Application of mathematics models in short term investment decisions

VIETNAM NATIONAL UNIVERSITY, HANOI SCHOOL OF BUSINESS DO THI QUYNH AN APPLICATION OF MATHEMATICS MODELS IN SHORT – TERM INVESTMENT DECISIONS MASTER OF BUSINESS ADMINISTRATION THESIS Hanoi - 2007 VIETNAM NATIONAL UNIVERSITY, HANOI SCHOOL OF BUSINESS DO THI QUYNH AN APPLICATION OF MATHEMATICS MODELS IN SHORT – TERM INVESTMENT DECISIONS Major: Business Administration Code: 60 34 05 MASTER OF BUSINESS ADMINISTRATION THESIS Supervisors: Dr Chu Thanh Mrs Tran Phuong Lan, MBA Hanoi – 2007 TABLE OF CONTENTS ACKNOWLEDGEMENTS i ABSTRACT ii TÓM TẮT iii TABLE OF CONTENTS iv LIST OF TABLES viii LIST OF FIGURES x INTRODUCTION 1 NECESSITY OF THE THESIS OBJECTIVE OF THE RESEARCH KEY RESEARCH AREA METHODOLOGY CONTRIBUTIONS OF THE THESIS THESIS STRUCTURE CHAPTER 1: LITERATURE REVIEW 1.1.Overview of financial decision making 1.1.1.Investment decision 1.1.2.Financing decision 1.1.3.Dividend decision 1.1.4.Other decisions 1.2.Overview about the model building 1.2.1.Definition of Models 1.2.2.Classification of Models 1.2.3.Basic Modeling Concepts 1.2.4.The method to set up a model and apply in the financial decision making 1.3.Models using in investment decisions in current assets iv 1.3.1.Determining the target cash balance 1.3.1.1.The BAT model 11 1.3.1.2.The Miller – Orr Model: A more general Approach 16 1.3.1.3.Implications of the BAT and Miller-Orr Models 18 1.3.1.4.Other Factors Influencing the Target Cash Balance 19 1.3.2 Inventory management decisions 20 1.3.3 Accounts receivable management 26 1.3.3.1 Credit Standards 27 1.3.3.2 Credit terms 32 1.3.3.3 Collection Effort 40 CHAPTER 2: ANALYZING BUSINESS ACTIVITIES OF SONADEZI LONG THANH SHAREHOLDING COMPANY AND TUONG AN VEGETABLE OIL JOINT STOCK COMPANY 42 2.1 Sonadezi Longthanh Shareholding Company 42 2.1.1 The introduction of Sonadezi Longthanh Shareholding Company 42 2.1.2 The Operating results of Sonadezi Long Thanh Shareholding Company 47 2.1.2.1 The operating results in 2005, 2006 and months 2007 47 2.1.2.2 Some ratios assess the financial stability and business activities results 48 2.1.3 Characteristic of cash in Sonadezi Long Thanh Shareholding Company and relating decisions 49 2.1.3.1 Characteristic of cash in Sonadezi Long Thanh Shareholding Company 49 2.1.3.2 Decision making relate to cash in Sonadezi Long Thanh 51 2.2 Tuong An Vegetable Oil Joint Stock Company (TAC) 52 2.2.1 The introduction of Tuong An Vegetable Oil Joint Stock Company 52 2.2.2 The Operating result of Tuong An Vegetable Oil Joint Stock Company 56 2.2.2.1 The operating result in 2005, 2006 and months 2007 56 2.2.2.2 Some ratios show the financial situation and business activities results .58 2.2.3 Characteristic of current assets in Tuong An Vegetable Oil Joint Stock Company and relating decisions 60 v 2.2.3.1 Characteristic of Inventory in Tuong An Vegetable Oil Joint Stock Company 60 2.2.3.2 Decision making relate to inventory in Tuong An Vegetable Oil Joint Stock Company 62 2.2.4 Characteristic of Account Receivables in Tuong An Vegetable Oil Joint Stock Company and relating decisions 63 2.2.4.1 Characteristic of Account Receivables in Tuong An Vegetable Oil Joint Stock Company 63 2.2.4.2 Decision making relate to Account Receivables in Tuong An Vegetable Oil Joint Stock Company 65 2.3 Conclusion 65 CHAPTER 3: APPLICATION OF MATHEMATICS MODELS IN SHORTTERM INVESTMENT DECISIONS IN SONADEZI LONGTHANH SHAREHOLDING COMPANY AND TUONG AN VEGETABLE OIL JOINT STOCK COMPANY 66 3.1 Apply the cash management model in decision making in Sonadezi LongThanh Shareholding Company 66 3.1.1 The BAT (Baumol) model 66 3.1.1.1 The guideline to apply the BAT (Baumol) model 66 3.1.1.2 Apply the BAT model in determining the target cash balance 67 3.1.2 The Miller – Orr Model 70 3.1.2.1 The guideline to apply the Miller – Orr model 70 3.1.2.2 Apply the Miller – Orr model in determining the target cash balance 71 3.2 Apply the Inventory Management Model and Credit and Receivable Management Model in decision making in Tuong An Vegetable Oil Joint Stock Company 73 3.2.1 The Economic Order Quantity Model 73 3.2.1.1 The guideline to apply the Economic Order Quantity model 73 vi 3.2.1.2 Apply the Economic Order Quantity model in determining the optimal size of inventory orders 73 3.2.2 Credit and receivables management models 75 3.2.2.1 The guideline to apply the Credit and Receivables Management Models .75 3.2.2.2 Apply the Credit and receivables management model 80 REFERENCES 86 APPENDICES 88 Appendix A: The development of Vietnamese businesses 88 Appendix B: The fact of using mathematics models in short – term investment decisions 95 Appendix C: Number of acting enterprises as of Annual 31 Dec by type of enterprise 106 Appendix D: Number of employees in enterprises as of Annual 31 Dec by type of enterprise 107 