Overview

Learning objectives

After studying this chapter, you should have developed an appreciation of:

1. The manner in which cash budgeting represents an important tool in cash management

2. The reasons profit is not the same as cash

3. Factors that need to be considered when extending credit to a customer

4. The role of an accounts receivable ageing schedule in credit management

5. How the economic order quantity (EOQ) can inform purchasing decisions

6. When to take advantage of a supplier s offer of a discount for early payment

7. The risk/return tradeoff apparent in short- vs long-term financing of current assets.

Introduction

Working capital was defined in Chapter 5 as current assets minus current liabilities. In this chapter we explore financial management issues relating to the main elements comprising current assets and current liabilities, i.e. cash, accounts receivable, inventory and accounts payable.

Initially, we will highlight the distinction between cash flow and profit. A clear understanding of this distinction is important. The immediate cause of bankruptcy is not a business s failure to make profit. Bankruptcy occurs when a firm does not have enough cash to honour liabilities that are due for payment. We will highlight this distinction between cash flow and profit by working through the mechanics of preparing a cash budget. The cash budget is particularly important as it predicts the timing of cash surpluses and deficits. Knowing when there will be a cash surplus allows investment plans to be formulated. Knowing the timing of a projected...