16.2 How Organizations Use Funds

Managing money in business is like juggling different-sized balls. You've got everyday expenses like salaries and rent, and big-ticket items like new equipment. Balancing these costs is crucial for keeping the business running smoothly and growing over time.

Smart businesses keep a close eye on their cash, what customers owe them, and their inventory. They also carefully evaluate big investments using fancy math to figure out if they're worth it. These strategies help companies make the most of their money and stay competitive.

Financial Resource Management

Short-term vs Long-term Expenses

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Top images from around the web for Short-term vs Long-term Expenses

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• Short-term operating expenses involve day-to-day costs necessary to run the business such as salaries and wages, rent and utilities, office supplies, and advertising and marketing; these expenses are recorded on the income statement and affect short-term liquidity and profitability
• Long-term capital expenditures are significant investments in assets that provide long-term benefits, including the purchase of property, plant, and equipment, research and development, and acquisitions and mergers; these expenditures are recorded on the balance sheet as assets, affect long-term growth and competitiveness, and often require large upfront costs and longer payback periods

Cash, Receivables, and Inventory Management

• Cash management involves maintaining sufficient cash reserves to meet short-term obligations using techniques such as cash forecasting to predict inflows and outflows, accelerating cash receipts by offering discounts for early payment, delaying cash disbursements by negotiating longer payment terms with suppliers, and investing excess cash in short-term, low-risk securities

• Accounts receivable management aims to minimize the time between sales and cash collection through strategies like establishing clear credit policies and terms, conducting credit checks on customers, invoicing promptly and accurately, following up on overdue accounts, and using factoring or selling receivables to third parties

• Inventory management optimizes inventory levels to balance customer service and carrying costs using approaches such as just-in-time (JIT) inventory to minimize holding costs, economic order quantity (EOQ) model to determine optimal order size, ABC analysis to prioritize inventory based on value and importance, and inventory tracking systems like barcodes and RFID to monitor stock levels

Capital Budgeting Techniques

• Net present value (NPV) calculates the present value of a project's future cash flows using the formula $NPV = \sum_{t=1}^{n} \frac{C_t}{(1+r)^t} - C_0$ where $C_t$ is the net cash inflow during period $t$, $C_0$ is the initial investment, $r$ is the discount rate, and $n$ is the number of time periods; projects with positive NPV are accepted

• Internal rate of return (IRR) calculates the discount rate that makes a project's NPV equal to zero using the formula $0 = \sum_{t=1}^{n} \frac{C_t}{(1+IRR)^t} - C_0$; projects with IRR greater than the required rate of return are accepted

• Payback period measures the time required to recover the initial investment using the formula $Payback\ Period = \frac{Initial\ Investment}{Annual\ Cash\ Inflow}$; projects with payback periods shorter than a predetermined threshold are accepted

• Profitability index (PI) calculates the ratio of a project's present value of future cash flows to its initial cost using the formula $PI = \frac{Present\ Value\ of\ Future\ Cash\ Flows}{Initial\ Investment}$; projects with PI greater than 1 are accepted