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Working Capital Management

 Self-Paced Overview

Ways to Manage Cash

Firms can manage cash in virtually all areas of operations that involve the use of cash. The goal is to receive cash as soon as possible while at the same time waiting to pay out cash as long as possible. Below are several examples of how firms are able to do this.

Policy For Cash Being Held

Here a firm already is holding the cash so the goal is to maximize the benefits from holding it and wait to pay out the cash being held until the last possible moment. Previously there was a discussion on Float which includes an example based on a checking account. That example is expanded here.

Assume that rather than investing $500 in a checking account that does not pay any interest, you invest that $500 in liquid investments. Further assume that the bank believes you to be a low credit risk and allows you to maintain a balance of $0 in your checking account.

This allows you to write a $100 check to the water company and then transfer funds from your investment to the checking account in a "just in time" (JIT) fashion. By employing this JIT system you are able to draw interest on the entire $500 up until you need the $100 to pay the water company. Firms often have policies similar to this one to allow them to maximize idle cash.

Sales

The goal for cash management here is to shorten the amount of time before the cash is received. Firms that make sales on credit are able to decrease the amount of time that their customers wait until they pay the firm by offering discounts.

For example, credit sales are often made with terms such as 3/10 net 60. The first part of the sales term "3/10" means that if the customer pays for the sale within 10 days they will receive a 3% discount on the sale. The remainder of the sales term, "net 60," means that the bill is due within 60 days. By offering an inducement, the 3% discount in this case, firms are able to cause their customers to pay off their bills early. This results in the firm receiving the cash earlier.

Inventory

The goal here is to put off the payment of cash for as long as possible and to manage the cash being held. By using a JIT inventory system, a firm is able to avoid paying for the inventory until it is needed while also avoiding carrying costs on the inventory. JIT is a system where raw materials are purchased and received just in time, as they are needed in the production lines of a firm.

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