NECESSITY OF THE THESIS
In fact, Board of Director and Chief Financial Officer often face with decisions making relate to financial issue, such as how to choose the target cash management, how to manage the inventory, how to management the accounts receivable,…These decisions play an important role, sometime it impact directly on company ‗s success or failure
From observation the financial management method in some companies, talking with some directors, studying the management experiences in some countries and through the time I work in Sonadezi Longthanh I think we can apply some mathematical models in financial decision making Its gives managers with the analyzing and making decision tool base on scientific and quantitative
So I decide to choose the topic: ―Application of mathematics models in short - term investment decisions‖
OBJECTIVE OF THE RESEARCH
The focus of this thesis will be on the researching some mathematical models and how those models can apply in making decision of Director or Chief Financial Officer This thesis has two aims The first aim is to research the way to apply financial models to resolve the issues and find out the best solution for each decision The second aim is to guide to manager apply the models in making decision.
KEY RESEARCH AREA
Thesis only concentrates on how to use the model in making decision in investment decision in current assets such as: the target cash balance, inventory management, and accounts receivable management These models will be applied in Sonadezi Longthanh Shareholding Company and in Tuong An Vegetable Oil Joint Stock Company.
METHODOLOGY
Thesis is used methodology of researching the secondary data, primary data, logic reason combination materialistic history, methods in raising the issues, interpretation, analysis and giving the conclusion
Thesis is also used statistic, formula illustration, interpreting the issues means and quantitative method.
CONTRIBUTIONS OF THE THESIS
The research of this thesis has the important meaning both the science and reality
About the science, this thesis chose and improves some theory models appropriate to conditions and management level of Vietnam
About the reality, this thesis provide for managers the effective tools in analyzing and making decision base on quantitative method and apply mathematical model.
THESIS STRUCTURE
Topic: ―Application of mathematics models in short - term investment decisions‖
LITERATURE REVIEW
Overview of financial decision making
Financial decision making is talked so much in corporate financial management
Van Horne and Wachowics (2001) state that financial management interested in buying and selling, financing and asset management follow the general objective
The studies by McMahon encompass this thesis that financial management interested in finding the capital to buy the asset and operating the company, analyzing the limited capital for different purposes, guaranteeing the capital is used effectively to get the target
Other researchers such as Brealey and Myers (2003), Ross and other authors (2003) are believed that financial management interesting in investment, financing, asset management to get the target Through the definitions above, we can see the financial decision making have 3 kinds: investment, financing and dividend decisions Besides, there are a lot of decisions relate to company operation but in the field of research, the thesis just study some decisions can quantitative analysis and use the model to make decisions There are some main financial decisions making
Investment decisions are decisions relate to (1) total asset values and the values of each assets (current assets and fixed assets) and (2) the balance between these assets We are used to with the balance sheet in accounting Investment decisions are related to the left hand sight of the balance sheet Concretely as follows:
- Investment decisions in current assets, include: o Cash management decisions o Inventory management decisions o Credit decisions
- Investment decisions in fix assets, include: o Financing new fixed assets decisions o Replacing old fixed assets decisions o Investing in project decisions o Long – term financial decisions
- The relationship between investing in current assets and investing in fixed assets decisions, include: o Using operating leverage decisions o Break – even point decisions Investment decision is considered the most important decision in financial decision making because it creates the value of firm (Hawawini & Vialiet, 2002) The right investment decision will contribute to increase the value of firm; and the shareholder wealth will increase too Vice versa, the wrong investment decision will decrease the value of firm, so the shareholder wealth decreases
If the investment decisions relate to the left hand sight of the balance sheet then financing decisions relate to the right hand sight of the balance sheet Its relate to chose which source of capital finance to purchase the assets, use owner‘s equity or debt, short term or long term capital In addition, financing decision also consider the relationship between retained earnings and payout earnings by dividend After choosing one kind in those, the second step the manager should make decision how can mobilize that source of capital Concretely as follows:
- Short term financial decisions, include: o Short term debt or trade credit decisions o Short term borrowing or commercial paper decisions
- Long term financial decisions, include: o Long term borrowing: bank loans or bond decisions o Common Equity or long term debt decisions o Common equity or preferred equity decisions
- The ratio of total debt to total assets decisions (Financial Leverage)
- Borrowing to buy the assets or leasing decisions
Those above relate to financing decisions in operating of company If manager lack the knowledge of analysis tools before making decision, in order to make the right decision is a big challenge
The third decision in financial decision making is the disposition of profits or dividend policy In this decision the Chief financial officer (CFO) must be choose between retained earnings or payout earnings by dividend In addition, CFO must be deciding to use what dividend policy and what effect of dividend policy on the value of firm or stock‘s value on the market
Besides 3 kinds of decisions in financial decision making, there is a lot of other decisions relate to the operations of the business But focus of this thesis will be on the decisions that the model can be applied to make decisions.
