Petty Cash Cash Equivalents

Table of Contents
1. Introduction
2. Recognising Cash
3. Controlling Cash
4. Managing Cash
5. Summary
1. Introduction
Cash is a company's most liquid asset. In earlier segments, you learnt that cash is reported in the balance sheet under
'current assets'. You also learnt that the sources of change in a company's cash balance during a reporting period are
reported in the statement of cash flows.
Typically, the reported cash amount in the balance sheet includes cash in-hand, cash in banks and petty cash. These funds,
when combined, are referred to as Cash in the balance sheet. Petty cash tends to be used to pay for small amounts.
Companies may also combine cash with cash equivalents in the balance sheet. An example of cash equivalents is short-
term government notes (treasury notes).
Objectives: Cash
Upon completion of this topic, you should be able to
describe the principles of controlling and managing cash
2. Recognising Cash
Recognising cash in a company's books is a straightforward process. When a company receives cash it debits the Cash
account, and when it pays cash it credits the Cash account. Cash receipts can be generated from cash sales, collection of
accounts receivable, equity issues, debt issues and sale of operating assets, among others. Cash payments can be made to
suppliers of goods and services (eg, employees' wages), debt-holders, accounts payables and investments, among others.
The balance sheet records a single entry for cash; however, companies typically maintain separate accounts for petty cash,
cash on-hand and cash in banks. Cash transfers among these accounts are recorded by debiting the cash-receiving account
and crediting the cash-paying account.
Measuring cash is a straightforward process. Cash is measured based on the number of monetary units. Unlike that of
other assets, the cash amount is not subject to any impairment (ie, decrease in value) or re-evaluation adjustment induced
by value depreciation or appreciation.
3. Controlling Cash
Cash funds are subject to theft, fraud and improper use by those who have immediate access to them. Company
stakeholders expect management to implement an internal control system that aims to effectively and efficiently safeguard
all of the company's assets, including cash funds.
Typically, internal control systems comprise the following principles:
Assigning responsibilities to individuals for a particular duty - eg, cash collections and cash payments should be
clearly assigned to certain individuals.
Separating duties where an individual's or a group's responsibility is distinct from that of another individual
or group - eg, the individual in charge of collecting cash should not keep the records, neither should the individual
in charge of paying cash authorise the payment or keep the records.
Documenting all transactions and events where documents can be tracked or traced using an effective
numbering system - eg, cash payments should be documented using cheques and payment slips.
Establishing and implementing an internal system that aims to independently test, review and update the
cash control system - eg, companies should periodically reconcile the balances of their bank accounts with those in
their books.
4. Managing Cash
Companies may encounter financial difficulties if they do not manage their cash effectively and wisely. Profitable
companies are not immune to these difficulties either. Cash must be generated to allow a company to make its cash
payments on time and to support its operations. Companies that do not manage their cash wisely may be forced to either
borrow unnecessarily or to use funds that may otherwise be available to enhance profits.
Borrowing funds unnecessarily incurs interest cost. Companies can reduce their interest costs by managing their operating
cycle carefully. An operating cycle is the time during which a company uses cash to purchase goods and services, sells
goods and services, and then collects cash from customers. An operating cycle of a merchandising company is illustrated
as follows:
As illustrated in the above graphic, available cash is used to purchase merchandise and to make payments to service
providers. Merchandise inventory is held by the company for further processing or for immediate sale. The inventory may
be sold in cash or on account. Companies that are slow in turning (or selling) their inventory during a period or in
collecting cash from their clients may run into cash difficulties which can affect their ability to make timely payments to
suppliers of goods and services. Slower sale of goods and services, as well as longer collection periods, limit the
company's ability to generate additional profits and to make payments to suppliers on time.
The operating cycle of a manufacturing company is usually longer than that of a merchandising company. Manufacturing
companies purchase raw materials to manufacture goods that are then sold to clients. The operating cycle of a service
company may be short or long, depending on the nature of the services it provides.
Regardless of the nature of the company, the following general principles of cash management will reduce a company's
exposure to cash crisis and minimise its net interest expense:
Turning over receivables at rates that are at least equivalent to those of payables - This can be achieved by
offering cash discounts that may induce clients to pay more quickly. Generally speaking, the implicit interest rate
associated with cash discounts should not exceed the company's borrowing rate.
Conserving cash by keeping inventory at low levels and slowing the repayments to suppliers - In general,
companies should not pay for payables any earlier than the specified due date.
Investing temporary cash surplus in highly liquid investments
Maintaining a minimum level of cash balance at all times
Preparing periodic cash budgets - Cash budgets comprise expected cash collections and expected cash payments
during a forthcoming period that may span more than one year. These budgets indicate when additional financing
will be needed and when cash surplus will be available. Cash shortage can be covered using additional borrowings
or by liquidating existing investments. Cash surplus can be used to repay borrowings and to make additional
investments.
For a hypothetical example of a cash budget, view the following animation.
Cash Budget
from GlobalNxt University
02:46
5. Summary
The following are the main points covered in this topic:

Cash is the most liquid asset of companies. Controlling and safeguarding cash are essential ingredients of a
company's internal control system.
Efficient and effective cash management is crucial to the success and long-term survival of a company.
Cash management involves:
turning over receivables efficiently
investing excess cash in liquid investments
maintaining a minimum cash balance
preparing and making use of periodic cash budgets
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Table of Contents

Upon completion of this topic, you should be able to

describe the principles of controlling and managing cash

Typically, internal control systems comprise the following principles:

For a hypothetical example of a cash budget, view the following animation.

The following are the main points covered in this topic:

text editing options

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