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Importance of Cash Management in Business

The document outlines various reasons for businesses to hold cash, including covering operational expenses and enabling quick investment opportunities. It also describes financial instruments like Treasury Bills, Certificates of Deposit, and Commercial Paper, which provide businesses with options for short-term cash management. Additionally, it explains trade credit terms like 2/10, net 30, and the implications of stockouts on inventory management and customer satisfaction.

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Melvin Almario
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10 views6 pages

Importance of Cash Management in Business

The document outlines various reasons for businesses to hold cash, including covering operational expenses and enabling quick investment opportunities. It also describes financial instruments like Treasury Bills, Certificates of Deposit, and Commercial Paper, which provide businesses with options for short-term cash management. Additionally, it explains trade credit terms like 2/10, net 30, and the implications of stockouts on inventory management and customer satisfaction.

Uploaded by

Melvin Almario
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Reasons for Holding Cash in Business

1. such as:
• Salaries and wages
• Rent and utilities
• Supplier payments
• Ensures smooth operations without delays in
payments.
📌 Example: A retail store keeps enough cash to pay
employees weekly and restock inventory without
waiting for receivables to be collected.
2. 📌 Example: A company sets aside funds to handle
sudden machine breakdowns or delays in customer
payments.
3. such as:
Buying inventory at a discount
Investing in short-term ventures
Acquiring a competitor’s assets quickly
Having liquid cash allows quick action without
waiting for financing.
📌 Example: A construction firm holds cash to
purchase bulk cement when market prices
temporarily fall.
4. 📌 Example: A company maintains ₱500,000 in its
account as a compensating balance for a bank loan.
1. Treasury Bills (T-Bills)
 Definition: Short-term debt securities issued by

the government (e.g., U.S. Treasury, Philippine


Bureau of the Treasury) to raise funds. They
mature in a year or less.
 How it works: Sold at a discount and

redeemed at face value. You don’t earn


periodic interest; instead, your profit is the
difference between purchase price and maturity
value.
 Example:

o You buy a ₱100,000 T-Bill for ₱98,000.

o After 6 months, the government redeems

it for ₱100,000.
o Profit = ₱100,000 − ₱98,000 = ₱2,000.

 Use Case: Popular for businesses needing safe,

short-term parking for cash.

2. Certificates of Deposit (CDs)


 Definition: A time deposit offered by banks,

where you invest a fixed amount of money for a


specific term (e.g., 3 months, 6 months, 1
year) at a fixed interest rate.
 How it works: The bank pays you interest but

you can’t withdraw before maturity without a


penalty.
 Example:

o Deposit ₱500,000 in a 1-year CD at 4%

annual interest.
o At maturity, you receive ₱520,000

(₱500,000 + ₱20,000 interest).


 Use Case: For individuals and companies that
want a guaranteed return and don’t need
immediate access to the funds.

3. Commercial Paper (CP)


 Definition: Short-term unsecured

promissory notes issued by corporations to


finance short-term needs, like payroll or
inventory. Maturities are usually 30 to 270
days.
 How it works: Sold at a discount, similar to T-

Bills, but riskier since it’s backed by a company,


not the government.
 Example:

o A company issues a ₱1,000,000 CP at

₱980,000 for 90 days.


o Investor earns ₱20,000 after 90 days when

the company pays full value.


 Use Case: Large firms with strong credit ratings

issue CP to raise cash at a lower cost than


bank loans.

4. Money Market Funds (MMFs)


 Definition: Mutual funds or investment funds

that pool money from investors to buy short-


term securities like T-Bills, CP, and repos.
 How it works: Investors buy shares in the

fund, and the fund manager invests in very low-


risk, short-term assets.
 Example:

o You invest ₱100,000 in a Money Market

Fund.
o Over a year, the fund earns 3%, so your
investment grows to ₱103,000.
 Use Case: Ideal for individuals or
businesses that want diversification and
liquidity without directly buying securities.

5. Repurchase Agreements (Repos)


 Definition: A short-term agreement where a

dealer sells securities (often government bonds)


to an investor and agrees to repurchase
them later at a slightly higher price.
 How it works: Functions like a collateralized

loan—the seller gets cash, and the buyer earns


interest.
 Example:

o A bank sells securities worth ₱10M with an

agreement to buy them back in 7 days for


₱10.02M.
o Investor earns ₱20,000 in a week.

 Use Case: Used heavily by banks and

institutions for short-term liquidity.

6. Treasury Notes/Bonds (Short Maturity)


 Definition: Government-issued debt securities

with maturities longer than T-Bills (1 to 10


years for notes, more for bonds). Short-term
investors buy these when they’re close to
maturity.
 How it works: They pay interest (coupons)

every 6 months and return principal at maturity.


