How much cash (cash refers to cash, money in the bank, and near cash e.g. on call) should a business have available? Answer: enough. How much will be determined by the needs of the business as calculated in its cash-flow forecast. It needs enough to pay wages, salaries, other expenses and suppliers that are due for payment plus an amount for contingencies such as unexpected expenditure and a safety factor to allow for debtors not paying on time. Any amount in excess of this is a waste - surplus funds should be placed in investments that pay a return.
What is the ideal amount of inventory? Answer: nil. Because of the holding costs associated with inventory an ideal situation would be to have no inventory. Ideal but not practical. In retail businesses you have to have stock for display purposes and to replace stock as it is sold - if you run out of stock you may lose sales. In other businesses stock is held because you cannot rely on suppliers to deliver timeously. It may also raise costs from suppliers if they have to deliver frequently and there is also a cost in respect of re-ordering and receiving goods. So taking the above into account, one would calculate the bare minimum of stock that is appropriate for the business. Once the minimum stock levels have been calculated the stock turnover for each of the categories of stock should be monitored to ensure that the highest possible stock turnovers are being achieved.
What is the ideal amount for debtors? Answer: nil. Wouldn’t it be great if all the sales we made were cash sales? Unfortunately few businesses can operate on a cash sale basis. Often for practical reasons - most customers are not administratively geared to make payments on delivery. The overriding reason is that businesses are forced to extend credit for competitive reasons. Some businesses, in the retail sector, that in the past operated on a cash sale basis have in recent years begun to offer credit. Others are forced to because their competitors offer credit. The amount tied up in debtors is subject to the most risk. There is a greater probability that a debtor may go bust than there is that a bank holding your cash will, and stock can be insured against loss by fire and theft. You can insure against debt but more about that later. The management of debtors is discussed in greater detail below (see Credit Management) - the management of cash is the realm of the financial manager (with inputs from other managers) and inventory management is a specialised field entailing materials requirement planning systems. As far as the latter is concerned you can use the stock turnover figures to monitor whether your business’s purchasing and inventory management systems are performing well.
Credit extended by suppliers is a common source of finance. While one should make use of the maximum possible credit terms allowed by suppliers, there are, however, costs associated with abusing credit facilities. If a supplier finds that its customers are consistently exceeding its terms they will adjust their pricing accordingly. Another, and far greater cost arising from this, could be in the market place. If word gets around (and competitors will ensure that it does) potential and existing customers may be reluctant to place orders with the business in question - particularly where ongoing support for the product is necessary.