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Learning Unit 8Asset management: the investment decision
INTRODUCTION AND AIM
In order to achieve the main objective of the firm, you need to effectively manage the
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investment in the assets (current and fixed) of the business. This learning unit explains
the management of cash and marketable securities, debtors and stock in order to suc-
cessfully pursue the main objective of the business. We also discuss the long-term in-
vestment decision and capital budgeting, where the concept of net present value (NPV)
is introduced. You need to understand NPV because this is a technique that you will be
using to evaluate capital projects.
93 STUDY CHAPTER 14 (section 14.8 – 14.9) IN ITBM
Contents of the learning unit
−− The management of current assets
−− Long-term investment decisions and capital budgeting
94 Learning objectives
After completing this unit, you should be able to
yy manage current assets
yy make long-term decisions
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KEY TERMS
current assets decisions stock
long-term investment decisions cash
marketable securities capital budgeting budgets
debtors investment projects
Refer to the end of chapter 14 in the prescribed book to familiarise yourself with the key
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terms for this learning unit before continuing.
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, MNB1601/001/4/2017
8.1 THE MANAGEMENT OF CURRENT ASSETS
Study section 14.8 in ITBM
8.1.1 The cost and risk of investing in current assets
Over-investment in current assets is costly because the capital tied up in current assets
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could be invested profitably elsewhere. For example, if one business has an inventory
of R200 000, and this stock level were to be reduced to R100 000, the surplus R100 000
could be invested in a short-term deposit, say at 10%. Thus the company would be earn-
ing R10 000 per annum instead of having the surplus stock lying in a warehouse (i.e.
over-investment) where it is not earning any income.
The ideal, of course, would be to have no capital tied up in stock, but that would mean that
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the suppliers would always have to deliver the raw material exactly when it is needed, or
the factory would have to deliver the finished product exactly when a customer wanted
it. But this under-investment is risky because if there is an unforeseen delay somewhere
along the line, there might be a serious delay in the factory (which is very costly), or the
customer will buy the product elsewhere.
Make sure that you understand the figures in table 14.13 which shows that a higher invest-
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ment in current assets leads to a higher liquidity (as in the case of business B), while a lower
investment in current assets leads to a higher rate of return (as in the case of business A).
8.1.2 The management of cash and marketable securities
You must understand the three basic reasons (motives) for having a certain amount of
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cash on hand. Let’s take the example of a gardening services provider. The provider wins
a contract to lay out the gardens of a new building. The job should take approximately
two months, and the contract price will be paid on completion of the job (i.e. after two
months). In the meantime, the contractor needs cash to purchase plants, grass, fertiliser,
and so on. He also needs cash to pay his labourers their weekly wages (after all, they can-
not be expected to wait two months before they are paid). This is the transaction motive.
But what if the client does not settle her debt on completion of the job? Or perhaps she
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delays payment for three weeks? The wages and other expenses still have to be paid. So
the contractor needs some additional cash as a precautionary motive.
Then one day he hears that a competitor has gone bankrupt, and that a large quantity of
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gardening equipment and tools can be bought at relatively cheap prices. If our contractor
doesn’t have any available cash on hand, he will not be able to make use of this opportu-
nity to obtain some valuable equipment at a very low price. So he also has a speculative
motive to keep some extra cash (or marketable securities) on hand.
When you look at the cash budget in table 14.7, note that the net cash position is the dif-
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ference between cash receipts and cash disbursements, plus or minus the cash on hand
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