 Hello, and welcome to this session in which we would look at cash management. The first thing we're going to look at is reasons for holding cash. Now this statement might seem odd. Why would you, why would you need a reason to hold cash? Cash is good. That's perfectly fine. But from a business perspective, cash has the lowest return. And when you have the lowest return, it means you are not really making money. So cash, if you have cash in the bank, cash is safe. There is no risk. No risk. You don't get compensated. So in theory, the perfect, in theory, the perfect thing to have is the same amount of cash coming in, the same amount of cash leaving you. So if the cash is perfectly synchronized in theory, then you don't need to have any cash because by holding cash, you are losing. There's an opportunity cost. You could be investing that cash somewhere else. Now there are a few reasons why you should hold cash, which we're going to look at those, but that's the beginning of this session. Why do we hold cash? Now this topic is covered on the CPA exam, as well as in your corporate finance course. If you are a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course. I am a useful addition. I explain the material differently by doing so I can add 10 to 15 points to your CPA exam score, which in turn will help you pass the exam. Your risk is one month of subscription. You try me for a month. You like it. You keep it. You don't. It doesn't work for you. You cancel, but that's your risk. Your return is potentially passing the exam. Are you willing to take that risk? This is an investment in your lifetime. Can you afford $30 to try whether that tool can help you or not? And if not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. I do have resources for other college courses and CPA material. If you haven't connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation. Like this recording. Share it with other connect would be on Instagram, Facebook, Twitter and Reddit. Please connect with me on Reddit. So what are the reasons for holding cash? So we said you should not hold cash because it doesn't have a return. It gives, you know, there's an opportunity cost for holding cash. There's a speculative motive. What is a speculative motive? Sometimes prices could drop. You could have a bargain purchase that might present itself. So if you don't have the cash, you cannot take advantage of this bargain purchase. For example, during the housing crisis or during any crisis. If you have cash prices go down, you'll take advantage of that or be able to take advantage of attractable interest rates. So if you have the cash and interest rate goes up, you might be making some money on your money favorable exchange rate fluctuation. Also, if you are involved in international trade, international, this is the international firm, international trade. What happened is you might have foreign currency demand or supply. So sometime you might want to buy the euros. Well, if the price is right and you have the money, you can take advantage of that favorable fluctuation and close your foreign position. So those are speculative motive. Another reason why we hold cash and we should all be familiar with this is precautionary motive and we should all have this precautionary motive. For example, on a personal level, you should have six month to one year cash reserve for your expenses, if you can need for safety to act as a financial reserve, because companies don't sometimes go through rough patches, slow down in the economy, slow down in the industry, slow down in the business. Well, you have to have some cash to survive those times. Otherwise, you'll be in big trouble. Obviously, we need cash for transactional motive and that's basically simply what pay your bills. We need cash to pay our wages, salaries, debt, taxes, dividends, so on and so forth. We need the cash and sometime we hold the cash for something called compensating balances. What happened is the bank would want us to keep, for example, $500,000 at all time in the bank if it's a large business. So you have to keep that money basically locked for banking services. So they will give you in return services for holding that cash. You have to remember the cost of holding cash is a trade off between cost and liquidity. OK, so liquidity means the cash is readily available. There's a cost for that. You have to kind of trade between those two to find out what's the optimal cash position. Now, the sources of cash for a typical business should be your receivable because you sell when you sell on credit, you're going to receive the money eventually. So the source of cash should be mainly for a healthy business, your receivable. Your receivable is determined by your credit policy. When you sell on account, you have to be careful. What is your credit standard? Are you selling people with 600 FICO score or 800? Now, if you're selling for 800, 700, 800, you should not have any problem collecting your money. If you're selling to people with 600 or below, you might have problem getting that money. OK, also the credit period that you offer to customers, for example, 2 slash 10 in 30, I'll give you 2 percent if you pay within 10 days to entice them to pay early. And we looked at this trade discount in the account spables. You have to know what's the savings or what's the cost or the full amount is due within 30 days, which is the credit period. Also your collection effort, how much effort are you putting into collecting the money? Do you have your own department? That's collecting the money. Do you outsource this job to a specialized company to collect your money? Simply put, companies can measure their management receivable by two ratios. Man, account receivable turnover, which has basically taken sales, let's assume we have 1.2 million in sales and average receivable of 100,000. That's going to give us account receivable turnover of 12. It means during the year, we sell, collect, sell, collect, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12. 