

It helps to asses the liquidity of the company.

An increase in creditors days is a sign of lack of long-term finance or poor
management of current assets.

Current Ratios:
Current Ratio =

Current assets
Current Liabilities

Acceptable level

2:1

Quick Ratios:
Quick Ratio/Acid Test Ratio =

Acceptable level

Current assets Stocks

Current Liabilities
1:1

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Objective of Working Capital Management:

The objective of working capital management is to strike a balance between liquidity and
profitability.
Day to day operations of the business must be run smoothly and day-to-day liabilities are
paid when they fall due.

The possible conditions in relation to working capital are as follows

Overtrading:

Overtrading is a situation in which business tries to do too much trade without long-term
capital base. This might result in following,
1. Increase in stock and debtors due to rapid increase in credit sales. Significant
increase in creditors, which will result in lesser working capital.
2. Financing of fixed assets from working capital.
3. Shortage of cash but the business is profitable.
4. There is little or no increase in long-term capital to support the ever increasing
volume of sale.

Symptoms:

Liquidity Ratios
Turnover Periods
Sales Turnover
Volume of Assets,
especially Current Assets.
Bank Overdraft.
Less long-term capital

Symptoms of Over Trading

Current Ratio<2:1
Indicate over trading.
Quick Ratio<1:1
Longer stock days.
Longer debtor days.
Even longer creditor days.
Rapid Increase
Rapid Increase.
It often reaches or even exceeds the agreed limit.
Repaying a loan without replacing it, will result in less long-term
capital to finance the current level of operations.

Remedies:
Short-term remedies:

Better management of stock and debtors.

Delay capital expenditure.
Maintain the sales volume instead of increasing it.

Long-term remedies:

Inject fresh capital.

Overcapitalization:

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The over investment by the company in current assets, like excessive stocks, debtors
and cash, and very few creditors, results in excessive working capital and this condition is
called overcapitalization.

In short, over investment in working capital is over capitalization.

Symptoms:
Sales/Working Capital
Liquidity Ratios
Turnover Periods
Sales Turnover

Symptoms of Over Capitalization

Comparison with previous years or similar companies
Current Ratio > 2:1
Indicate over investment.
Quick Ratio > 1:1
Long turnover periods for stock.
Long turnover periods for debtors.
Short credit period from suppliers.
Decrease.

Remedies:

Optimal management of stock, debtors and creditors.

Investment of surplus cash in profitable investments.

Methods of Financing Working Capital:

There are following methods of Financing Working Capital:
a) Conservative Approach.
b) Moderate/Matching Approach.
c) Aggressive Approach.
All these approaches are in relevance to two types of current assets.
Types Of Assets
Fixed Assets.
Permanent Current
Assets.

Fluctuating Current
Assets.

Nature
These benefit a business for several accounting
periods.
Core level or minimum level of investment in current
assets needed for a given level of business activity.
Examples include certain stock levels maintained to
meet unexpected demand and certain permanent
debtor e.g. govt. institutions etc.
The variable portion of current assets required on
demand or need basis.

a) Conservative Approach:

All permanent current assets and majority of fluctuation current assets are financed from
long-term sources.
This is a risk adverse approach, which will result in low risk and low return.

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b) Moderate/Matching Approach:

Permanent current assets are financed from long-term sources and fluctuating current
assets are financed from short-term sources e.g. overdraft.
This is a risk neutral approach, which results in moderate risk and return.

c) Aggressive Approach:

All the fluctuating current assets and majority of the permanent currents assets are
financed from short-term sources.
This is a risk seeker approach and results in high risk and high return.

Working Capital Management :

Working Capital Management implies the following:
a)
b)
c)
d)

Management of Stocks.
Management of Debtors.
Management of Cash.
Management of Creditors.
a) Management of Stocks:

Why we hold stock:

To meet the day to day demand of production.

In order to meet emergency demand.
Stock may be kept in anticipation of inflation of prices in the future.
Stocks may be part of production process.
Stock may be held to provide buffer between two processes.
Stock may be held as a deliberate investment policy.