 Example:
o You buy a ₱1M Treasury Note with a 5%
annual coupon and only 1 year to
maturity.
o You’ll earn ₱50,000 interest plus get your

₱1M back at maturity.


 Use Case: For conservative investors who want
a steady income and government backing.

2/10, net 30

The term 2/10, net 30 is a common trade credit


term used in business transactions. It means the
buyer can take a 2% discount on the invoice
amount if payment is made within 10 days of the
invoice date. If the buyer does not take the
discount, the full payment is due in 30 days. For
example, if an invoice is ₱100,000, paying within
10 days would cost only ₱98,000. This incentivizes
early payment and helps sellers improve cash flow
while giving buyers a chance to save money.

Stockout

A stockout happens when a business runs out of a


product that customers want to buy, meaning
there’s no inventory available to meet demand.
Stockouts can lead to lost sales, unhappy
customers, and damage to a company’s
reputation, especially if they occur frequently.
They often happen due to poor inventory
management, inaccurate demand forecasting,
supplier delays, or unexpected spikes in customer
demand. For example, if a clothing store doesn’t
have enough stock of a popular shirt size during a
sale, it loses potential revenue and may drive
customers to competitors. Companies prevent
stockouts by using inventory tracking systems,
safety stock, and strong supplier
relationships.

Common questions

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Government-backed securities like Treasury Notes can play a stabilizing role in a conservative investment portfolio by providing steady income with lower risk, given their government backing. They pay interest semi-annually and return principal at maturity, making them attractive for conservative investors seeking reliability and low risk. This risk profile supports allocation strategies aimed at income consistency and capital preservation .

Investing in commercial paper (CP) presents risks and advantages. The primary advantage is that it can provide higher returns than government-backed securities as CP is issued by corporations. However, it is also riskier since it is unsecured and relies on the issuing company’s creditworthiness for repayment, making it less secure than government-issued securities like T-Bills .

Short-term financial instruments, such as T-Bills, CDs, CP, and money market funds, provide businesses with liquidity and risk management advantages. They offer safe, often government-backed options for short-term cash parking, enabling quick access to funds when needed. However, the drawback is that some options like CDs restrict access until maturity, potentially hindering liquidity flexibility. Additionally, instruments such as CP involve higher credit risk, although they typically offer higher yields compared to government securities .

Maintaining a compensating balance for a bank loan can benefit a company by potentially lowering interest rates, improving creditworthiness, and securing favorable loan terms. However, it implies the tying up of funds that could otherwise be used more freely, thus reducing available liquidity for other opportunities or immediate needs .

Treasury Bills (T-Bills) are short-term debt securities issued by the government to raise funds, maturing in a year or less. They are sold at a discount and redeemed at face value, so the profit for investors is the difference between the purchase and maturity values. This makes T-Bills a popular option for businesses needing safe, short-term parking for cash since they provide a guaranteed return without periodic interest .

Maintaining liquidity is crucial for businesses to address sudden financial needs, such as unexpected machine breakdowns or delays in customer payments, without having to secure additional financing at potentially high costs . For example, a company might hold cash reserves to quickly act on opportunities like buying discounted inventory or acquiring assets, ensuring smooth operations and financial stability .

Trade credit terms like 2/10, net 30, are strategically important for cash flow management. They incentivize early payment, allowing buyers to save money by availing of discounts, which can enhance cash flow by reducing immediate outflows. Simultaneously, sellers benefit from accelerated receivables increasing liquidity. For example, an invoice of ₱100,000 can be settled for ₱98,000 within 10 days, assisting the buyer’s cash management while supporting the seller's cash liquidity .

Money market funds and repurchase agreements are both used for short-term liquidity management but serve slightly different purposes. Money market funds pool investor money to invest in low-risk, short-term securities such as T-Bills and commercial papers, offering diversification and liquidity without direct security purchases . Repurchase agreements involve selling securities with an agreement to repurchase them at a higher price, effectively serving as a collateralized short-term loan widely used by banks for cash management .

Stockouts can negatively impact a business by leading to lost sales, dissatisfied customers, and potential damage to its reputation. They often occur due to poor inventory management, inaccurate demand forecasting, supplier delays, or unexpected demand spikes. Preventative measures include implementing robust inventory tracking systems, maintaining safety stock, and developing strong supplier relationships to ensure product availability and meet customer demand consistently .

Certificates of Deposit (CDs) offer investors a guaranteed return due to their fixed interest rates. They are a time deposit requiring a fixed amount invested for a specific term. However, they limit liquidity as funds cannot be withdrawn before maturity without incurring penalties, thus they suit investors who do not need immediate access to their funds but are seeking security and return assurance .

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