Cash management
Cash forecasting is extremely important to most firms. It enables them to anticipate periods of surplus cash and periods where financing will be necessary. This anticipation is the reason for which cash forecasting is necessary. Anticipation enables the firm to plan much more effectively for investment and financing, and via these planning, produce superior returns. The Square Textiles Ltd. uses the Tally software specially customized for the company for preparing cash budgets and making forecasts.
1.1. Cash Budget: The types of cash forecasts generated by the firms can be differentiated along two dimensions: the length of periods included with the cash forecast and the approach to cash flows used in the cash forecast.
1.1.1 The length of periods: It refers to the units of time into which the cash forecast is divided. The Square Textiles Ltd. forecasts their cash needs on monthly basis. They forecast their cash inflows and outflows for single period.
1.1.2 Approaches to cash flow: The Square Textiles Ltd. applies the receipts and disbursements approach to cash flow in generating the cash forecast. The receipts and disbursement approach uses the amounts of cash expected to be received and disbursed by the firm over the periods chosen for the forecast. This approach uses the amounts of cash expected to be
received and disbursed by the firm over the periods chosen for the forecast. This method minutely traces the movement of cash and preferred by firms that exercise very close cash control. The firms that made forecasts for relatively short time horizons use it.
1.1.3 Items to be forecasted: In the receipts and disbursements cash forecasting method, estimates need to be made of the numerous major and minor items that the firm collects and that it pays. The more individual categories of items the firm includes in its forecast procedure, the more accurate the forecast may be. A list of some inflows forecasted by Square Textiles Ltd. is provided as follow: Accounts receivable collections Miscellaneous receipts Some possible types of cash disbursements: Cash purchase of materials Payroll-Executive Taxes Maturing accounts payable Lease payments Utility payments Interest payments Miscellaneous disbursements
1.1.4 Estimating uncertainty in cash forecasts: As the Square Textiles Ltd. forecasts their cash need for relatively short time horizon they consider the following three uncertainties mainly: Sales uncertainty: It refers to the risk regarding the firm’s future levels of sales. Most firms try to forecast accurately enough to hold errors in short run sales forecasts to less than 10%
and for Square Textiles Ltd. the level of acceptable errors for monthly sales data is 5%. Collection rate uncertainty: This is the uncertainty regarding the firm’s future collection patterns of receivables. The firm may historically have collected an average of a certain percent of its outstanding receivables from a particular period in another particular period, but this average contains considerable variability. Further, changing market ad economic conditions may make chancy extrapolations of past historic data into future periods. The firm first supplies its products to dealers at credit and receives cash after dealers sell the products in the market, and this is the main source of uncertainty faced by Square Textiles Ltd. in case of accounts receivable. Production cost uncertainty: This is the risk with the actual labor and material costs that go into the making of a product or service. Labor productivity may be more or less than expected, which makes labor costs uncertain. The costs of materials used may vary due to unexpected changes in price or in amount of materials necessary to produce products and services. As Square Textiles Ltd. imports most of its raw materials from abroad, changes in exchange rate of dollars also affects the cost of production.
1.1.5 Estimating uncertainties: Square Textiles Ltd. assesses the individual sources of uncertainty on important individual outcome variables. This requires sensitivity analysis. This kind of analysis provides very useful information about the amounts of possible surpluses and deficits in the future.
1.2. Balance Policy: At the end of the each period of cash forecast, the firm expects to be in either a surplus or deficit position. Without some kind of hedge against the uncertainties of future cash flows, the firm incurs costs that could be avoided by the use of hedging strategy. There is a trade off between the cost of the hedge and the expected costs that it avoids.
1.2.1 Extra borrowing capacity: The Square Textiles Ltd. maintains Current Accounts with Citi Bank NA, Standard Chartered, Bank Alfalah and HSBC. When the firm faces ay difficulty for financing its disbursements by internal income it can overdraft from these accounts.
1.3. Investment Policy: The Square Textiles Ltd. has investment in the stocks of Square Ltd. one of its subsidiaries. However this investment is for long term thus it does not work as balancing of excess cash available to the firm.
1.4. Bank Loan: For financing the production activities Square Textiles Ltd. uses short-term bank loans. The firm has Revolving Credit Accounts with Citi Bank NA, Standard Chartered, Bank Alfalah and HSBC and the firm uses funds from these accounts to meet its short term fund need. The firm mainly uses this loan for purchasing raw materials, to carry on the costs of production, to pay its accounts payable and to carry the factory overhead cost and some other short-term costs.
Chapter 2 Inventory Management Policy.