Objectives of Stock Mangement:

To minimize total stock related costs.
To ensure that stock available to meet routine and emergency demands.
Objective # 1: To minimize total costs associated with stocks.
(i)

Costs of stocks:
Purchase cost.
Annual costs of keeping stock include holding costs and ordering costs where;

Annual Ordering cost =

Where;
Number of orders =

No. of orders x Ordering cost/ order

Annual Demand
Order Size/ quantity

Ordering Cost is the cost incurred to place one order, which includes:
Ordering staffs salary.
Administration cost e.g. postage, telephone, and expenses.
Delivery costs.
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 Holding cost =
Where;
Average stock =

Average Stock x Holding cost per unit per annum (H)

(Q) Order Quantity/ Store Size
2

Holding cost is the cost incurred to store/hold one unit of stock for a year.
Cost of Capital.
Store related costs:
Storekeepers salary.
Rent of Store.
Heating, Lighting and cooling of store.
Insurance cost.
Store equipment and vehicles cost.
Obsolescence of stock.
Pilferage, theft and deterioration of stock.
Opportunity cost of investment blocked in stock.

As the objective is to minimize costs which gives us

Q=

2 x Ordering cost per order x Annual demand

Holding cost per unit per annum

This is the Economic Order Quantity Model.

EOQ is the optimal order quantity or order size at which ordering and holding costs are
minimum.
Total annual costs = Purchase cost + Ordering cost + Holding cost.
Exercise # 1:
Demand for a product is 70,000 units/month. Cost of holding a unit in stock for a week is 0.2.
Cost of ordering an order is 15. The purchase cost of a unit of output is 4.
Required:
a) Calculate EOQ.
b) Calculate Total Annual Costs at EOQ.
Example # 2:
A Ltd. has annual demand of 40,000 units, holding cost is 0.2/month and cost of placing one
order is 2. Purchase price is 10/unit.
Required:
Calculate total stock related cost if stock is ordered in following quantities.
a) 1,000 units /order.
b) 10,000 units /order.
c) EOQ.
(ii)

Discounts:

If discounts are offered on bulk purchase of item, it only makes sense to avail them.
But other costs along with the purchase cost should be considered to reach at a decision
whether to avail the discount offered or not.
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Now total annual costs will be minimized:

At pre-discount EOQ level, so that a discount is not worthwhile, or
At the minimum order size necessary to earn discount.

Exercise # 3:
The following data for the current year relate to a study lamp purchased by a departmental store:
Annual demand
Monthly Holding cost per lamp
Cost of placing per order
Purchase cost per lamp

10,000
2
150
220

From the start of next year the cost of placing an order will increase by 20% but all the other data will remain
the same.
For the current year the supplier has offered the following discounts:
Order size
500 750
751 and above

Discount %age
4%
7%

Required:
a) Calculate EOQ.
b) Calculate EOQ of the next year.
c) Which order size would minimize the total annual costs?

Objective # 2: To reduce or eliminate the risk of stock-outs thus the stock-out costs.
Stock out costs arises if stock is not available to meet certain demand and production is
stopped.

Stock-out costs include:

Labor Idle time.
Cost of potential sales.
Extra costs of emergency stock.
Loss of customer goodwill and future sales.
Cost of production stoppages.
Wastage of Machine time.
Low employee morale.

Cost of Stock-outs = Cost of Stock-outs x Expected number of Stock-outs per order x Number of
orders per year.
Where; expected number of stock-outs per order = various levels by which demand could exceed the reorder level during the lead-time.

Stock Control Level:

Lead Time:
The time gap between placing an order and eventual receipt of order from supplier.
(i)

Re-order level:

Re-order level is the measure of stock, at which a replenishment order should be made.
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Action
Order placed too late.
Order placed too early.

Result
Stock-out costs
Excessive stock holding costs.

Reorder level includes a buffer/safety stock.

It is important when there is uncertainty concerning volume of demand and the time taken
to attain the required stock (lead time).
Re-order level = maximum usage x Maximum lead-time.

(ii)

Maximum Level:

It is a warning signal to management that stocks are getting excessive.

Maximum Stock Level = Re-order level + Re-order Qt. (Minimum usage x Minimum lead time).

(iii)

Absolute Minimum Level/Buffer Stock/Safety Stock:

It is a warning to management that stocks are reaching a dangerously low level and the
stock-out is possible.
Min. Stock Level/Buffer/Safety Stock = Re-order Level (Max. Usage x Max. Lead-time).
Annual cost of safety stock = Qt. of Safety stock x Stock holding Cost per unit/annum.