Overview about the model building
A model is a simplified representation of an empirical situation Ideally, it strips a natural phenomenon of its bewildering complexity and duplicated the essential behavior of the natural phenomenon with a few variables that are simply related
The simpler the model, the better for the decision maker, provided the model serves as a reasonably reliable counterpart of the empirical problem The advantages of a simple model are:
- It is economical of time and thought
1 Bonini, Hausman, Bierman,(1997), Quantitative Analysis for Management (9 th Edition), McGraw
- It can be understood readily by the decision maker
- If necessary, the model can be modified quickly and effectively
The object of the decision maker is not to construct a model that is close as possible to reality in every respect Such a model would require an excessive length of time to construct, and then it might be beyond human comprehension
Rather, the decision maker wants the simplest model that predicts outcomes reasonably well and is consistent with effective action
There are several types of decision models To understand and build the models, first we need to know how to classify the model base on different criteria
- The nature of models o Physical model o Notion model o Mathematical model
- The level of complication o Simple Problems
Decision analysis models o Complex Problems
Linear and integer programming models
PERT or Critical path models (CPM)
- The dynamic nature‘s models o Certain models o Uncertain models
Major variables in a decision problem are
Simple Case models Decision analysis
PERT or Critical path models
Simulation Inventory models Queuing models
( Sources: Bonini, Hausman, Bierman 1997 Quantitative analysis for management 9 th
Edition New York: McGraw – Hill/ Irwin)
A model is a simplification of a business decision problem The simplification is accomplished by including only important elements and omitting the nonessential consideration Because it is simplified, it is highly useful The factors or variables that the decision maker considers important, includes: a Decision Variables: the decision variables are those under the control of the decision maker They represent alternative choices for managers These are the major choices, these are the decision variables b Exogenous variables: exogenous or external variables are those that are important to the decision problem but are controlled by factors outside the purview of the decision maker Generally, economic conditions, actions of competitors, prices of raw materials and similar factors are exogenous variables c Policies and constraints: A decision maker often operates within constraints imposed by company policy, legal restraints or physical limitations For example, there may be limited capacity available in the plant, and this may restrict the sales that can be made d Performance measures: In making a decision, managers have goals or objectives that they are trying to achieve Criteria or performance measures are quantitative expression of these objectives e Intermediate variables: A number of other variables are usually needed to include all the important factors in the decision problem Often these are accounting variables that relate to cost or revenue factors They are used to relate the decision variables and exogenous variables to the performance measures They are thus intermediate variables in the sense that they are between the other variables
Figure 1.1 show how the various categories of variables are related Decision variables, exogenous variablea and policies and constraints are input to the model, and performance measures are outputs The model itself represents the set of all relationships among the variables
Figure 1.1: The various categories of variables are related
1.2.4 The method to set up a model and apply in the financial decision making
Depend on the simple or complex problems and the aim of decision maker, the model can be a simple models, complex models or very complex models These steps to set up a model:
Step 1: define the aim or the nature of decision
Step 2: define the variables affect decision Step 3: define the relationship among the variables and the aim of decision (Set up the model)
Step 4: input the data of variables into the model, check the result
Step 5: change the data of variables and check again effect on the result.
ANALYZING BUSINESS ACTIVITIES OF SONADEZI
Sonadezi Longthanh Shareholding Company
2.1.1 The introduction of Sonadezi Longthanh Shareholding Company a General Information
Company: SONADEZI LONG THANH SHAREHOLDING CO
Address: LongThanh Industrial Zone, LongThanh district, DongNai province
E-mail: longthanhiz @ sonadezi.com.vn
Website: www.sonadezi com.vn
- Surveying, designing, investing, contributing, managing, and operating the infrastructure of industrial zone, house and house for rent
- Consulting about setting up and operating business plan
- Leasing ready – built workshop, office and warehouse
- Doing services assistant to residential area c Corporation For The Development Of Bien Hoa Industrial Zone (Sonadezi Corporation – Sonadezi Bienhoa) Structure
Sonadezi Corporation has 20 subsidiary companies, which was established with main business scope of industrial zones development in Dong Nai Province From its first days of operation with the re-construction the infrastructure of Bien Hoa 1 Industrial Zone, Sonadezi has become one of the biggest and most reliable names in Vietnam in the field of industrial estates development
- Ready-built workshop for lease
- Residential Estates Development Sonadezi Longthanh is a subsidiary company of Sonadezi Corporation, with the capital contributed by Sonadezi Bienhoa 51.19% Sonadezi Longthanh is one of the larget company operate in construction and development infrastructure of industrial zone It is the main business scope of Sonadezi Corporation
College of Technical and Management of Sonadezi
Dongnai Construction Joint - Stock company
Dongnai Construction No.01 joint-stock co
Engineering consultants Joint- stock company
Dong Nai Vehicle Stand and Transport Service Joint Stock Company
Dong Nai Port Joint-stock company
Housing Dongnai joint – stock co
Dong nai Transportation Works Contruction Joint-stock company
Dong Nai Land And Water Transport Company
Dong Nai Electric Appliances Joint- Stock Company
Dong nai Mechanical Joint- stock company
Dong Nai material and building Investment Joint- stock company
Dong Nai Transport Communication Machanical Company
Sonadezi Chau Duc shareholding company
Sonadezi Service Joint - Stock company d Capital Structure
Sonadezi Long Thanh is the shareholding company which is set up by Sonadezi Bien Hoa and the capital is contributed by all companies list below:
- Electricity of Vietnam – Dong Nai Branch;
- Sonadezi Shareholding Construction Company (Sonacons);
- Dong Nai Investment and Development Fund
Table 2.1: Capital structure of Sonadezi Long Thanh
No Name Value Unit Contribution ratio
4 Dong Nai Weter Plant 5.328.000.000 VND 5,33%
Sonadezi Shareholding Construction Company (Sonacons)
Sonadezi Bienhoa Electricity of Vietnam – Dong Nai Branch Dong Nai Investment and Development Fund Dong Nai Weter Plant
