Mba 540 Risk Investment Decision

Running head: RISK ANALYSIS ON INVESTMENT DECISION

Risk Analysis on Investment Decision

University of Phoenix

MBA/540 Maximizing Shareholders Wealth

January 22, 2008

Capital Budgeting

Cash management involves forecasting, receiving, controlling, disbursing, and investing funds from a company's operation. Effective cash management can help to improve liquidity, increase cash flow, reduce cash outflow and increase the yield on idle funds (Cash Management, 2007). The rapid growth of businesses in the last two decades requires financial managers to be creative in the way he or she provides adequate financing for companies. Rapidly increasing sales may cause increased pressure for inventory and receivables buildup that can drain a company's cash resources. According to Block & Hirt, 2005, "...a large increase in sales creates an expansion of current assets, especially accounts receivable and inventory" (p. 1). Financing can occur through the firm's retained earnings but most often the firm's internal funds will not provide enough financing, therefore external funds must be found. As sales grow, the greater the probability that the majority of the financing will be from external sources. The funds may come from the sale of common stock, preferred stock, long-term bonds, short-term securities, bank loans, or from combinations of short and long term fund sources (Block & Hirt, 2005).

Asset Growth

Current assets change daily, if not hourly, and managerial decisions must be made. Working capital management includes the financing and management of the current assets of the company. Financial managers devote more time to working capital management than to any other activity. There can be no delay in action regarding short-term decisions on working capital because those decisions may determine whether the company will get to the long term. The key to current asset planning is the ability of management to forecast sales accurately and then to match the production schedules to the sales forecast. If the actual sales are different than the forecast, unexpected buildups or reductions in inventory occur that will affect receivables and cash flow. In a simple business, all the firm's current assets will be self-liquidating assets that are to be sold, receivables collected and bills paid. As the firm expands some of the inventory will be completely liquidated, but some items will form the basic stock of the business, or become "permanent" stock. As the business continues to grow, so does the permanent stock of current assets. Inadequate financing arrangements can result if management fails to realize that the business is carrying not only self-liquidating inventory, but also permanent current assets (Block & Hirt, 2005).

Elements of a Cash Management System

To effectively control cash flow, companies must implement adequate cash management techniques to speed up cash collections and check clearing in order to access and use funds. Cost effective disbursement mechanisms for transferring funds must be developed. The board or management is ultimately responsible for identifying the best collection and payment processes in addition to ensuring that appropriate oversight of the processes exists.

Holding Cash Balances

Managing cash has become more sophisticated in the global and electronic age and most financial managers seek to keep non-earning assets to a minimum. Minimizing cash balances and understanding how cash moves in and out of a company can improve the overall profitability of the company. "The reasons for holding cash are varied. The reasons may be for transaction balances, for compensating balances for banks, and for precautionary reasons" (Block & Hirt, 2005, p. 2). Cash held for transactions is often to be used for corporate expenses such as payroll, supplies, and taxes. Cash can also be held to compensate a bank for services provided rather than paying for the services directly. Cash is held for precautionary reasons because management wants cash for emergency purposes when cash inflows are less than projected. Precautionary cash balances are likely to be needed in seasonal or cyclical industries where cash inflows are uncertain (Block & Hirt, 2005).

Float

Cash is not always portrayed as actual dollars at a given time. In a corporation's books are two cash balances of importance and they are the corporations recorded amount and the amount credited to the corporation by the bank. The difference between the two balances is called the float. Float arises from delays in mailing, processing, and check clearing. In general, float is a delay in the cash flow timeline. Float is measured in dollar days and a company can benefit from shortening all types of float associated with cash inflow and lengthening all types of float associated with cash outflow. Float can be managed by a combination of disbursement and collection strategies (Block & Hirt, 2005).

Collections

The collection process involves speeding up the conversion of receipts into available funds (Cash Management, 2000). The collection and check-clearing process can be expedited through a number of strategies. Those strategies include using a variety of collection centers throughout the company's marketing areas. Each collection center performs a billing and collection-deposit function. Another strategy is using the lockbox system, which can replace the network of regional collection offices. The lockbox system can be operated at a lower cost and simply requires customers to forward checks to a post office box in the customer's geographic area and a local bank picks up the checks. The bank processes the local checks through the local clearinghouse for rapid collection and fund may be available for use 24 hours or less (Block & Hirt, 2005).

Company's can also collect payment electronically by wire transfer or by an automated clearinghouse (ACH) system. Wire transfers are used for large payments when speed and closure is important, but can be expensive. Electronic payments are less expensive than wire transfers. The main advantages