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Cash reserves: minimum, factors, trade-offs, inventory conversion, liquidity, strategy

1. Should the minimum cash reserves be a fixed number in all circumstances?

2. What factors would determine the cash reserves?

3. How can changing the manufacturing process assist in achieving the balance between cash and profits? What are some trade-offs involved in this process?

4. With a different MOQ, how will the inventory conversion period (the time between the receipt of raw materials and production of finished goods) impact the decision to borrow and/or the decision to change the credit period for customer?

5. What other factors of production does MOQ impact?

6. When does it make sense for the company to have higher liquidity rather than higher returns as an investment objective?

7. If the company's competitive position is weak, what working capital management strategy should it adopt?

8. In what circumstances does it make sense for a company to maintain higher inventory levels?

9. How would industry norms impact your decisions about supplier credit and customer credit?

Solution Preview

1. Should the minimum cash reserves be a fixed number in all circumstances?

Cash is one of the important current assets for the operations of the business. It is required to run the operations smoothly. It should not be a fixed number in all the circumstances. For example during the busy season the organization must have higher cash reserves to run day to day operations smoothly. Thus the Objective of Cash Management is to have optimum balance of cash:

A firm should hold an optimum balance of cash, and invest any temporary excess amount in short-term (marketable) securities. In choosing these securities, the firm must keep in mind safety, maturity and marketability of its investment.

Four facets on Cash Management

- Cash planning
- Managing the cash flows
- Optimum cash level
- Investing surplus cash
For the factors just see Q-2.

2. What factors would determine the cash reserves?

The following are the reasons for holding cash reserves:

- Transaction Motive for Holding Cash
A firm needs cash to make payments for acquisition of resources and services for the running the business.

- Precautionary Motive for Holding Cash
A firm keeps additional funds to meet any emergency situation.

- Speculative Motive for Holding Cash
Some firms may also maintain cash for taking advantages of speculative changes in prices of input and output.

(Pandey, I.M., Financial Management)

Other factors are:

Business cycle:

As discussed above during the busy season or getting the big order will require more cash reserves. During recession there may be fewer requirements of cash reserves.

It will also depend on the manufacturing process, competitive position of the organization, working capital strategy of the organization. For example lean manufacturing will require less cash reserves, organization having high competitive advantage will also require less of the reserves and aggressive working capital strategy will also require less reserves.
http://www.labyrinthinc.com/SharedContent/SingleFaq.asp?faqid=50 as retrieved on 10 Aug 2006 21:18:43 GMT.

3. How can changing the manufacturing process ...

Solution Summary

In a 1350 word solution, the problems and the concepts are fully explained, including one reference for the student to use.

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