Importance of Financial Management and Cash Management Techniques in Business

Introduction

Every business entrepreneur is to adopt that sort of technique and management policy which can make a drastic impact on the business in order to achieve the goal and objectives set by the management. Financial management is the key to the success of any organization which is why one needs to keep a closer look at that area. Different modes of financing can be selected by an organization like Short or long term financing or manage inventory, working capital and cash. In this paper different cash management and short term financing modalities are discussed.    

Comparing and Contrasting Various Cash Management Techniques

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• Firms hold reserve cash, short term and liquid marketable securities for three purposes
• For conducting transactions
• Satisfying precautionary needs
• Financing possible speculation

The transactions motive for holding cash reserve is simply to make sure that the cash is needed for operating the business. If the firm’s net cash flows are volatile it may hold cash reserve for precautionary reasons (Mathur, 1997). A firm may hold cash to be able to capitalize on unforeseen situations the firm speculates on the utilization of funds.

Description

Cash management involves improving collection and slowing disbursements. Concentration banking and using the lock box system are two methods of improving cash collections. In concentration banking the firm selects a number of fund collection points. Customer’s payment at these points is deposited in local banks. Excess funds in local banks are transferred by either draft wire to the firm major or concentration bank (Brigham and Daves, 2006). In a lock box system customers are directed to send their payments to a post office box. The firm’s bank picks up payments in the post office several times a day and posts them to the firm’s account. The lock box system is efficient in collecting receivable but is expensive.

Banks provide variety of cash management services to firms and are paid either directly by firms or through maintenance of checking account balances or compensating balances (Mathur, 1997). The compensating balances have to be large enough so that returns earned on the balances equal to the cost of providing banking services. A firm with good cash management policies will show a large float which is the difference between the firm’s checking account balances on the bank’s books and its own book. Firms control and slow disbursements by paying bills just before their due dates by matching bank account balances to clearances rather than the firm’s book. Another method of slowing disbursements is to draw checks on banks in remote areas, thereby increasing the time it takes for the check to clear through the firm’s checking account. In addition to cash firms also hold marketable securities; short term investments should assure the safety of the principal is liquid and has a reasonable yield.

Comparing and Contrasting the Various Methods of Short-Term Financing

Any debt that was originally scheduled for repayment within 1 year is called short term debt. Major sources of short term debt are trade credit, loans and commercial papers. Trade credit is created by purchasing goods and services on credit. There are three vehicles of trade credit.

• Open account,
•  promissory note
•  trade acceptance

Use of trade credit is affected by merchandise characteristics, the financial strength of the buyer and the seller and accepted industry practice. Trade credit has both explicit and implicit costs. Both need to be considered before trade credit is utilized.

There are three major sources of unsecured loans

• Line credit
• Revolving credit arrangement
• Transaction loans
• Description

For seasonal financing needs the first two of the three major sources are more appropriate. Whereas, for temporary needs or short-term financing, a transaction loan is more appropriate (Keown, 2004). Banks require that line of credit or revolving credit clients maintain a demand deposit balance or compensating balance, with the bank. The compensating balance requirements are based either on the credit limit or on the amount borrowed. Interest rates on unsecured loans are based on credit worthiness of the borrower (Brigham and Daves, 2006). Low-risk firms pay the lowest rates (Brigham and Daves, 2006).

Short term loans can be secured by using receivables or inventories for collateral. Receivables can be pledged to secure loans. The loan value of a receivable is based upon its quality. If average accounts are small the lender may use a floating line to secure the loan (Mathur, 1997). Interest rates on loans secured with receivables tend to be high because of the amount of record keeping work involved. Receivables financing is continuous, since the borrower is constantly pledging new receivables. If receivables are sold rather than pledged the process is called factoring. A factor or buyer of receivables provides credit checking, lending and risk bearing services. Factoring can be with or without recourse. The risk of bad debt losses is borne by the factor in factoring without resources. Factoring costs also tend to be high because of record keeping costs.

If inventories are non-perishable, marketable and with a stable market price, then it can be used as a collateral for short term loans. Trust receipts and warehouse receipts financing are popular methods for using inventories as collateral. Commercial paper refers to short term unsecured promissory notes issued by large and financially strong firms. Interest on commercial paper is generally 0.5 percent lower then the prime rate. Commercial paper can be issued with maturities varying from 30 to 180 days (Brigham and Daves, 2006). Commercial paper financing offers certain advantages over bank financing but has its disadvantage also.

Conclusion

All in all, we can say that finance is the life and blood of any organization particularly managing the cash reserves and adaptation of different short-term financing techniques which can help out the administration to take prompt and quick measures which accelerates the flow of funds rapidly and also minimizes the risk.

References

1. Brigham, Eugene F. and Daves, Phillip R. (2006). Intermediate Financial Management.
2. J. Keown, Arthur (2004). Financial Management: Principles & Applications.
3. Sagner, James and Allman-Ward, Michele (2003). Essentials of Managing Corporate Cash.
4. Mathur, Iqbal (1997). Introduction to financial management. Collier Macmillan.

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