Cash Management

Cash Cycle
Factors that influence the desired level
of cash
Optimal cash inventories
Short-term investment strategies

The Manager

Resource Decisions
Investment Decisions
Operating
Decisions
Human Resources
Decisions

Managing an entitys Resources

Cash Management
Inventory Management
Working Capital Management
Investment in Human Capital
Long-term Assets
Accounts Receivable

Recruitment, Selection
Training, Productivity
Performance Appraisal
Compensation
Unions & Labor Relations

Information
Decisions

Economics of Information
Database Management
Data Modeling
IS Planning & Development

Financing Decisions

Debt vs. Tax Financing

Life cycle effects,

Business cycle,
public events,
etc.

Cash Inflows

Value
Creation

Discount Rate

Cost of
Capital

Financial
Markets

Overview
ST finl planning = deals w/ short-lived assets and liabilities
(working capital management);
concerned w/ 1) size of investment in CA like cash, A/R,
Inventorya tool is cash budget analysis and 2) how to
finance ST assetsa tool is performing credit analysis

Managing WC involves determing:

How much to invest in CA?
- CA vs. FA
- Nature of activities/programs

In each CA?
- Cash, A/R, Inventory
- Cash Mgt
- A/R is Credit Mgt
- Inv = POM & Cash balance models

Our objectives
Learn about the Cash Cycle
Understand the factors that influence the
desired level of cash
Learn two models that calculate the optimal
level of cash
Gain an overview of what factors/areas are
inputs to a cash budget and how they affect
the cash balance

Objectives of Public Money

Managers
Bringing the entitys cash
resources within control
Achieving optimum
conservation and utilization of
the funds

Key areas of Public Cash

Management
Organization
Collection and disbursement of funds
Netting of interagency payments
Investment of excess funds
Optimal level of cash balances
Cash planning and budgeting
Bank relations

Treasury Management of
Cash Balances
Operate with smaller amount of
cash
Supervision is centralized
Better service from banks
Proper allocation of funds

How much cash should a

organization keep on hand?
Enough cash to make payments when
needed. (transactions motive)
(Daily or Weekly Cash Budget helpful)

Additional cash may be held for unexpected

requirements. (precautionary motive)

The size of the minimum cash

balance depends on:
How quickly and cheaply a organization can raise
cash when needed.
How accurately managers can predict cash
requirements.
(Cash Budget helpful)

How much precautionary cash the managers need

for emergencies.

The organizations maximum cash

balance depends on:
Available (short-term) investment opportunities
e.g. money market funds, CDs, commercial paper

Expected return on investment opportunities.

e.g. If expected returns are high, organizations should
be quick to invest excess cash

Transaction cost of withdrawing cash and making

an investment
Demand for Cash for daily transactions
(Cash Budget helpful)

Consider Cash an Inventory

the
--hold
little
Antrade-offs:
inventory
approach
to
Cash
the
trade-offs:
hold
littlecash
cash==invest
invest
remainder
in
remainder
inM/S
M/Sto
toearn
earninterest
interest
Balance
decisions:
Grantsville has a daily demand for cash of $10,000.
Grantsvilles
treasurer
invests excess
cash in the state investment pool
--ififhold
holdtoo
toolittle
littlecash
cash==incur
incurtransactions
transactions
that earns
.01%
per day.
In order to transfer funds from the state pool,
costs
coststo
tomeet
meetcash
cashneeds
needs
Grantsville must pay a transaction cost of $20. How much cash should
it transfer when it runs out. (Grantsville can complete the cash
transfer electronically so
--hold
it waits
lots
of
the==cash
forgo
balance
investing
is zero).
in
hold
lotsuntil
ofcash
cash
forgo
investing
inM/S
M/S
and
andearning
earninginterest
interest

Optimal Cash Balance via Baumol Model

50000000 1002 504 339.3333333 258 210

Cost ($)

M
M==$10,000
$10,000

rr==.01%
.01%
.0001
.0001

Z*=
Z* [(2M*TC)/r]
ZZ==$63,246
$63,246

TC
TC==$20
$20

Total Costs
Holding Costs:
(Z/2)*r

Order Costs:(M/Z)*TC

Z*

Order Quantity (Z)

Problems with the Baumol Model

Cash flows may not be very predictable, much less

constant

Treasurers may want a safety stock of cash

The Miller - Orr Model

The Miller-Orr Model provides a formula for
determining the optimum cash balance (Z), the
point at which to sell securities to raise cash (lower
limit L) and when to invest excess cash by buying
securities and lowering cash holdings (upper limit
H).
Depends on:
transaction costs of buying or selling securities
variability of daily cash (incorporates uncertainty)
return on short-term investments

Dollars in the Cash Account

The Miller - Orr Model

Upper Limit

Buy Securities

Z
Lower Limit

Sell Securities
Days of the Month

The Miller-Orr Model

- Target Cash Balance (Z)
3

Z=

3 x TC x V
+L
4xr

where: TC = transaction cost of buying

or selling securities
V = variance of daily cash flows
r = daily return on short-term
investments
L = minimum cash requirement

The Miller-Orr Model

- Target Cash Balance (Z)
Example: Suppose that short-term securities yield
5% per year and it costs the organization $50 each
time it buys or sells securities (TC). The daily
variance of cash flows is $1000 (V) and your bank
requires $1,000 minimum checking account
balance (L).*

Z=

3 x 50 x 1000
4 x .05/360

+ $1,000

= $3,000 + $1,000 = $4,000

The Miller-Orr Model

- Upper Limit
The upper limit for the cash account (H) is
determined by the equation:
H = 3Z - 2L
where:
Z = Target cash balance
L = Lower limit
In the previous example:
H = 3 ($4,000) - 2($1,000) = $10,000

Dollars in the Cash Account

The Miller - Orr Model

Upper Limit

Buy Securities

$10,000

$4000

Lower Limit

Sell Securities
Days of the Month

$100
0

Cash Pooling
Centralized cash management involves
transfer
of an agencys cash in excess of minimal
operating requirements into a centrally
managed
account also known as a cash pool.
Procedure
and
Benefits

Investment of excess
funds

The Collection & Disbursement of Public Funds

Managing Cash Balances
Safety
Liquidity
Maximize pool of funds
available for investment
Concentration Accounts
Zero-balance accounts

Highest yield

Controlling Cash
Collection &
Disbursement
Dual responsibility
Receipts maintained in a
location separate from
cash & checks
Certification of vouchers

Collection of funds
Need for accelerating collections
How to accelerate collection of
receivables

Disbursement of funds
Importance of disbursement of funds
Review of disbursements
Payment instruments being used (checks,
drafts, wire transfers, etc.)
Bank charges and internal costs
Techniques being used
Time involved for processing of
instruments

Payments Netting in
Public Cash
Management
Need for payments netting
Procedure involved
Only netted amount is transferred (bilateral
netting)
Netting center (multilateral netting)

Our objectives
Learn about the Cash Cycle
Understand the factors that influence the
desired level of cash
Learn two models that calculate the optimal
level of cash
Gain an overview of what factors/areas are
inputs to a cash budget and how they affect
the cash balance

Stop Here

Payments netting in
Public Cash Management
(contd.)

Payments Netting in
Public Cash Management
(contd.)

Cash Planning and

Budgeting

Cash Planning and Budgeting

(contd.)