Dong Nai Posts & Telecommunications Sonadezi Shareholding Construction Company
Figure 2.2: Capital structure of Sonadezi Long Thanh e Company Organizing Structure
Figure 2.3: Company Organizing Structure of Sonadezi Long Thanh
2.1.2 The Operating results of Sonadezi Long Thanh Shareholding Company
2.1.2.1 The operating results in 2005, 2006 and 9 months 2007
The operating results of 2006 is the large progression of Sonadezi Longthanh: in
2006, the total assets increase 58.43% against 2005, the main product of company is the land, 2006 the net sales increase 48.41% against 2005 because the land sublease increase and the price increase (2006: land sublease 60,6 ha with average price 25 USD/m2; 2005: land sublease 25 ha with average price 22 USD/m2) The profit after tax in 2006 increase 99.57% against 2005
In general the operating results of 9 month in 2007 is a good development against the plan set up in the beginning of the year Concretely, the profit after tax in 9 months of 2007 is 57.7 billion VND increase against 2006 (Table 2.2)
Table 2.2: Operating results in 2005, 2006 and 9 months 2007
Land 134.338.803.469 227.145.318.783 170.462.600.927 Water 1.341.627.628 5.990.069.460 8.081.472.280 Waste water treatment
Total Assets Net sales Profit after tax
Figure 2.4: Operating results in 2005, 2006 and 9 months 2007
2.1.2.2 Some ratios assess the financial stability and business activities results
In general, all ratios of Sonadezi Longthanh is quite good, exclude the debt ratio (liabilities/total resources) quite high (2006: 69.25%) because the specific characteristic of industry The liabilities is the prepay cost equivalent to the area of land sublease in that year If deduct the accrued expenses this ratio will be 5% in
Table 2.3: Financial stability and business activities results of SZL
Current assets/Total assets % 41.85 56.92 68.40 Long-term assets/Total assets % 58.15 43.08 31.60
Liabilities/Total resources % 64.04 69.25 67.03 Owner‘s Equity/ Total resources % 35.96 30.75 32.97
Total assets/Total liabilities Time 1.56 1.44 1.49 Current liquidity ratio
(Current asset/Current liability) Time 0.69 0.84 1.03 Acid test ratio
2.1.3 Characteristic of cash in Sonadezi Long Thanh Shareholding Company and relating decisions
2.1.3.1 Characteristic of cash in Sonadezi Long Thanh Shareholding Company
Base on the balance sheet of Sonadezi Longthanh through 2005, 2006 and 9 months in 2007, we can see the cash account of company like this:
Table 2.4: Cash account of Sonadezi Long thanh
In the table 2.4 we can see Sonadezi Longthanh deposited all cash in the bank The cash in hand is very low
Because of the characteristic of land subleasing business of Sonadezi Long Thanh is leasing the land and receiving cash in one time but almost the expenses (construction cost) pay through the bank account, pay after the construction contract finished and pay gradually So Sonadezi Longthanh doesn‘t need a large cash in hand and don‘t have any decision making relate to cash balance management in the past The liquidity ratios increase through 2005, 2006, 2007 show that Sonadezi Longthanh has enough ability to pay current liability on time (Table 2.5)
Table 2.5: Liquidity ratios of Sonadezi Long thanh
Total assets/Total liabilities Time 1.56 1.44 1.49 Current liquidity ratio
(Current asset/Current liability) Time 0.69 0.84 1.03 Acid test ratio
2.1.3.2 Decision making relate to cash in Sonadezi Long Thanh
Sonadezi Longthanh set up maximum cash on hand per day is 5,000,000 VND (C)
If basing on Baumol assumptions such as Constant Disbursement Rate; no Cash Receipts during the Projected Periods; no Safety Stock of Cash is allowed for; the cash flow is discontinuous and the equation to calculate the opportunity cost and trading cost we can calculate the total cost like this:
Total cost = Opportunity costs + Trading costs
- T is the total amount of new cash needed for transactions purposes over the relevant planning period, say, one month
- F is cash withdrawal fee, transaction fee
- R interest rate of demand deposits (0.2 %/month) - Vietcombank
Tuong An Vegetable Oil Joint Stock Company (TAC)
2.2.1 The introduction of Tuong An Vegetable Oil Joint Stock Company a General information
Company name: Tuong An Vegetable Oil Joint Stock Company
Abbreviation name: Tuong An Oil
Company birthday: 20 November 1977, which has become joint stock company since 1 st October 2004
Address: 48/5 Phan Huy Ich Street, Ward 15, Tan Binh District, Hochiminh City, Vietnam
E-mail: tuongan@tuongan.com.vn
Website: http://www.tuongan.com.vn
Manufacturing, trading, importing and exporting products processed from vegetable and animal oils, fats, oilseeds and nata de coco
Trading, exporting and importing machinery, equipments, materials for vegetable oil processing and production
Manufacturing, trading spices used for food processing industry, sauces (production is not carried out at head office)
Manufacturing and trading instant food products (noodles, rice vermicelli, noodle soup, dry pancake and instant soup)
Agent in trading and on consignment
Entertainment centre services (not operate at head office)
Cultural activities (organizing meetings, cultural exchange relations)
Accommodation business (constructing buildings for trading or for leasing) c Production capacity
After nearly 30 consecutive years of building and development, till now with the advanced machinery system and processing technology, Tuong An has total capacity of 130,000 tons per year, including 02 factories:
Address: 48/5 Phan Huy Ich Street., Ward 15, Tan Binh District, Hochiminh City, Vietnam
Address: 153 Nguyen Viet Xuan Street, Hung Dung Ward, Vinh City, Vietnam
3 Tuong An are building the third oil factory in Phu My 1 industrial park, Vung Tau province This is the biggest and most modern oil factory with capacity of 600 tons per day in Vietnam This new factory is scheduled to operate in the end 2006, totaling overall capacity of Tuong An twice higher than current one d Main export markets: Japan, the Middle East, Eastern Europe, Hong Kong, Taiwan, etc, e Distribution network
Tuong An distribution network with over 200 distributors and agents, 100 industrial customers and 400 supermarkets, restaurants, kiosks, schools and nursery schools, etc., all over 64 cities and provinces nationwide
The branches and representative offices:
Address: 916 Bach Dang Street, Thanh Luong Ward, Hai Ba Trung District,
Address: 54-58 Le Trong Tan Street, Hoa Phat Commue, Hoa Vang District,
Address: 108/95/16 Nguyen Viet Hong Street, An Phu Ward, Ninh Kieu District, Can Tho City, Vietnam
The most important objective is to continuously enhance product quality, meet all demands of customers
In June 2000, Tuong An is one of the first Vietnamese companies granted quality certificate of ISO 9001, latest version 2000 by British BVQI Applying and maintaining efficiency of ISO 9001:2000 quality management system is our commitment to meet the increasingly demands of customers and bring the most satisfaction to them g Capital Structure Table 2.6: Capital structure of Tuong An Vegetable Oil Joint Stock Company
No Name Value Unit Contribution ratio
National Company for Vegetable Oils, Aromas and Cosmetics of Vietnam (VOCARIMEX)
Vocarimex In Company Out of Company