Appendix E: Annual average capital of enterprises by type of enterprise 108 Appendix F: Net turnover of enterprises by type of enterprise 109 vii LIST OF TABLES Table 1.1: Classification of models Table 1.2: Credit Evaluation Data Compiled by Bassett Furniture Industries 28 Table 1.3: Bassett Furniture Industry’s Analysis of the Decision to Relax Credit Standards by Extending Full Credit to Customers in Credit Risk Group .31 Table 1.4: Nike’s Analysis of the Decision to Change Its Credit Terms from “Net 30” to “Net 60” 34 Table 1.5: CBS Record Company’s Analysis of the Decision to Offer a Percent Cash Discount 38 Table 2.1: Capital structure of Sonadezi Long Thanh 45 Table 2.2: Operating results in 2005, 2006 and months 2007 47 Table 2.3: Financial stability and business activities results of SZL 48 Table 2.4: Cash account of Sonadezi Long 50 Table 2.5: Liquidity ratios of Sonadezi Long 50 Table 2.6: Capital structure of Tuong An Vegetable Oil Joint Stock Company .55 Table 2.7: Operating result in 2005, 2006 and months 2007 of TAC 57 Table 2.8: Structure of sales and expenses in 2006 57 Table 2.9: Financial stability and business activities results of TAC 58 Table 2.10: Liabilities structure of TAC 59 Table 2.11: Inventory structure of TAC 60 Table 2.12: Inventory turnover of TAC 61 Table 2.13: Comparison inventory turnover of Tuong An oils and Marvella oils 61 Table 2.14: Comparison inventory turnover between Tuong An oils and Marvella oils 63 Table 2.15: Account receivable turnover of TAC 64 Table 2.16: Comparison account receivable turnover between Tuong An Oils and Marvella Oils 64 viii Table 3.1: The optimal cash balance of Sonadezi Longthanh from January to June, 2007 Table 3.2: Total cost of the optimal cash balance from January to June in 2007 Table 3.3: The total cost in optimal cash balance compare with others cash balance in January 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 Table 3.5: The optimal cash balance of Sonadezi Longthanh from January to June, 2007 Table 3.6: The average cash balance of Sonadezi Longthanh from January to June, 2007 Table 3.7: The economic order quantity (EOQ) of Tuong An Vegetable Oil Joint Stock Company per year form 2005 - 2007 Table 3.8: The total cost of Tuong An Vegetable Oil Joint Stock Company per year form 2005 - 2007 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 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 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” Table 3.12: Tuong An Vegetable Oil Joint Stock Company’s Analysis of the Decision to offer a percent cash discount ix LIST OF FIGURES Figure 1.1: The various categories of variables are related Figure 1.2: Cost of holding cash 10 Figure 1.3: Cash Balance for the Company A 11 Figure 1.4: The Miller – Orr Mode 16 Figure 1.5: Costs of holding inventory 23 Figure 1.7: Liberal credit policy model 32 Figure 1.8: Illiberal credit policy model 32 Figure 1.9: Lengthen the credit period model 36 Figure 1.10: Shorten the credit period model 36 Figure 1.11: Increase Cash discount policy model 39 Figure 1.12: Decrease Cash discount policy model 40 Figure 1.13: Credit and receivables management model 41 Figure 2.1: Sonadezi Corporation Structure 44 Figure 2.2: Capital structure of Sonadezi Long Thanh 46 Figure 2.3: Company Organizing Structure of Sonadezi Long Thanh 46 Figure 2.4: Operating results in 2005, 2006 and months 2007 48 Figure 2.5: Tuong An Vegetable Oil Joint Stock Company Ownership .55 Figure 2.6: Company Organizing Structure 56 Figure 2.7: Operating result in 2005, 2006 and months 2007 of TAC 58 Figure 3.1: Liberal credit policy model 76 Figure 3.2: Illiberal credit policy model 77 Figure 3.3: Lengthen the credit period model 78 Figure 3.4: Shorten the credit period model 78 Figure 3.5: Increase Cash discount policy model 79 Figure 3.6: Decrease Cash discount policy model 80 x INTRODUCTION 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 APPENDIX B: THE FACT OF USING MATHEMATICS MODELS IN SHORT – TERM INVESTMENT DECISIONS 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 Description of survey The survey had done by questionnaire send to 30 companies in Dongnai, Vungtau, Ho Chi Minh city by email and the result is having 27 companies replied,… with two company‘s primary business activity are manufacturing and trading company in there has three Type of Ownership are Private enterprise, Limited Liability company and Shareholding company The structure of companies are classifying by company‘s primary business activity and Type of Ownership 95 Table 1.1: The structure of companies are surveying by company’s primary business activity and Type of Ownership Company’s primary business activity Manufacturing company Quantity Ratio 19 70.37% Trading company Total Type of OwnershipPrivate enterprise Limited Liability company Shareholding company