8, 9, 10, 11, 12. It means we sell, then we collect, we sell, then we collect 12 times during the year. And this is how we measure this, sales or sales on credit divided by the average receivable. Now also what we can do, we can compute their sales and account receivable or the account receivable period. Simply put, taking this turnover, 365 and divided by this turnover, it should give us approximately 30 days. There's another way to do it. You will take average receivable divided by sales multiplied by the number of days in the period. So you want your turnover to be high. You want your turnover to be high. As your turnover is high, days in account receivable should be low. So let's assume we can reduce our receivable to 50,000. That's going to give us a turnover of 24. So if we take 365 divided by 24, and that's going to cut our days accounting period, receivable period and half divided by 24, now you're collecting your money approximately every 15 days. You want the money, you want the money to get there early. Now what are some techniques you can do to get that money early? We talked about obviously the discount, there are other techniques you can do. But let's take a look at a timeline how the cash collection takes place. So it's very important to see if we can use this technique. For example, the customer mails to check here, day zero. It may take, well, one, two, three, four days until you receive that money. Now, during COVID, it may take longer. Okay. But let's assume it takes you four days. Well, you may not, you may, you may, you may, you may deposit that money the same day or may take you another day to deposit the money. Now the money in the bank, day five. Then from day five, it may take day six, seven, eight until the money is available because the cash is not available immediately. So that could happen. So the customer sends the check on day zero, you don't have the money available until day eight. Now this is talking about traditional, traditional mailing. Now this, this topic is becoming less and less relevant, obviously, because everyone, like I pay my bills, most of my bills through my phone or through the internet. So that time, the cash, the cash is received by the, at the bank much, much sooner. Okay. So what do you need to do to reduce the mail float? You want to reduce the mail time. The flow time, you want to, and every time you could reduce the flow time. So you want to go from day zero to day six or from day zero to day five where the money is available rather to day eight. So one way to do it is to reduce the mail float. Well, for example, have all the checks mailed to one location. The process is faster. You are more efficient. Now if you have customers in different places of the country, you have some in LA, some in Washington state, some in the northeast, some, some in the southeast, well, what you do, then you, then you have different mail collection points to reduce mailing time. So the people in LA will send their check to LA. It takes less time. The people in Washington state, they will send their check in Washington state. So you would, you would reduce this mailing time. That's one thing you can do. Also, hire an outside firm that specializes in cash collection. If you don't have a good collection department in collection, people are very important because they know what to do. They follow up. Well, hire someone else, hire an outside company, log box system. And usually you basically think of a mail box. Usually it's inside the banks and the banks collect the checks directly. And basically, rather than send, the customer sends the money to you, if they send it to the bank directly, it go from receiving to depositing the same day. And if it's the same day, it may reduce the, it may reduce the cash availability. So you want to reduce that flow time, the time that the check is outstanding. Okay. So the bag that deposit the check directly into the firm's account, and this is a good internal control because this way you're taken away the money from your employees, which is, could be susceptible to theft. So a log box is a good internal control. And we talked about internal control in auditing. So that's a good practice. Also what you could do is electronic log box, which is pay by phone or internet. There's no check. There's nothing to worry about because everything is tracked electronically. Also you could have what's called cash concentration, moving cash from multiple bank account into the firm's main account because you want the cash in one place, lots of it. It will earn more interest. You'll have more leverage with the bank and you want to do this as fast as possible. Also, if you have receivable, another way to do it is to sell your receivable, which is factoring. Selling the receivable has a cost. So you have to evaluate whether my cost is worth versus benefit. So you have to say, well, if I get the money early, this is my benefit. What is the cost? If the benefit is greater than the cost of the cost is less than the benefit, you will go ahead with factoring. Otherwise, you will not. Sometimes you do factoring, although the cost is very high because you are in need of the money, but that's one way to get your money earlier. But the logbox system is something you want to be concerned about on the CPA exam because they could give you questions about this. I'm going to work an example here, but if you want to go to my website, I do have additional practice. Let's assume the average number, average number of payment per day is 400 payment, 400 checks. The average value per page per check is $990. If you open a logbox, it's going to charge you for every check they receive, 35 pennies. And the daily interest rate on the money market securities is 0.068 percent, which is 0.00068. This is the daily interest rate on the money. So what happened is this? What happened if you agree to open the logbox system and you'll be able to reduce by four days the money received, so you'll be able to free up some cash earlier. How much cash can you free up? How much cash can you release? Well, you're going to be receiving every day 400 checks every four days. You're going to reduce it by four days and the average check is $990. So you're going to be able to release cash of one million, one million, five hundred and eighty-four thousand. Is it worth it? Is it worth to release this get this cash earlier? Well, you have to compare the cost. Well, if you get this cash earlier, you're going to have a return and your return is this much, which is the amount of cash that you can release earlier, which is something called the present value, times the daily interest rate. Then you have to subtract this from the cost. The cost is per check is 35 pennies, 35 pennies times 400 checks. Let's do the computation just to show you the cost versus the benefit. So the cost, let's see, 0.35 times 400. And that's going to be your cost, which is equal to $140. Your benefit getting this money earlier, although you are paying you are paying for it. It's going to earn you 0.00068. That's going to earn you $1,251.20 minus $140. That's going to give you, well, listen, let's do the calculation again, because when I did it earlier, maybe I mistyped something, 0.35 times 400. That's your cost, $140.1 million, $584,000 times 0.00068. That's 1000. I must have typed something incorrectly. Minus, this is the benefit minus you're going to earn that much because you're getting your money earlier minus $140. So the benefit is 937. The company will go ahead and will accept, will accept this offer, the log box system where they will go after this offer. If you have this question, if you have any questions, please let me know. At the end of this recording, I'm going to remind you to take a look at my website farhatlectures.com. I don't replace your CPA review course. I make it easier for you to understand your CPA review material. Good luck, study hard and most importantly, stay safe.