Figure 2.5: Tuong An Vegetable Oil Joint Stock Company Ownership h Company Organizing Structure
2.2.2 The Operating result of Tuong An Vegetable Oil Joint Stock Company
2.2.2.1 The operating result in 2005, 2006 and 9 months 2007
In table 2.7, the operating result of 2006 is development against 2005, concretely in
2006, the total assets increase 28% against 2005, the main product of company is the oils, 2006 the net sales increase 28% against 2005 The profit after tax in 2006 increase 14% against 2005 In 2006, the net sales increase 28% but the profit after tax just increase 14% against 2005 and the net sales quite high against the profit after tax because the cost of goods sold, Selling expenses and General & administration expenses of oils industry is quite high Such as in table 2.8 we can see the struture of sales and expenses in 2006
Table 2.7: Operating result in 2005, 2006 and 9 months 2007 of TAC
Table 2.8: Structure of sales and expenses in 2006
Item Net sales and services
Cost of sales Selling expenses
In general the operating result of 9 month in 2007 is a good development against the result of 2006 Concretely, the profit after tax in 9 months of 2007 is 91.02 billion VND increase against 2006 (45.690 billion VND)
Total Assets Net sales Profit after tax
Figure 2.7: Operating result in 2005, 2006 and 9 months 2007 of TAC
2.2.2.2 Some ratios show the financial situation and business activities results
In general, all ratios of Tuong An is quite good, exclude the debt ratio (liabilities/total resources) quite high (2006: 51.75%) because current liabilities is quite high in liabilities structure but almost current liabilities is liabililties of materials which must to pay for Vocarimex
Table 2.9: Financial stability and business activities results of TAC
Item Unit 2005 2006 9 months (2007) Asset turnover
Current assets/Total assets % 75,91 48,06 64.20 Long-term assets/Total assets % 24,09 51,94 35.80
Liabilities/Total resources % 43,54 51,75 49.92 Owner‘s Equity/ Total resources % 56,46 48,25 50.08
Total assets/Total liabilities Time 2,30 1,93 2.00
Current liquidity ratio (Current asset/Current liability) Time 1,89 1,05 1.57 Acid test ratio
Table 2.10: Liabilities structure of TAC
Current liabilities 251,401,316,787 Long-term liabilities 31,901,851,834
2.2.3 Characteristic of current assets in Tuong An Vegetable Oil Joint Stock Company and relating decisions
2.2.3.1 Characteristic of Inventory in Tuong An Vegetable Oil Joint Stock Company
In table 2.11, the ratio inventory over cost of goods sold is quite low through 2005,
2006 and 9 months 2007 it means the ratio between inventory and cost of goods sold is reasonable
Table 2.11: Inventory structure of TAC
Raw material 48,411,557,114 58,574,611,556 68,877,961,077 Instrucments and tools 80,365,745 128,445,660 154,233,708
Goods in process 15,085,934,890 12,988,271,761 17,026,337,471 Finished goods 13,030,628,621 43,141,614,711 42,527,866,059
In table 2.12, the financial ratios in inventory of Tuong An Vegetable Oil Joint Stock Company are quite good, the inventory turnover (over 12) is proved that company manage the inventory effectively This thing also prove by the increase in sales and profit after tax in 2005, 2006 and 9 months 2007 The average inventory period lower than 30 days prove that the Tuong An oils is liked in the market.
+ Average inventory period = turnover Inventory
Table 2.12: Inventory turnover of TAC
+ Average inventory 65,158,772,392.25 95,869,496,901.50 121,922,725,695.00 + Average inventory period 22.28 24.98 28.30
Comparison inventory turnover of Tuong An oils and Marvella oils we can see the inventory management of Tuong An oils more effective than Marvella oils The ratio inventory/cost of goods sold of Tuong An oils is lower than Mavellar oils
Table 2.13: Comparison inventory turnover of Tuong An oils and Marvella oils
2.2.3.2 Decision making relate to inventory in Tuong An Vegetable Oil Joint Stock Company
Tuong An Vegetable Oil Joint Stock Company has no decision making ralete to economic order quantity of inventory So basing on the inventory beginning of each year, we can calculate the cost they must pay for inventory because not apply the EOQ model
The inventory in the beginning of each year of Tuong An Vegetable Oil Joint Stock Company like this:
Total units selling per year (T)
With the restocking costs and carrying cost like this:
Year Restocking costs/order (F) Carrying costs/unit (CC)
We can calculate the total costs with the units order equal to the inventory in the beginning of the year
Year Total CC Total F Total cost
2.2.4 Characteristic of Account Receivables in Tuong An Vegetable Oil Joint Stock Company and relating decisions
2.2.4.1 Characteristic of Account Receivables in Tuong An Vegetable Oil Joint Stock Company
In table 2.14, we can see the ratios between Account receivable and Total Assets or between Account receivable and Net sales are quite low and maintain nearly constant through 2005, 2006 and 9 months 2007 These ratios show that Tuong An Vegetable Oil Joint Stock Company is applying a illiberal credit policy
Table 2.14: Characteristic of Account Receivables in Tuong An Vegetable Oil
Total assets 427,827,566,009 547,408,667,444 653,132,842,015 Net Sales 1,182,278,272,303 1,516,516,302,466 1,708,240,973,237.00 Accout receivable 21,865,403,106 28,061,725,178 32,565,527,737
In table 2.15, the account receivable turnover of Tuong An Vegetable Oil Joint Stock Company is quite high, it means company shorten the time to collect the credit of customers and in the table 2.15 can show that the average collection perios decease from 2005 to 2006 Those things can lead the net sales of Tuong An maybe decrease in the future because the customer change to buy the products of others company having the average collection period longer than Tuong An
+ Account receivable turnover receivable Account
+ Average collection period = turnover receivable
Table 2.15: Account receivable turnover of TAC
Table 2.16: Comparison account receivable turnover between Tuong Anoils and
We can see in table 2.16 the account receivable turnover of Marvella is shorten than Tuong An, that means Marvella gives their customers the longer credit period than Tuong An This is advantage competitive of Marvella against Tuong An in the market
2.2.4.2 Decision making relate to Account Receivables in Tuong An Vegetable Oil Joint Stock Company
Through the analysis account receivable turnover of Tuong An Vegetable Oil Joint Stock Company, we can see Tuong An is applying the illiberal credit policy for all customers Tuong an Vegetable Oil Joint Stock Company didn‘t apply the account receivable management models in decision making relate to credit policy for different customers This thing lead to the competition abilty of Tuong An maybe decrease against others company in the same industry and the net sales in the future maybe decrease too In oder to increase the competition of company in the market, this thesis guide to apply the account receivable management models Basing on the calculation of this model about the sales and expenses, the Board of Directors of Tuong An Vegetable Oil Joint Stock Company can give the resionable, effective decision relate to credit policy.