(iv)

Average Minimum Stock Level:

Stock levels fluctuate evenly between minimum and maximum stock level.
Average Minimum Stock level = Reorder level (Average Consumption x Average Lead time)

Example # 4:
Maximum Lead time = 9 days
Minimum Lead-time = 5 days.
Maximum Consumption / day = 20 units
Minimum Consumption / day = 10 units
Annual Demand = 2,000 units.
Ordering Cost = 2 /order.
Holding cost = 1 / unit/ month.
Objective # 3: Avoiding the need to carry any stocks.
Just-in-Time Procurement System:
It is the policy of obtaining the stocks from suppliers at the latest possible time.
Benefits:
Reduction in stock holding costs.
Reduced manufacturing lead-time.
Improved labor productivity.
Reduced scrap/rework/warranty cost.
Lower level of investment in working capital.
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Exercises
Exercise # 1:
Oak Ltd has the following balance sheet and income statement:
Balance Sheet at the Y/E Dec 2006:

Non Current assets

Property, Plant and equipment
Intangible Assets
Current Assets
Stock
Debtors
Cash
Equity and Liabilities
Ordinary share Capital
Loan Notes 12%
Profit for the year
Current liabilities
Creditors
Taxation

50,000
10,000

60,000

10,500
10,700
22,000

40,000
10,200
44,300
5,000
3,700

43,200
103,200

94,500
8,700
103,200

Income Statement at the Y/E Dec 2006:

Sales
Cost Of Sales
Opening stock
Production cost
(Closing Stock)
Gross Profit
Expenses:
Depreciation
Wages and salaries
Administration costs
Selling and distribution costs
Profit before interest and Tax
Interest
Profit Before Tax
Tax
Profit After Tax

140,000

10,000
89,000
(15,000)
4,200
450
3,000
1,350

(84,000)
56,000

(9,000)
47,000
(2,000)
45,000
(7,00)
44,300
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Required:
Calculate the following:
a) Stock Days.
b) Debtors Days.
c) Creditors Days.
d) Trade Cycle.
e) Working Capital.
f) Current Ratio.
g) Acid Test Ratio.
Exercise # 2:
Debtors days = 15
Creditors days = 27
Stock days = 54
Sales turnover = 178,000
Purchases = 78,000
Cost of sales = 94,000
Required:
a) Operating Cycle.
b) Average Stock.
c) Trade debtors.
d) Trade creditors.
Exercise # 3:
Furlong Co. income statement
For the year ended 31 December 2008,

Revenue
Cost of sales
Opening Stock
Production
Closing stock
Gross profit
Expenses:
Depreciation
Selling and administration cost
Interest
Net Profit

30,000

1,200
12,000
(1,000)
1,000
5,300
3,000

(12,200)
17,800

(9,300)
8,500

Balance sheet
For the year ended 31 December 2008,

Non current assets

Current Assets
Inventory
Receivables

10,000

1,000
1,500

2,500
12,500
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Equity and Liabilities

Ordinary share capital
Share premium Account
Retained earnings

1,000
200
9,000

Creditors
Overdraft

1,000
1,300

10,200
2,300
12,500

Required:
Calculate the following:
a) Stock Days.
b) Debtors Days.
c) Creditors Days.
d) Trade Cycle.
e) Working Capital.
f) Current Ratio.
g) Acid Test Ratio.
Exercise # 4:
Debtors days = 45
Creditors days = 17
Stock days = 20
Average Trade debtors = 230,000
Average trade creditors = 350,000
Average stock = 78,000
Required:
a)
b)
c)
d)

Cost of sales
Purchases
Credit Sales turnover
Operating cycle.

b) Management of creditors:
Objectives of Creditors Management:
Attempting to obtain credit from the supplier.
Attempting to extend credit when needed.
Maintaining good relationship with the supplier.
Evaluation of discounts offered from suppliers.
Step # 1: Annualize the discount with following formula;
D
Annualize discount %age =

