NaimExplain

Why is an understanding of inventory management useful for cash management? Answer: Cash is simply a raw material - like inventories of other goods - that you need to do business. Capital that is tied up in large inventories of any raw material rather than earning interest is expensive. So why do you hold inventories at all? Why not order materials when you need them? The answer is that placing many small orders is also expensive. The principles of optimal inventory management and optimal cash management are similar.

What are the costs and benefits of holding cash? Answer: Cash provides liquidity, but it doesn't pay interest. Securities pay interest, but you can't use them to buy things. As financial manager, you want to hold up cash to the point at which the incremental or marginal benefit of liquidity is equal to the cost of holding cash, that is, the interest you could earn on securities.

What are costs and benefits of holding inventories? Answer: The benefit of higher inventory levels is the reduction in order costs associated with restocking and the reduced chances of running out of material. The costs are the carrying costs, which include the cost of space, insurance, spoilage and the opportunity cost of the capital tied up in inventory. The ECONOMIC ORDER QUANTITY is the order size that minimizes the sum of order costs plus carrying costs.