APPLICATION OF MATHEMATICS MODELS IN SHORT-
Apply the cash management model in decision making in Sonadezi LongThanh
AN VEGETABLE OIL JOINT STOCK COMPANY
Through the analyzing in the chapter 2 and result of the survey (in Appendix B) show that the necessary of applying the models in making decision In this chapter the author applies these mathematics models in short – term investment decision in Sonadezi Longthanh and Tuong An Vegetable Oil Joint Stock Company We can see the different of the total cost of two companies after applies these models
3.1 Apply the cash management model in decision making in Sonadezi LongThanh Shareholding Company
3.1.1 The BAT (Baumol) model 3.1.1.1 The guideline to apply the BAT (Baumol) model
The Baumol model was establish with the purpose to determine the target cash balance based on two costs, they are opportunity costs and trading costs This model base on following assumptions:
- No Cash Receipts during the Projected Periods
- No Safety Stock of Cash is allowed for
- The cash flow is discontinuous
These assumptions are created some restrictions when apply the Baumol model in fact and the real situation is rarely suitable for the assumptions of model Despite, the Baumol model still has the meaning and the valuation to apply in the practice
F The fixed cost of making a securities trade to replenish cash
T The total amount of new cash needed for transactions purposes over the relevant planning period, say, one year
R The opportunity cost of holding cash This is the interest rate on marketable securities
C* Optimal size of the cash balance
General guideline for collecting data of these variances as follows:
- F: In The Baumol model, F is the fixed cost of making a securities trade to replenish cash, include brokerage costs and other related costs In fact, almost companies in Vietnam don‘t use surplus capital to buy short term securities In Vietnam F includes all costs relate to changing money to asset and vice versa In concrete, what costs F includes depend on where the company invests in? In the simple and popular case, the company will use the surplus capital to deposit in to the bank to get interest or buy some derivatives such as treasury notes, bank deposit certificate In those case F includes cash withdrawal fee, transaction fee, brokerage costs, discount fee and loss when sell derivatives in the difficult condition of market
- T: In the Baumol model, T is the total amount of new cash needed for transactions purposes over the relevant planning period, say, one year However, if
T is one year then it is not real and breaks the assumption of Baumol model So we can choose T is a quarter, a month or a week
- R: In the Baumol model, R is the opportunity cost of holding cash, it is how much interest is forgone This is the interest rate calculate by the unit %/year
When estimate R, we need concentrate in some issues First, adjusting R suitable to the planning period use to estimate T Second, the opportunity cost use to estimate
R, must be equal interest rate of demand deposits Next, depend on how ability the company use the money we adjust R increase to suitable rate
3.1.1.2 Apply the BAT model in determining the target cash balance
Apply the Baumol model to calculate the optimal size of target cash balance of Sonadezi Longthanh per week
- T is the total amount of new cash needed for transactions purposes over
- F is cash withdrawal fee, transaction fee
- R interest rate of demand deposits (0.2 %/month) - Vietcombank
Table 3.1: The optimal cash balance of Sonadezi Longthanh from January to
January 13,123,546,178.00 1,500,000.00 0.20% 4,436,814,089.75 February 13,537,083,535.00 2,000,000.00 0.20% 5,203,284,258.04 March 13,209,468,435.00 2,000,000.00 0.20% 5,139,935,492.79 April 25,964,583,120.00 2,100,000.00 0.20% 7,384,146,839.82 May 24,670,897,462.00 1,900,000.00 0.20% 6,846,510,438.01 June 26,472,198,465.00 2,200,000.00 0.20% 7,631,437,389.05
Conclusion: C* is the optimal cash balance by calculating the various costs at this balance, as well as a little above and a little below, take the example of optimal cash balance in January
Table 3.2: Total cost of the optimal cash balance from January to June in 2007
January 4,436,814,089.75 4,436,814.09 4,436,814.09 8,873,628.18 February 5,203,284,258.04 5,203,284.26 5,203,284.26 10,406,568.52 March 5,139,935,492.79 5,139,935.49 5,139,935.49 10,279,870.99 April 7,384,146,839.82 7,384,146.84 7,384,146.84 14,768,293.68 May 6,846,510,438.01 6,846,510.44 6,846,510.44 13,693,020.88 June 7,631,437,389.05 7,631,437.39 7,631,437.39 15,262,874.78
Table 3.3: The total cost in optimal cash balance compare with others cash balance in January Cash Balance Opportunity
The total cost at the optimum cash level is 8,873,828.18 VND (minimum) and it does appear to increase as we move in either direction
We can suppose that the assumptions of Baumol model (Constant Disbursement Rate; no Cash Receipts during the Projected Periods; no Safety Stock of Cash is allowed for; the cash flow is discontinuous) suitable with the real situation in Sonadezi Longthanh We compare the total cost of 2 cases:
Case 1: Setting up the optimal cash balance on hand per month base on Baumol model
Case 2: Setting up the maximum cash on hand (cash balance) per month base on the experiences and opinion of general director
Table 3.4: Comparison of the total cost of holding cash in the case of using
Baumol model and in the case of basing on experiences
Month Case 1 (Baumol model) Case 2
Cash balance per week Total cost Cash balance per week Total costs
January 4,436,814,089.75 8,873,628.18 5,000,000 3,937,068,853 February 5,203,284,258.04 10,406,568.52 5,000,000 5,414,838,414 March 5,139,935,492.79 10,279,870.99 5,000,000 5,283,792,374 April 7,384,146,839.82 14,768,293.68 5,000,000 10,905,129,910 May 6,846,510,438.01 13,693,020.88 5,000,000 9,374,946,036 June 7,631,437,389.05 15,262,874.78 5,000,000 11,647,772,325
In table 3.4 we can see that setting up the optimal cash balance per week base on Baumol model can safe the cost for Sonadezi Longthanh with the assumption that the cash flow of Sonadezi Longthanh satisfies the assumptions of Baumol model
3.1.2 The Miller – Orr Model 3.1.2.1 The guideline to apply the Miller – Orr model
The Miller – Orr model is also use to determine the target cash balance but different with Baumol, Merton Miller and Daniel Orr develop the target cash balance model with cash inflows and outflows that fluctuate randomly from day to day In this model, Baumol‘s assumption is removed and adding by an assumption that the net cash follow has standard distribution
