Cash Management & Factoring: Methods, Advantages & Disadvantages

Posted on Oct 7, 2024 in Economy

Cash Management Methods

Just in Time (JIT)

JIT is an efficient system for producing necessary quantities at key moments, enabling timely and consistent delivery based on customer needs. This method optimizes distribution channel costs, avoids stockouts and overstocking, simplifies administrative tasks, maintains product value, and guarantees quality and resource availability. It’s ideal for companies aiming to keep low inventory levels by acquiring raw materials shortly before production. However, JIT carries risk due to its reliance on tight delivery and distribution timelines.

Wilson Method

The Wilson method suits companies with fixed-price orders regardless of quantity. It calculates the ideal order quantity by balancing order frequency and warehousing costs. This model uses a constant order quantity and interval, aiming for zero stock upon order arrival.

Cash Conversion Cycle (CCC)

CCC measures the time a company takes to convert inventory investments into cash. It comprises:

  • Inventory Conversion Period (ICP): Average days a company holds inventory before sale.
  • Receivables Collection Period (RCP): Average days to receive payment after a sale.
  • Payables Conversion Period (PCP): Average days to pay supplier invoices.

Importance of the Cash Flow Statement

The cash flow statement is crucial as it reveals a company’s cash position. A successful business needs sufficient cash to cover expenses, loan repayments, taxes, and asset purchases.

Factoring: Advantages and Disadvantages

Factoring involves selling accounts receivable to a third party (factor) at a discount to address immediate cash needs or achieve strategic goals. Some industries, like textiles and apparel, use factoring as a traditional financing method.

Advantages of Factoring

  1. Immediate Liquidity: Factoring provides immediate cash, albeit with a commission, allowing faster access to funds from invoices.
  2. No Debt Incurred: Factoring is an exchange of rights, not a loan, preserving debt capacity.
  3. Outsourced Collection Management: Factoring eliminates the need for internal resources dedicated to collections.
  4. Financial and Commercial Advice: Factoring often comes with additional financial and commercial guidance.

Disadvantages of Factoring

  1. High Financial Cost: Factoring involves commissions (2-3% of invoice value) and interest charges.
  2. Potential Negative Image: Miscommunication about factoring can create a perception of financial instability.
  3. Customer Acceptance: Factors typically prefer more solvent customers.
  4. Reduced Customer Negotiation: Customers have less flexibility negotiating payment terms with a factor.