Inventory, receivables, cash and marketable securities management
Financial Management · Unit III · Topic 11 of 16 · 4 min read
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Cases checked to exist. Read the judgment before quoting a holding.
Every case cited here has been checked to exist — the citation resolves and names the right parties. The propositions attributed to each case have not been verified line by line against the judgment. Case names link through to the full judgment: read it before quoting a holding in an examination answer, and never carry a proposition from notes into court on trust.
1. Inventory management
Inventory is raw materials, work-in-progress, finished goods and stores. Motives for holding it: transaction (to keep production and sales going), precautionary (against delays and demand surges), and speculative (to gain from expected price rises). Too much stock locks up funds and raises storage, insurance and obsolescence costs; too little stops production and loses sales.
Economic order quantity (EOQ) balances the cost of ordering against the cost of carrying: EOQ = √(2AO ÷ C), where A is annual usage, O the cost per order and C the carrying cost per unit per year.
Example: A = 7,200 units, O = Rs. 50, C = Rs. 2. EOQ = √(2 × 7,200 × 50 ÷ 2) = √3,60,000 = 600 units; 12 orders a year.
| Cost at EOQ | Working | Rs. |
|---|---|---|
| Ordering cost | 12 orders × 50 | 600 |
| Carrying cost | (600 ÷ 2) × 2 | 600 |
| Total | 1,200 |
At the EOQ ordering cost equals carrying cost; that is the check.
Stock levels: reorder level = maximum usage × maximum lead time; minimum level = reorder level − (average usage × average lead time); maximum level = reorder level + reorder quantity − (minimum usage × minimum lead time). Safety stock is the buffer against uncertainty.
Other techniques: ABC analysis (A items, about 10% of items and 70% of value, under tight control; C items, about 70% of items and 10% of value, under simple control); VED (vital, essential, desirable) for spares; FSN (fast, slow, non-moving); just-in-time (materials arrive as needed, as in Toyota’s system); perpetual inventory and periodic stock-taking; inventory turnover ratio.
2. Receivables management
Receivables (debtors, bills receivable) arise from credit sales. Credit boosts sales but ties up funds and brings collection cost and bad debts. The finance manager sets:
- Credit standards: who gets credit, judged by the five Cs — character, capacity, capital, collateral and conditions;
- Credit terms: the credit period and cash discount (“2/10, net 30”);
- Collection policy: reminders, follow-up, and legal action;
- Monitoring: debtors turnover, average collection period and ageing schedule;
- Factoring: selling receivables to a factor for immediate cash; in India governed by the Factoring Regulation Act, 2011, and for MSMEs the RBI’s Trade Receivables Discounting System (TReDS).
Credit decision example. Sales Rs. 10,00,000 on 30 days’ credit. Extending credit to 60 days adds Rs. 1,00,000 of sales at a 20% contribution. Cost of funds 15%. Debtors at sales value (360-day year): now 10,00,000 × 30/360 = 83,333; after, 11,00,000 × 60/360 = 1,83,333; extra investment Rs. 1,00,000, costing Rs. 15,000 a year. Extra contribution Rs. 20,000. Net gain Rs. 5,000: extend the credit (before any extra bad debts).
3. Cash management
Keynes (General Theory, 1936) named three motives for holding cash: transaction, precautionary and speculative; firms add a compensating motive (balances banks require). Cash earns nothing, so the aim is the minimum balance that meets the motives.
- Cash budget: forecast of receipts and payments month by month, showing shortages to be borrowed and surpluses to be invested.
- Speeding collections and controlling payments: lock-box and concentration banking, electronic transfer (NEFT, RTGS, UPI), paying on the due date and not before.
- Baumol model (1952): treats cash like inventory. Optimal cash withdrawal C = √(2TF ÷ i), where T is cash needed in the year, F the cost per conversion of securities into cash and i the interest rate. With T = Rs. 72,00,000, F = Rs. 100 and i = 10%, C = √(2 × 72,00,000 × 100 ÷ 0.10) = √(14,40,00,00,000) = Rs. 1,20,000; 60 conversions a year; average balance Rs. 60,000.
- Miller–Orr model (1966): for uncertain cash flows: the balance moves freely between a lower limit and an upper limit; when it hits the upper limit, securities are bought to bring it to the return point; when it hits the lower limit, securities are sold. The spread is 3 × (¾ × transaction cost × variance of daily cash flow ÷ daily interest rate)1/3.
4. Marketable securities
Surplus cash is parked in short-term, safe, liquid securities until needed. Criteria: safety, liquidity (marketability), maturity and yield. In India: Treasury bills (91, 182 and 364 days), commercial paper, certificates of deposit, call and notice money (for banks), bank fixed deposits, liquid and overnight mutual funds, and repos. The firm holds them as a substitute for cash (sold when cash runs short) or as a temporary investment of seasonal surpluses.
How this is examined
The 6-mark inventory note is section 1 without the stock-level formulas; put in the EOQ formula and the example to lift the answer above a list. The receivables note is section 2. A 10-mark question on “optimal investment in current assets” takes one paragraph from each section and the liquidity–profitability trade-off from the working-capital note.
Now try the real questions: Financial Management past question papers.