The Miller – Orr model determines the target cash balance by an upper limit to the amount of cash (U*) and a lower limit (L), and a target cash balance (C*) The firm allows its cash balance to walk around between the lower and upper limits As long as the cash balance is somewhere between U* and L, nothing happens
When the cash balance reaches the upper limit (U*), such as it does at Point X, the firm moves U* - C* dollars out of the account and into marketable securities This action moves the cash balance down to C* In the same way, if the cash balance falls to the lower limit (L), as it does at Point Y, the firm will sell C* - L worth of securities and deposit the cash in the account This action takes the cash balance up to C*
Determining the target cash balance by an amount instead of a certain number is extends the ability to apply this model in every cases of company
F The fixed cost of making a securities trade to replenish cash
R The opportunity cost of holding cash This is the interest rate on marketable securities σ 2 the variance of the net cash flow per period
U* is the upper control limit of cash balance
L is the lower control limit of cash balance
C* is the target cash balance
General guideline for collecting data of these variances as follows:
- L : depend on using money in what profitable purpose is, company can imply the cash balance is the cash on hand or cash on hand plus cash in bank
- F and R: similar to the guideline in Baumol model
- σ 2 : to calculate this variable, collecting the data of cash inflows and cash outflows per period, then take the difference of two cash flow we have the net cash flow
3.1.2.2 Apply the Miller – Orr model in determining the target cash balance
Apply the Miller – Orr model to calculate the optimal size of target cash balance of Sonadezi Longthanh per week
- L is the lower control limit of cash balance
- F is cash withdrawal fee, transaction fee, in one month
- R interest rate of demand deposits (0.2 %/month) – Vietcombank
- σ 2 : the variance of the net cash flow per period, a month
Table 3.5: The optimal cash balance of Sonadezi Longthanh from January to
January 5,000 1,500 0.2 18,662,767,708,691,3 2,194,607.09 6,573,821.3 February 5,000 2,000 0.2 32,466,203,503,485,2 2,903,439.6 8,700,318.8 March 5,000 2,000 0.2 10,356,788,665,412,0 1,985,441.9 5,946,325.9 April 5,000 2,100 0.2 23,867,782,300,539,5 2,663,811.5 7,981,434.4 May 5,000 1,900 0.2 24,800,290,383,681,1 2,609,637.04 7,818,911.1 June 5,000 2,200 0.2 11,361,590,353,660,9 2,113,455.1 6,330,365.3
Table 3.6: The average cash balance of Sonadezi Longthanh from January to
Month The average cash balance
Conclusion: C* is the optimal cash balance by calculating the various costs at this balance
Apply the Inventory Management Model and Credit and Receivable
3.2.1 The Economic Order Quantity Model 3.2.1.1 The guideline to apply the Economic Order Quantity model
The economic order quantity (EOQ) model is the best-known approach for explicitly establishing an optimal inventory level, which minimizes the total inventory cost
This model is using to determine what optimal order size the firm should use when it restocks its inventory, depends on data below:
- T: Total unit sales per year
- F: Fixed cost per order, every time we place an order, there are fixed costs associated with that order such as: procedure cost, checking cost
- CC: Carrying costs per unit, such as storage cost, insurance cost, the opportunity cost of capital on the invested amount
3.2.1.2 Apply the Economic Order Quantity model in determining the optimal size of inventory orders
Apply the economic order quantity (EOQ) model in determining the optimal size of inventory orders of Tuong An Vegetable Oil Joint Stock Company
- T: Total unit sales per year;
- CC: Carrying costs per unit;
Table 3.7: The economic order quantity (EOQ) of Tuong An Vegetable Oil Joint
Stock Company per year form 2005 - 2007
Year T (liter) F(VND)/order CC(VND)/liter Q* (liter)
Which the total units sales per year from 2005 – 2007, apply the equation
We can calculate the optimal order size to establish an optimal inventory level
Total carrying costs = Average inventory x Carrying costs per unit
Total restocking cost = Fixed cost per order x Number of orders
Total costs = Carrying costs + Restocking costs
Table 3.8: The total cost of Tuong An Vegetable Oil Joint Stock Company per year form 2005 - 2007
Year Total carrying cost Total restocking cost Total cost
The total cost it means the optimal total cost per year
Compare the total cost of using EOQ model to determine the economic order quantity with the total cost of the order quantity not apply this model, we can see the total cost of applying EOQ model is smaller than the total cost not apply this model
Case 1: Determine the economic order quantity base on EOQ model
Case 2: Determine the order quantity base on experiences and the inventory in the beginning of that year
Table 3.9: Comparison of the total cost of holding inventory in the case of using
EOQ model and in the case of basing on experiences
Year Order quantity Total cost Order quantity Total cost
3.2.2 Credit and receivables management models 3.2.2.1 The guideline to apply the Credit and Receivables Management Models
All Credit and Receivables Management Models were written in chapter 2 which are used to help Chief Financial Management (CFO) to determine credit policies of company
The credit policies of company include: i Credit standard policy ii Credit term policy iii Cash discount policy
In order to making decision about credit and receivable management, CFO need to collect data, input data in the model and process the data However, the processing data and making decision relate to credit and receivable management is complexity so the mathematic model is complex to apply Therefore, Van Horn and Machowicz
(2001) set up the model to analyze and make decision base on effective of policy on two aspects:
- If the purpose of the policy is increasing profits then considers in increase profits equal or more increase costs
- If the purpose of the policy is decreasing costs then considers in save costs compensate the decreasing in profits i Credit standard policy Credit standards are the criteria a company uses to screen credit applicants in order to determine which of its customers should be offered credit and how much The credit standards policy includes liberal credit policy and illiberal credit policy To determine which policy company should apply, CFO can do the process of analysis follow one in two model hereafter:
Figure 3.1: Liberal credit policy model
Increase profit equal or more increase Costs
Figure 3.2: Illiberal credit policy model
This model can apply in manufacture and distribution companies To apply this model, we can do steps follow:
First, set up a credit standard
Second, forecast the changing in sales when using either liberal or illiberal credit policy
Third, forecast the changing in costs when using either liberal or illiberal credit policy
Fourth, compare between profits and costs to make decision
Fifth, keep track of effect of liberal or illiberal credit policy on sales and costs to change the policy on time ii Credit term policy The credit term is the maximum period company allow customer buy product but not pay Excess this period the debt that customer has not paid is the bad debt A changing in credit period can be lengthen the credit period or shorten the credit period
Safe Costs equal or more Decrease profit
Figure 3.3: Lengthen the credit period model
Figure 3.4.: Shorten the credit period model
To apply this model, CFO need to cooperate with Business Manager, Sales Manager to estimate data input:
- Estimate the changing in sales ratio when the credit period changing
- Estimate the changing in average collection period when the credit period changing
- Estimate the changing in account receivables affect by changing in sales and average collection period
Safe Costs equal or more Decrease profit
Increase profit equal or more increase Costs
- Estimate opportunity of account receivables
Base on the estimated data, CFO can calculate changing in profits and costs
Compare between profits and costs to make decision which policy can apply in company iii Cash discount policy
A cash discount is a discount offered on the condition that the customer will repay the credit extended within a specified period of time A cash discount is normally expressed as a percentage discount on the net amount of the cost of goods purchased (usually excluding freight and taxes) Cash discounts are offered (or increased) to speed up the collection of accounts receivable and, by extension, reduce a company‘s level of receivables investment and associated costs We have two model of cash discount policy
Figure 3.5: Increase Cash discount policy model
Safe Costs equal or more Decrease profit
Figure 3.6: Decrease Cash discount policy model
To apply this model, CFO need to cooperate with Business Manager, Sales Manager to estimate data input:
- Estimate the changing in average collection period when the cash discount ratio changing
- Estimate opportunity of account receivables
Base on the estimated data, CFO can calculate changing in profits and costs
Compare between profits and costs to make decision which policy can apply in company
3.2.2.2 Apply the Credit and receivables management model
Apply the Credit and receivables management model to determine credit policies of Tuong An Vegetable Oil Joint Stock Company per year i Credit standard policy
- Additional investment in inventory: 1,246,264,620VND
- Variable production, administrative, and marketing cost: 70% of total sales
Increase profit equal or more increase Costs
- Profit contribution ratio per dollar of sales is: 30%
- The company‘s required pretax rate of return: 25%
Table 3.10: Tuong An Vegetable Oil Joint Stock Company’s Analysis of the Decision to relax Credit Standard by Extending Full Credit to customers
Marginal profitability of additional sales 102,494,458,394.2
= Profit contribution ratio x Additional sales
Step B: Additional investment in receivables 56,161,347,065.33
= Additional average daily sales x average collection period ditional annual sales/365*60
Cost of the additional investment in receivables 14,040,336,766.3
= Additional investment in receivables x Required pretax rate of return
Step C: Additional bad-debt loss 23,915,373,625.3
= Bad-debt loss ratio x Additional sales
Step D: Additional investment in inventory 1,246,264,620
Cost of the additional investment in inventory ditional investment in inventory x
Required pretax rate of return 311,566,154.9
Step E: Net change in pretax profits 64,227,181,847.64
Conclusion: Tuong An Vegetable Oil Joint Stock Company can use Liberal credit policy with the above hypothesis With relaxing the Credit Standard the Net change in pretax profits of Net change in pretax profits is 64,227,181,847.64VND ii Credit term policy
- Expect average collection period to increase: from 35 day to 65 days
- The bad debt loss ratio: 7%
- Additional investment in inventory: 1,246,264,620 VND
- Variable production, administrative, and marketing cost: 70% of total sales
- Profit contribution ratio per dollar of sales is: 30%
- The company‘s required pretax rate of return: 25%
Table 3.11: Tuong An Vegetable Oil Joint Stock Company’s Analysis of the
Decision to change its credit term from “net 30” to ” net 60”
Marginal profitability of additional sales 102,494,458,394.22
= Profit contribution ratio x Additional sales
Step B: Additional investment in receivables 201,244,826,984.09
= New average balance - Present average balance
Cost of the additional investment in receivables 50,311,206,746.02
= Additional investment in receivables x Required pretax rate of return
Step C: Additional bad-debt loss 23,915,373,625.32
= Bad-debt loss ratio X Additional sales
Step D: Additional investment in inventory 1,246,264,620
Cost of the additional investment in inventory 311,566,154.93
= Additional investment in inventory x Required pretax rate of return
Step E: Net change in pretax profits 27,956,311,867.95
= A - (B + C + D) Conclusion: Tuong An Vegetable Oil Joint Stock Company can Lengthen the credit period with the above hypothesis With changing its credit term from ―net 30‖ to ‖ net 60‖ the net change in pretax profits of Tuong An Vegetable Oil Joint Stock Company is 27,956,311,867.95 VND iii Cash discount policy
- Present Average collection period: 50 days
- New Average collection period: 28 days
- 40% of the company‘s customers will take the advantage of the new cash discount
- The company‘s required pretax rate of return: 25%
Table 3.12: Tuong An Vegetable Oil Joint Stock Company’s Analysis of the
Decision to offer a 1 percent cash discount
Step A: Decrease in average receivables balance 102,962,469,619.76
= Present average balance - New average balance
Earnings on the funds released by the decrease in receivables 25,740,617,404.94 rease in receivables x Required pretax rate of return
Step B: Cost of cash discount 6,832,963,892.95
= annual sales x Percentage taking discount x Percentage discount