365
x

100 D

Where;
D = discount, e.g. if discount is 6% then D would be 6.
T = reduction in the credit period in order to avoid discount.
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Step # 2: compare the required rate of return of the company / business with annualized discount
%age.
If the annualized discount is greater than the required rate of return the discount should be
accepted.
Example # 1:
Suppliers of A Ltd. offer 50 days credit. Supplier has offered 3% discount for payment within 15
days.
Then, (3/ 15 x 50)
Where; 3 is the 3% discount.
Discount is offered if the payment is within 15 days.
Otherwise the normal payment period is 50 days.
Company can invest at 20% per annum / required rate of return of the business.
Required:
Evaluate the viability of the early settlement discount.
Solution:
Annualized discount %age / Cost of lost discount = 3 / (100 3) x 365/35
= 32.25%
As the annualized discount %age exceeds required rate of return of the company, the discount
should be availed.
Example # 2:
Supplier has offered the following terms (2/12 x 38)
The required rate of return of the company is 30 %.
Required:
Evaluate the suppliers offer.
Solution:
Annualized discount %age / Cost of lost discount = 2 / (100 2) x 365/38
= 19.6%
As the annualized discount %age is less than the required rate of return of the company, the
discount should not be availed.
Bills of exchange:

It is a form of trade credit.

Supplier or the creditor issues the bills of exchange on customer, that he would pay the
certain amount of money on a certain date.
Customer signs the bill to accept and give acknowledgement of his/her debt to creditor.
When a certain date is reached, customer pays the creditor.

Acceptance credit:

It is an alternative to bank overdraft.

It is a source of finance from banks for large companies.

Difference from bills of exchange/trade bills:

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It is a facility to customer to draw bills on the bank, which bank would accept.
Accepted bills are sold by the bank in the discount market on behalf of the customer.
The money obtained from sale less the bank s acceptance commission is made
available to the customer.
When bill matures, customer will pay the bank the value of bill, bank will turn pay the bill
holder/creditor.

Attractiveness of Acceptance Credit:

It is an alternative source of finance.

There is a specific period of time limit for credit.
There is cost advantage to customer, as the rate of discount on bank bills is lower than
the interest rate on bank loan or overdraft.
There is the certainty in the cost of the credit facility, as it is fixed.

c) Management of debtors:
Objectives of management of debtors:
i. Granting of credit:
Assessing credit worthiness of customers.
Decision about credit limits to be granted.
ii. Extension of credit/ early settlement of discounts:
Evaluation of financial consequences of extension in credit limit and credit period.
Evaluation of financial consequences of early settlement discount offered to
customers.
iii. Financing of Debtors:

Evaluation of different financing option.

Evaluation of;
a) Factoring proposals.
b) Invoice discounting opportunities.
iv. Managing overseas debtors:
Assessing credit worthiness of overseas debtors.
Evaluation of credit extension for overseas debtors.
Overseas factoring.
v. Use of customers data:
Debtors aged analysis report.
Internal credit ratings.
Individual customer profitability analysis.
Detailed Discussion of Objectives:
i. Granting of credit:
1) Assessing credit worthiness of potential customer.

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Following are the sources of information with the help of which credit worthiness of a customer
can be judged;
References:
a) Reference from other customers.
b) Reference from the bank.
c) Reference from the supplier.
Credit ratting agencies.
Audited financial statement of the potential customers.
Department of trade and industries.
Business journal.
Press cuttings.
2) Extension of credit limit/ early settlement discount:

Evaluation of financial consequences of extension in credit limit and credit period.

a) Return on investment approach.
b) Cost of financing debtors.

Return on Investment Approach

Step # 1:
Calculate current average debtors using
following formula.
Avg. Debtors =

Debtors
Payment Period
365

Credit
x Sales

Step # 2:
Calculate revised sales and revised average
debtors.
Step # 3:
Calculate increase in average debtors.
Step # 4:
Calculate increase in contribution.
Step # 5:
Calculate the return on investment using the
following formula;
Return on
Investment =

Increase in
Contribution
Increase in Avg.
Debtors

Cost Of Financing Debtors

Step # 1:
Calculate the current average debtors and
current cost of financing average debtors.
Cost of
Financing Avg.
Debtors
=

Avg.
Debtors

X Interest rate

Step # 2:
Calculate the revised average debtors and
revised cost of financing debtors.
Step # 3:
Calculate increase in financial cost due to
change in policy.
Step # 4:
Calculate increase in contribution.
Step # 5:
If there is more increase in contribution than
increase in cost of financing debtors, the policy
is worthwhile.