Total Table 1.2: The characteristic of Companies in the survey Quantity The operation time Sales Total Assets 96 Ratio The result of survey Training, knowing and using financial models Almost the person who answered the questionnaire was chief accountant, accounted 51.85%, accountant, accounted 29.63%, and Board of Management, accounted 18.52% The ratio 81.48% the person who answered the questionnaire worked in financial field can assure that the information collected could be trusted The ratio of attending in training courses that update the financial management method is not high That means the condition to apply the advanced financial management method still limit There was 62.96% the person who answered the questionnaire just attend in financial management course – times, in which 94% is accountant and chief accountant About 25.93% the person who answered the questionnaire attend in financial management course – times, persons attend usually and person never attending The practice of cash management The result of the survey show that 33.33% in 27 companies in the survey answer that they usually set the cash plan, in which just have 3.7 % answer that they are never set the cash plan On the others side, 51.85% companies in the survey answer that that set the cash plan per month, 22.22% per week and 7.41% never interested in setting the periodic time for cash plan (Table 2.1) 97 Table 2.1: The practicing of setting cash plan The periodic time of cash plan Total Periodic period of cash plan Never Every Week Every Month Every quarter Every months Every year Total The determining the target cash balance, the table 2.2 show that having 18.52 % businesses in the survey often or usually determining the target cash balance, in which about 33.33 % businesses in the survey never or rarely determining the target cash balance So the general trend is that businesses rarely interested in setting up the target cash balance policy Almost businesses in the survey think that the cash balance is the different between the cash in and cash out but they don‘t have any cash management policy Besides, the table 2.2 still show that 62.96 % businesses in the survey setting up the target cash balance base on experience of the manager The ratio of business apply the cash management theory in setting up the target cash balance is very minimum; just have one company equal to 3.7 % That means the cash management theories haven‘t applied popularly in practicing in Vietnam 98 Table 2.2: The practicing of determining the target cash balance Determining the target cash balance The decisions of target cash balance Researching about the shortage or surplus cash, the table 2.3 shows that 33.33% businesses in the survey never or rarely shortage cash in the account, 7.4% businesses in the survey often or usually shortage cash Vice versa, in the table 2.3 having 51.85% businesses in the survey show that they are often or usually surplus cash, just have 18.52% businesses in the survey show that they are never or rarely surplus cash This result suitable to the discovery of Kack and Lindgren (1999) and Vuong Hoang Quan (1998) said that Vietnamese businesses always reserve the cash so that the current ratios very high affect to the revenue ratio The table 2.3 also shows the result about the investment of cash those 51.85% businesses in the survey answer that they don‘t invest the surplus cash for getting the profit There is having 37% businesses in the survey deposit cash in the bank account to get interest And almost no company invests the surplus money in 99 monetary market such as buying the commercial treasury, commercial papers That means Vietnamese monetary market hasn‘t developed, and the result is that businesses have no chances to invest the surplus cash for profit purpose Table 2.3: The shortage or surplus cash The shortage cashNever The surplus cash Total Investment the surplus cash Deposit in the bank Buying commercial treasury Leave in the account Others Total The practicing of account receivable management In the table 2.4 shows that about 77.78% businesses in the survey said they often or usually give the credit to customers, only 3.7% never give the credit to customers However, having only 62.96% business in the survey set up the credit policy In 100 which, having 7.41% never set up the credit policy and they have the trend give credit to any customers Table 2.4: Credit policy Account receivables Total Setting up the Credit policy Never Rarely Occasionally Often Usually Total The periodic time of checking account receivables and bad-debt, a high ratio of businesses (about 59.26%) said that they observe the account receivables and baddebt every month However, having 7.41% business in the survey said that they never interested in bad-debt (Table 2.5) Thus, like the cash management, the periodic