Miller-Orr Model for Cash Management: Most firms maintain a minimum amount of cash on hand to meet daily obligations

or as a requirement from the firm's bank. A maximum amount may also be specified to reflect the tradeoff between the transaction cost of investing in liquid assets (e.g. Money Market Funds) and the cost of lost interest if the cash is not invested. The Miller-Orr model computes the spread between the minimum and maximum cash balance limits as Spread = 3(0.75 x transaction cost x variance of daily cash flows / daily interest rate) ^(1/3) (where a^b is used to denote "a to the power b"). The maximum cash balance is the spread plus the minimum cash balance, which is assumed to be known. The "return point" is defined as the minimum cash balance plus spread/3. Whenever the cash balance hits (or exceeds) the maximum, the firm should invest the difference between the amount available and the return point; if the minimum is reached, sufficient securities should be sold to bring it up to the return point. MILLER-ORR MODEL:
A CASH UPPER LIMIT
RETURN POINT

LOWER LIMIT B TIME

Graph Explanation: When cash balance reaches point `A', the upper limit, company will invest the surplus to bring down the cash balance to return point. When cash balance touches down point `B', the lower limit, the company would liquidate some of its securities to increase the balance back to return point. Upper and lower limits are determined as explained above. These limits depend upon variance of cash flow, transaction cost and interest rate. If variability of cash flow is high and transaction cost is high too, then the limits will be wide apart, otherwise narrow would suffice. If interest rates are high then the narrow limits would be set