X 100

Step # 6:
Compare ROI with required ROI, if Required
ROI is less, the policy is worthwhile and can be
implemented.
Exercise#1:
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Russian Bread Ltd. is considering a change of credit policy, which will result in an increase in the
average collection period from one to two months. The relaxation in credit is expected to produce
an increase in sales in each year amounting to 25% of current sales volume.
Selling price per unit
Variable cost per unit
Current annual sales

10
8.50
2,400,000

The required rate of return on investments is 20%. Assume that the 25% increase in sales would
result in additional stocks of 100,000 and additional creditors of 20,000.
Required:
Advise the company on whether or not to extend the credit period offered to customers, if:
a) All customers take the longer credit of two months.
b) Existing customers do not change their payment habits, and only new customers take a
full two months credit.
Exercise#2:
Lowe and Price Ltd. Has annual credit sales of 12,000,000 and three months are allowed for
payment. The company decides to offer a 2% discount for payments made within ten days of
invoice being sent, and to reduce the maximum time allowed for payment to two months. It is
estimated that 50% of customers will take the discount.
Required:
If the company requires a 20% return on investments, which will be the effect of the discount?
Assume that the volume of sales will be unaffected by the discount? Assume that the volume of
sales will be unaffected by the discount.

Exercise#3:
Enticement Ltd. Currently expects the sales of 50,000 a month. Variable costs of sales are
40,000 a month (all payable in the month of sale). It is estimated that if the credit period allowed
to debtors were to be increased from 30 days to 60 days, sales volume would increase by 20%.
All customers would be expected to take advantage of the extended credit. If the cost of capital is
12.5% a year ( or approximately 1% a month), is the extension of the credit period justifiable in
financial terms?

Exercise#4:
Grabbit Quick Ltd. achieves current annual sales of 1,800,000. The cost of sales is 80% of this
amount, but bad debts average 1% of total sales, and annual profit is as follows.

Sales
Less: cost of sales
Less: Bad Debts
Profit

1,800,000
1,440,000
360,000
18,000
342,000
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The current debt collection period is one month, and the management considers that if credit
terms were eased (option A), the effects would be as follows.

Additional Sales (%)

Average Collection Period
Bad Debts (% of sales)

Present Policy
1 Month
1%

Option A
25%
2 Month
3%

The company requires a 20% return on its investments. The costs of sales are 75% variable and
25% fixed. Assume there would be no increase in fixed costs from the extra turnover; and there
would be no increase in average stocks or creditors.
Required:
Which is the preferable policy, Option A or the present one?
d) Management of cash
Cash flow problems may arise if:
A business is continuously making losses.
Its the time of inflation, and the business requires ever increasing amount soft cash just
to replace old assets.
The business is growing it needs to acquire more fixed assets and to support higher
amounts of stocks and debtors.
There are seasonal/cyclical sales, which would result in cash flow difficulties at certain
times of the year.
There is a single non-recurring item of expenditure.
Motives of holding Cash:
(i)

Transaction Motive:

Business needs cash to meet its regular

commitment of paying its creditors, wages,
taxes, and annual dividends to shareholders.

(ii)

Precautionary Motive:

Business needs to maintain a buffer of cash for

unforeseen contingencies, which might be
provided by an overdraft facility.

(iii)

Speculative Motive:

Business might maintain surplus cash as a

speculative asset in the hope that interest rates
will increase.

Objective # 1: to avoid cash shortages.

Acquisition of new fixed assets might be deferred, in situations where the postponement
has no serious consequence.
Press debtors for early payment might improve the cash in flow but would result in a loss
of customer goodwill.
Revising past investment decisions by selling assets previously acquired.
Delaying the cash outflows:
Extension of credit period, which would have adverse effect on the credit
rating.
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Rescheduling the loan repayments with the banks.

Deferral payment of cooperation tax in agreement with Inland Revenue.
Dividend payments could be reduced.

