Cash Management

The working capital of an organization changes on a continuous basis and should be carefully monitored by finance managers to determine the correct course of action to take. “The financial executive probably devotes more time to working capital management than to any other activity.” (Block & Hirt, 2005, p. 145) The goal of financial executives in managing working capital is to keep costs to a minimum. This goal is accomplished through understanding the nature of asset growth, the process of matching sales and production, and financial aspects of working capital management.

Nature of Asset Growth

While most companies would like for all of their current assets to be self-liquidating and have zero debt, the very nature of business is to grow and obtain assets. For example, John starts a home t-shirt business printing t-shirts from home and sells them at the local beach to tourists. Each day he sells all his t-shirts leaving him with no inventory and a handful of cash. John takes his cash and invests a percentage in more supplies for t-shirt production and a percentage is invested in an interest bearing account. Over time John makes enough money to invest in a t-shirt company which provides t-shirts to retailers nationwide. As his business has grown John has acquired fixed assets on top of current assets. “Fixed assets grow slowly as productive capacity is increased and old equipment is replaced, but current assets fluctuate in the short run, depending on the level of production versus the level of sales.” (Block & Hirt, 2005, p.146)

Level Production vs. Matching Sales and Production

The level of production is vital to understanding how production flow is going to take place and what kind of financing would be needed. “Some firms employ level production methods to smooth production schedules and use manpower and equipment efficiently at lower cost. Other firms may try to match sales and production as closely as possible in the short run.” (Block & Hirt, 2005, p. 146) The benefit of matching sales and production is that current assets will increase and decrease with the level of sales. Level production methods are not as accommodating and companies will find that current assets will go up and down when sales and productions are not equal. If John’s t-shirt company practices level production and t-shirt sales are seasonal. The company may see an increase in inventory, a depletion of cash funds and no account receivables. John would need to find financing to hold the company over until the inventory starts to move and account receivables start to come in.

Financial Aspects of Working Capital Management

Comparing the relations of current assets, fixed assets, inventory, accounts receivables and cash over a one or two year period will give financial managers a better understanding of the asset cycle of the company. This analysis will help to determine the financing the company may need during off season cycles and how much to finance. “The financial manager’s selection of external sources of funds to finance assets may be one of the firm’s most important decisions.” (Block & Hirt, 2005, p. 153)

Once the need for financing has been established a financial manager must determine how to finance the company’s assets. “The most appropriate financing pattern would be one in which asset buildup and length of financing terms are perfectly matched…temporary buildup in current assets is financed by short-term funds…permanent current assets and fixed assets are financed with long-term funds.” (Block & Hirt, 2005, p.155) Determining which current assets are permanent and which are temporary poses a problem for the finance manager; as well as the uncertainty of available long and short-term financing. A company may need to look into other alternative mixes of financing such as “using long-term capital to cover part of short-term needs.” (Block & Hirt, 2005, p.156) This mix of financing would ensure the company would have capital at all times.

While large corporate businesses may have the necessary bond and stock offerings needed to acquire the long-term loans needed to sustain a business, most small businesses do not have the capital needed and have to rely on the short-term bank and trade credit. “A firm could develop a working capital financing plan in which short-term funds are used to finance not only temporary current assets, but also part of the permanent working capital need of the firm.” (Block & Hirt, 2005, p. 156) The advantage

...