2.1: Inventory Procurement Policy: Inventory of the firm mainly consists of raw materials of the products and packing materials. Square Textile Ltd. mainly concentrates on inventory of raw materials and packing materials. But its inventory stocks consists of raw materials, packing materials, raw materials in transit, work-in-process, finished goods, waste cotton, spares& spares in transit.. Inventories are bought from foreign market as well as from local market. All packing materials are purchased from local market.
2.1.1: Reasons for holding different kinds of inventory: Reasons for holding raw materials inventory: •
It makes production scheduling easier
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It helps to avoid price changes for these goods.
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The firm may keep extra raw materials inventory to hedge against supply shortages
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The firm may order and keep additional inventories of raw materials to take advantage of quality discount.
Reasons for holding work in process inventory: •
A major reason that firm keeps work in process inventory beyond the minimum level is to buffer production.
Reasons for holding finished goods inventory: •
One reason to keep finished goods inventory is to provide immediate service to the customers.
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A second reason to keep finished goods inventory is to stabilize production.
2.1.2: Costs that are considered in inventory procurement policy: Different types of costs are discussed in the following paragraphs: •
Cost directly proportional to amount of inventory held:
Carrying cost of inventory or holding cost of inventory. The formula for this type of costs are Cost = (a) (amount of inventory) Where, a is a coefficient representing the sum of all costs that are directly proportional to the level of inventory.
• Cost not directly proportional to the amount of inventory held: There are group of costs that varies with inventory size but not in direct proportionality. The formula for these costs is: Cost = f (inventory level) Where, f (inventory level) means that cost is a function of inventory level, with the particular mathematical relationship depending upon the type of cost being considered.
• Cost directly proportional to the number of orders: There are costs to the ordering, delivering and payment processes. these costs depend directly on the number of times the orders are placed and received. Cost of this sort include set o[ costs on machines to produce inventory, costs of generating a purchase order for the inventory, costs of writing a cheque and mailing it in payment for the order, fixed costs of unloading the order and so forth. The formula for this type of cost is: Cost = © (number of orders) Where, c is a coefficient representing the sum of all the costs in this type. •
The price per unit of inventory obtained:
Due to quantity discounts and economics of scale in production, the price per unit of goods purchased or produced for inventory may vary with the amount ordered. The formula for the total cost of the inventory is:
Cost = Pa S Where Pa is the unit price for the quantity ordered by the firm and S is the yearly usage of the good. •
Stockout cost:
Another cost that is dependent on the firm’s inventory strategy is stockout cost. Stockout cost occurs when immediate service is required but inventory is unavailable. Usually a minimum amount of spoilage occurs for holding inventory. But ordering cost and carrying cost of inventory is considerable in case of materials purchased from foreign market. Materials that are purchased from local market incur less amount of both direct and indirect cost of holding inventory. Stock out cost is a common problem for the firm. This happens because of low predictions about market demand. A good prediction about market demand and safety stock position can alleviate the problem. But the firm does not have a good policy for maintaining adequate safety stock. Another problem for not meeting up the market demand is a long lead time, which helps to fail the fulfillment of demand.
2.2: Inventory Store Management: The management of inventory is one of the oldest concerns of management science. Like all other assets inventory represents a costly investment to the firm. There are some reasons why a firm may want to carry inventory. Square Textiles Ltd. follows the periodic inventory system for managing the inventory records. The problem that they face with stocks is somewhat related to dynamic inventory problem where the goods have value beyond the initial period; they do not lose their value completely over time. The process of followed by Square textiles Ltd for managing inventory is as follows: Where the cost of merchandise purchased during the year is debited to a Purchases account, rather than to the inventory account. When merchandise is sold to a customer, an entry is made recognizing the sales revenue, but no entry is made to
reduce the inventory account or to recognize the cost of goods sold. The inventory on hand and the cost of goods sold for the year are not determined until year end. At the end of the year, all goods on hand are counted and priced at cost. The cost assigned to this ending inventory is then used to compute the cost of goods sold. The only computation that is kept up to date in the accounting records is the purchases account. The amounts of inventory at the beginning and end of the year are determined by annual physical observation.
2.3: Inventory Valuation Method: The break up of Inventory Stock of Square Textile ltd for the year 2004 is as follows: The break up is under: Raw materials Raw material in transit Packing Materials Work in Process Finished Goods Spares at Store Spares in Transit Waste Cotton taka
336456255 2442980 2898296 6570867 20740646 32539232 698685 3102848 405449809
The basis of inventory valuation is as follows: Inventory stocks comprise of raw materials, packing materials, raw materials in transit, work-in-process, finished goods, waste cotton, spares& spares in transit. Stocks are valued at the lower of cost and net realizable value. Value of stock other than stock of finished goods represents weighted average cost. Finished goods are valued at lower of cost or net realizable value and include allocation of production overheads while works in process are valued at material cost.