Optimum Amount of Cash:

There are two approaches to decide the optimum amount of cash.
a) Inventory Approach
b) Miller-Orr Model
a) Inventory approach:

Deciding the optimum cash balances is like deciding on optimum stock levels.
Costs involved in obtaining cash:
Fixed cost that is the issue cost of equity finance or the cost of negotiating an
overdraft.
The variable cost/opportunity cost keeping the money in the form of cash.

This approach uses an equation quite similar to the EOQ formula for stock management.

Avg. total cost incurred for period in holding a certain

level of cash (C ) =

Qi
2

FS
+

Where;
S = the amount of cash to be used in each time period.
F = the fixed cost of obtaining new funds.
i = the interest cost of holding cash or cash equivalents.
Q = the total amount to be raised to provide for S.

Then the C is minimized when:

Q=

2 FS
i

Drawbacks:

It is unlikely to be possible to predict amounts required over future periods with much
certainty.
There is no buffer stock of cash; there must be cost of running out of cash.
There may be normal costs of holding cash, which increase with the average amount
held.
b) Miller-Orr Model:

It is a more realistic approach to cash management.

If there is no attempt to manage the cash balances, the cash balances will drift upwards
or downwards.
A limit must be imposed on this drifting.
Figure: 1 Miller-Orr Model

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Cash
balance

Upper limit
The firm buys
securities

Return point
The firm sells
securities

Time

If the cash balance reaches an upper limit, the firm buys sufficient securities to return the
cash balance to a normal level/the return point.
When the cash balance reaches a lower limit, the firm sells securities to bring the balance
back to the return point.
Upper and lower limits:
Wider limits

Closer limits

Lower limit

Day-to-day variability of cash flows is high.

The transaction cost in buying and selling securities
is high.
Interest rates are low
The interest rates are high.
Day-to-day variability of cash flows is low.
The transaction cost in buying and selling securities
is low.

To keep the interest cost of holding cash down, the return point is set at one-third of the
distance (spread) between the lower and the upper limit.
Return Point = Lower limit + 1/3 x spread

The formula of Spread is as follows;

Spread = 3 x ( x transaction cost x variance of cash flows/ interest rate)

Steps to use Miller-Orr Model:

Step-I

Set the lower limit for the cash balance. This may be zero, or may be
set at some minimum safety margin above zero.

Step-II

Estimate the variances of cash flows.

Step-III

Note the interest rate and transaction cost for each sale or purchase of
securities.

Step-IV

Compute the upper limit and the return point from the model and
implement the limits strategy.
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Objective # 2: to avoid the deviations from expected cash flows.

Cash Budgets are only estimates.

An analysis of the sensitivity of the cash flows forecasts to changes in estimates of sales
and costs.
A Probability Distribution of possible outcomes for the cash position will allow a more
accurate estimate to be made of the minimum cash balances.
Unforeseen deficits can be hard to finance at a short notice and advance planning is
desirable.

Objective # 3: to reduce the float.

Float is the amount of money tied up between the time when a payment is initiated and
the time when the funds become available for use in the recipients bank account.

Reasons for a lengthy float and measures to shorten it:

(i)

Reasons
There is a transmission delay,
because it will take a day or two
longer for the payment to reach payee
when sent through the post.

Measures
The payee must ensure that the
lodgment delay is kept to a minimum.
Cheques received should be presented
to the bank on the day of receipt.
The payee might arrange to collect
cheques from the payers premises.

(ii)

There is a delay in banking the

payments received. The length of this
delay might depend on the
administrative procedures in the
payees organization.

Efficient administrative procedures to

bank the payments and cheques
received.

(iii)

There is a delay in the cheque

clearance by the bank.

The payer might be asked to pay

through his own branch of a bank,
using the bank giro system.
BACS is a banking system, which
provides for the computerized transfer
of funds between banks.
Standing orders or direct debits might
be used.
CHAPS is computerized system for
banks to make same-day clearances
between each other.

Objective # 4: to reduce delays in receiving payment from debtors.

Reducing the length of credit period.

Compiled by: Qassim Mushtaq

Premier DLC

Notifying the invoicing department that goods have been dispatched, so that the invoices
are sent promptly.
Invoices should contain clear instructions so that the cheques are correctly made out.

Compiled by: Qassim Mushtaq

Premier DLC