month still use to check the account receivables and bad-debt 101 Table 2.5: The periodic time of checking account receivables and bad-debt Quantity Ratio Checking the Account receivables Checking the bad-debt Relating to the question the ratio between bad-debt and sales, 85.19% businesses in the survey said that their bad-debt ratio not higher than 10% (Table 2.6) This number shows that the businesses manage the account receivables quite good However, having 3.7% businesses in the survey said that they didn‘t know the baddebt ratio 102 Table 2.6: The ratio of bad debt and sales The ratio between bad debt and sales The practicing of inventory management The table 2.7 shows quite high ratio (81.48%) businesses in the survey often or usually check the inventory and 77.78% often or usually set up the inventory plan Only 3.7% never set up the inventory plan 103 Table 2.7: The periodic time of setting up the inventory plan and checking inventory Checking inventory Total Setting up the inventory plan Never Rarely Occasionally Often Usually Total When asking about how to make decision about the optimal inventory quantity, 74.07% businesses in the survey said that they base on their experience, only 7.41% make decision base on inventory management theory (Table 2.8) On the others side, they rarely use the Economic Order Quantity Model - EOQ model in the inventory management The highlight is 70.37% businesses don‘t know this model and 18.52% know this model but they never use this model in making the inventory decision Only 3.7% businesses in the survey use the EOQ model 104 Table 2.8: The fundamental for decision the optimal inventory quantity and using the EOQ model Decision the optimal inventory quantity Using the EOQ model Through analyzing the result of the survey show in the table 2.7 and 2.8 we can see that Vietnamese businesses know a little about inventory management theory Although they often observing the inventory quantity and set up inventory plan, the applying these models in making decision very limit 105 APPENDIX C: NUMBER OF ACTING ENTERPRISES AS OF ANNUAL 31 DEC.BY TYPE OF ENTERPRISE TOTAL State owned enterprise Central Local Non-state enterprise Collective Private Collective name Limited Co Joint stock Co having capital of State Joint stock Co without capital of State Foreign investment enterprise 100% foreign capital Joint venture TOTAL State owned enterprise Central Local Non-state enterprise Collective Private Collective name Limited Co Joint stock Co having capital of State Joint stock Co without capital of State Foreign investment enterprise 100% foreign capital Joint venture 106 APPENDIX D: NUMBER OF EMPLOYEES IN ENTERPRISES AS OF ANNUAL 31 DEC BY TYPE OF ENTERPRISE TOTAL State owned enterprise Central Local Non-state enterprise Collective Private Collective name Limited Co Joint stock Co having capital of State Joint stock Co without capital of State Foreign investment enterprise 100% foreign capital Joint venture TOTAL State owned enterprise Central Local Non-state enterprise Collective Private Collective name Limited Co Joint stock Co having capital of State Joint stock Co without capital of State Foreign investment enterprise 100% foreign capital Joint venture 107 APPENDIX E: ANNUAL AVERAGE CAPITAL OF ENTERPRISES BY TYPE OF ENTERPRISE TOTAL State owned enterprise Central Local Non-state enterprise Collective Private Collective name Limited Co Joint stock Co having capital of State Joint stock Co without capital of State Foreign investment enterprise 100% foreign capital Joint venture TOTAL State owned enterprise Central Local Non-state enterprise Collective Private Collective name Limited Co Joint stock Co having capital of State Joint stock Co without capital of State Foreign investment enterprise 100% foreign capital Joint venture 108 APPENDIX F: NET TURNOVER OF ENTERPRISES BY TYPE OF ENTERPRISE TOTAL State owned enterprise Central Local Non-state enterprise Collective Private Collective name Limited Co Joint stock Co having capital of State Joint stock Co without capital of State Foreign investment enterprise 100% foreign capital Joint venture TOTAL State owned enterprise Central Local Non-state enterprise Collective Private Collective name Limited Co Joint stock Co having capital of State Joint stock Co without capital of State Foreign investment enterprise 100% foreign capital Joint venture 109 ... HANOI SCHOOL OF BUSINESS DO THI QUYNH AN APPLICATION OF MATHEMATICS MODELS IN SHORT – TERM INVESTMENT DECISIONS Major: Business Administration Code: 60 34 05 MASTER OF BUSINESS ADMINISTRATION... 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. .. data of variables and check again effect on the result 1.3 Models using in investment decisions in current assets In the field of research, the thesis just study some model using in investment decisions