Internal Financial Planning and Control in an Organization

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By: Site Engineer, Staff

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The entrepreneur should know that the successful management of internal finance through good planning and firm control determines how successful his company will perform. Although, raising money is important, using that money wisely is an equally vital task. So, financial managers spend a good deal of their time managing the firm’s working capital and making capital-budgeting decisions.

Management of Working Capital

The ultimate goal of managing working capital is to minimize the amount of money that is tied up in excess cash, uncollected bills (receivables) and inventory. The trick is to match the amount of money flowing out of the business with the amount flowing in. The success depends on shortening the period between the purchase of raw materials and services from vendors and the collection of cash from sales to customers.

Managing Cash and Marketable Securities

Although excess cash might make you feel secure, it is not earning any interest for you. An underlying concept of financial management is that money should be productively employed. Companies occasionally find themselves with more cash on hand than they need.

In a seasonal business, there may be a quiet period between the time revenues are collected from the last season and the time suppliers bills are due. Department stores, for examples, may have excess cash if it is holding funds to meet a large commitment in the near future. It may be about to reach the next stage in the construction of a new plant, or it may be waiting for a special bargain on supplies.

Finally, every firm keeps some surplus each on hand as a cushion in case its needs are higher than expected.

Part of the financial manager’s job is to make sure that this cash is invested so that it earns interest. The interesting part is to look for good opportunities where the fund can be invested, some sort of investment that will yield highest possible return but will create no problem if the firm needs to liquidate the investment for instant cash. A number of short-term investments, called marketable securities, meet those needs. They are said to be “marketable” because they are relatively low in risk and can easily be converted back to cash. Marketable securities include stocks, bonds, and other investments that can be turned into cash quickly.

Managing Receivables and Payables

One of the big problems in managing working capital is that a company’s revenues do not always come in at exactly the same rate that bills have to be paid. The financial manager must therefore carefully monitor cash flow, the total amount of money acquired and spent to keep the business running.

The volume of receivables depends on the financial manager’s decisions regarding several issues. For example, who qualifies for the credit and who does not? How long do customers have to pay their bills – 30 days, 60 days, or 90 days? How tough is the firm in collecting its debts? Does the firm give a discount for early payment?

In order to find an answer to these questions, the financial manager analyses the firm’s receivables to identify patterns that might indicate problems. For example, the manager might rank the receivables according to size and age, so that efforts can be focused on collecting from the largest accounts and those that have been overdue the longest.

The flip side of managing receivables is managing payables – the bills that the company owns to its creditors. In this part, the objective is generally to postpone paying bills until the last moment, since accounts payable represent interest – free loans from suppliers. However, the financial manager also needs to weigh the advantages of paying promptly, if doing, so entitles firm to cash discounts.

Managing Inventory

Inventory is another area where financial managers can fine-tune the firm’s cash flow. Many companies carry an excess inventory of both raw materials and finished goods, feeling that it is better to have too much stock on hand to lose customers by running short of a product. However, inventory sitting on the shelf represents capital that is tied up without earning interest.

Furthermore, the firm incurs expenses for storage and handling, insurance, and taxes. And there is always a risk that the inventory will become obsolete before it can be converted into finished goods and sold.

The firm’s goal is to maintain enough inventories to fill orders in a timely fashion at the minimum cost. To achieve this goal, the financial manager tries to determine the Economic Order Quantity (EOQ), or quantity of raw materials that, when ordered regularly, results in the lowest ordering and storage costs. The problem is complicated by the fact that minimizing ordering costs tends to increase storage costs and vice versa.

The best way to cut ordinary costs is to place one big order for parts and materials once a year, while the best way to cut storage costs is to order a small amount of inventory frequently. The challenge facing the financial manager is to find a compromise that minimizes total costs.

Whereas the optimal level of finished goods inventory varies depending on the type of business, the typical company generally turns over its inventory about five times a year. This means that the average firm should carry about 75 days’ worth of finished goods inventory at any given time. Inventory that has been in storage longer than 75 days should be shipped or sold off, at a discount if costs, quantity of inventory that should be ordered for more information on inventory.

Capital-Budgeting

The entrepreneur is being introduced into the knowledge of capital budgeting in order to help him in his proper monitoring through his financial manager. Apart from managing the firm’s working capital, the financial manager must also help the firm choose long-term investments that provide satisfactory cash flow and rate of return. The process of evaluating and comparing alternative investments is called capital budgeting.

The types of projects considered in the capital budgeting process are called capital investments. They include new facilities or equipment required to expand the business machinery to replace equipment that is wearing out, improvements required by law to maintain safety or meet environmental improvements required by law to maintain safety or meet environmental requirements, and other investments such as land, acquisitions, or patent rights. Capital investment refers to money paid out to acquire something of permanent value in a business.

The ultimate goal in managing working capital is to minimize the amount of money that is tied up in excess cash, uncollected bills (receivables), and inventory.

Cash Management

Cash management involves managing the monies of the firm in order to attain maximum cash availability and maximum interest income in any idle funds.

Proper cash management of any organization is very vital to any entrepreneur because no organization can operate without enough cash. Cash is ‘raw’ money available to an organization or individual. It is the most liquid of the current assets and hence of all the assets of the company. Cash is the most liable to stealing as many companies normally have problems because of fraud by employees who steal cash in different ways.

The entrepreneur should, therefore, manage his cash efficiently in order to forestall stealing. Managing cash means managing the monies of the firm in order to attain maximum cash availability and maximum interest income in any idle funds.

What this definition is saying is that cash management involves two things:

  • Availability of cash when needed at the right time and quantity, and
  • Idle fund investment so that the company can have a maximum possible return on them.

In an organization normally, the way an entrepreneur manages cash, if not properly done, will affect one negatively at the expense of the other. If a company keeps excess cash (that is more than needed) such a company is highly liquid but the excess cash kept in the value of the firm will reduce the profitability of the company. This is because the cash that would have been re-invested either for expansion purposes or in marketable securities is left idle. On the other hand, keeping inadequate cash means that most of the funds of the company are invested.

So if excess cash could reduce profitability and inadequate cash could reduce liquidity, how much should a firm have in its possession at a given time? First and foremost, this could depend on the level of operations of the company.

However, the level of the cash a firm should maintain at a given time will depend on the understanding of the entrepreneur on the reason why cash should be maintained at all.

Reasons for Holding Cash

There are three reasons for holding cash:

  • Speculative Motive: At times equally, cash is kept for speculative purposes where the company may want to take chances of some speculations and kept cash to take advantages of such profitable opportunities. Cash kept for this type of purpose is said to be for speculative motives.
  • Transaction Motive: Cash is kept for daily transactional purposes like; maintenance of machinery and equipment, buying stationery, postages, baying of consumables, wags payments purchases of other raw materials.
  • Precautionary Motive: Any good entrepreneur should know unexpected expenses may arise from time to time in organizations hence some cash will always be kept for such unexpected expenses like maintenance of broken down machines. Cash kept for such unexpected expenditure is said to be done for precautionary motives or measures.

However, whatever cash an organization may keep must be for a motive, so that important thing is the prioritization of such funds in order not to accumulate too many idle funds. Marketable securities are there to invest in so that at a short-term the cash can be gotten through conversion or such marketable securities.

 

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