Step C: Net change in pretax profits 18,907,653,511.99
Conclusion: Tuong An Vegetable Oil Joint Stock Company can to offer a 1 percent cash discount with the above hypothesis With offering a 1 percent cash discount the net change in pretax profits of Tuong An Vegetable Oil Joint Stock Company is
1 Brigham, E F., (1992), Fundamentals of Financial Management, 6 th
2 Van Horne, J.C., and Wachowicz, J.M., (2001), Fundamentals of Financial Management, 11th Edition, Prentice Hall
3 Higgins R C, ( 2001), A n a l y s i s f o r Financial Management, 6 th Edition , McGraw-Hill/Irwin
4 Bonini, Hausman, Bierman, (1997), Quantitative Analysis for Management
(9 th Edition), McGraw-Hill/ Irwin
5 Brealey, R.A., and Myers, S.C., (2003), Principles of Corporate Finance, 6 th Edition, McGraw-Hill/Irwin
6 David Whitehurst, (2003), Fundamentals of Corporate Finance, 6 th Edition, McGraw-Hill/Irwin
7 Beverley Jackling and et al, (2003), Accounting – A framework for decision making, McGraw-Hill/Irwin
8 Leopold A Bernstein, (1993), Financial Statement Analysis, 3 rd Edition, McGraw-Hill/Irwin
9 Citi bank, (1994), Basic of corporate Finance, Latin America Training and
10 Financial Statement of Sonadezi Long Thanh and Tuong An Vegetable Oil Joint Stock Company
11 Sonadezi Long Thanh and Tuong An Vegetable Oil Joint Stock Company annual report
APPENDIX A: THE DEVELOPMENT OF VIETNAMESE BUSINESSES
Depend on the statistical censuses and surveys of General Statistics Office of Vietnam the development of Vietnamese businesses in recent year like this: the increasing about the number of acting enterprises, number of employees in enterprises, annual average capital of enterprises, and net turnover from business of enterprises This development contributed in growth rate of economics such as GDP
2 quarter of 2007 were estimated in increasing 7.87% against same period in 2005 and 2006 Three economic sectors had growth rates: The agriculture, forestry and fishery sector increased by 2.67%; the industry and construction increased by 9.88%; the service rose by 8.41% For 7.87% GDP, the agriculture, forestry and fishery contributed 0.53 points percents; the industry and construction shared by 3.94 points percents; the service shared by 3.4 points percents 15
1 Acting enterprises a Number of total acting enterprises increase very quickly, annual average was increasing by 22% against previous year, concretely:
15 Source: Press release: socio-economic statistical data, 2 Quarter in 2007 General Statistics Office of Vietnam
Figure 1: Number of acting enterprises in Vietnam from 2001 - 2005
(Source: General Statistics Office of Vietnam) b Number of acting enterprises classifying by type of enterprise
State owned enterprise Non-state enterprise Foreign investment enterprise
Figure 2: Number of acting enterprises classifying by type of enterprise in
(Source: General Statistics Office of Vietnam)
2 Employees in enterprises a Number of employees in total enterprises increase very quickly, annual average was increasing by 12% against previous year, concretely:
Figure 3: Number of employees in enterprises in Vietnam from 2000-2005
(Source: General Statistics Office of Vietnam) b Number of employees in enterprises classifying by type of enterprise: from
2000 to 2005 the employees move from state owned enterprise to Non – state enterprise and foreign investment enterprise Figure 2.4 can prove that information
State owned enterprise Non-state enterprise Foreign investment enterprise
Figure 4: Number of employees in enterprises classifying by type of enterprise in
Vietnam from 2001 - 2005 (Source: General Statistics Office of Vietnam)
3 Annual average capital of enterprises a Annual average capital of total enterprise increase year by year, annual average capital was increasing by 20% against previous year, concretely:
Figure 5: Annual average capital of enterprise from 2000 -2005
(Source: General Statistics Office of Vietnam) b Annual average capital of enterprises classifying by type of enterprise, the figure 2.6 shows that the capital in state owned enterprise is the largest from
2000 – 2005 but the ratio is decrease compare with non state enterprise and foreign investment enterprise
State owned enterprise Non-state enterprise Foreign investment enterprise
Figure 6: Annual average capital of enterprises classifying by type of enterprise
(Source: General Statistics Office of Vietnam)
4 Net turnover from business of enterprises a Net turnover from business of total enterprises increase year by year, annual average capital was increasing by 21.8% against previous year, concretely:
Figure 7: Net turnover from business of total enterprises (Source: General Statistics Office of Vietnam) b Net turnover from business of enterprises classifying by type of enterprise
The figure 2.8 show that the net turnover of non-state enterprise and foreign investment enterprise increase year by year in which the net turn over of state owned enterprise decrease year by year That mean two types of enterprise is stronger than state owned enterprise It is suitable with the policy of government
State owned enterprise Non-state enterprise Foreign investment enterprise
Figure 8: Net turnover from business of enterprises classifying by type of enterprise
(Source: General Statistics Office of Vietnam)
APPENDIX B: THE FACT OF USING MATHEMATICS MODELS IN
The managers often make financial decision base on their intuition With senior managers, this method can successful but to complicate situations this method maybe failure Besides, the scale of business larger more complicated so hard to make decision base on intuition to expend the business operation
Therefore, the manager more and more interested in using financial models to find out the optimal solution However, the applying financial models are needed complicate calculation so the manager often gives to other department When having the result they can not know it is right or wrong because they don‘t follow the process from the beginning This thing makes decrease the applying of model and affect the decision of manager, contribute the doubt about the real value of models
To understand more clearly about the fact of applying the mathematical model in financial decision making especially in investment decision in current assets such as cash management decisions, inventory management decisions, credit decisions, I already done the survey to find out how the manager of others company use these models to make decision
The survey had done by questionnaire send to 30 companies in Dongnai, Vungtau,