Treasury Management and Control

Prof. Prapti Paul

 Cash management refers to the management of cash and bank balance  1.

2. 3. 4.

or in a broader sense it’s the management of cash inflows and outflows. Every firm must have a minimum cash balance. There are different motives for holding cash: Transaction motive: demand for cash flow arising out of day to day transactions. In order to meet the obligations for cash flows arising in the normal course of business, every firm has to maintain adequate cash balance. Precautionary motive: is based on the need to maintain sufficient cash to act as a cushion or buffer against unexpected events. Speculative motive: cash maybe held for speculative purposes in order to take advantage of potential profit making situations. Compensation motive: commercial banks require that in every current account there shd always be a minimum cash balance. This amount remains as a permanent balance with the bank so long as the current account is operative.

(ii) Proforma balance sheet. There are 3 methods of preparing cash budgets: (i) adjusted Net Income. . the firm shd prepare a cash budget. This plan will help in preparation of a statement of receipts and disbursements expected at different point in time of that period.. and 2) to minimize the idle cash held by the firm. In all the methods the information with which the final cash budget is constructed is basically the same.In order to take care of all these transactions.  A cash budget is a summary of movement of cash during a particular period. Objectives of cash management: Built ard 2 goals: 1) to provide cash needed to meet the obligations. and (iii) cash receipts and disbursements. It will enable the management to pinpoint the exact timing of excess cash or shortage of cash etc.  Cash management: Planning Aspects: the implementation of an efficient cash management system starts with the preparation of a plan of firm’s operations for a period in future.

100 only. 1.00.000 21. was Rs. for the period Jan-Apr 2007 Jan sales Raw material Manuf.000 Feb Rs. Prepare cash budget for the period of 4 months( ignore interest on borrowings).000 11.5.000 10.05. however.000 20.000 21.000 1. the cash balance on Jan 1st.000 70.80. 2/3 of debtors are collected in the same month and balance next month. the firm must have is estimated to be Rs. There is no expected bad debt.000 80.000 Apr Rs. Exp Loan install Rs.000.000 85. 2007 were Rs.1. Illustration 1: the foll forecasts have been made for ABC Ltd.000 16.000 29.000  Additional info: (i) all sales are made on credit basis. if any can be made in multiples of Rs. (iii) borrowing.75.05. . (ii) the minimum cash balance.000.30. The debtors on Jan 1st.000 Mar Rs.

22.000 10.500 Mar 5.30.000 1. Cash Inflows: Drs (prev.000) 85.000 20.000 1.000 -30.000 60.000 1.20.000 1. month) Total cash avail (A) Outflows: Raw material Manuf.00.000 13.35.000 50.00.000 1.000 Apr 5.500 70.500 25.000 Opg.000 1.000 16.000) Borrowings (refund) - .000 21.month) Drs(cur.000 1.000 35.500 35.6.500 30.000 29.000 81.000 5.000 11.000 1.000 70.000 86.000 30. Exp Loan install Total outflows (B) Cash Bal (A-B) Rs.60.000 (25.500 80.31.500 1.000 (8. Solution 1: cash budget for the period Jan-Apr 2007 Jan Feb 5.000 21.000 70.

Once the cheques/ drafts are received frm customers. manager shd take steps for speedy recovery from the debtors and for this purpose proper internal control system should be installed by the firm. This requires controlling and reviewing of the whole exercise on a regular basis. . Once the credit sales have been effected. Periodic statements shd be prepared to show the outstanding bills.  The efficiency of the firm’s cash management program can be enhanced by the knowledge and use of various procedures aimed at: (a) accelerating cash inflows. Cash Management: Control Aspects.after the preparation of cash budgets.  Controlling inflows: the fin. Incentives offered to the customers for early/ prompt payments shd be well communicated to them. there shd be a built in mechanism for timely recovery from the debtors. The time lag in collection of receivables can be considerably reduced by managing the time taken by postal intermediaries and banks. and (b) controlling cash outflows. the financial manager should ensure that there are no significant differences between the expected/ budgeted cash flows and the actual cash flows. no delay shd be there in depositing these receipts with the banks. Concentration banking and lock box system help reduce this time lag.

. This is known as concentration banking. However concentration banking involves a cost in terms of minimum cash balance required with a bank in form of normal minimum cost of maintaining a current account. the customers mail their payments to a post office near their workplace. The firm arranges with a local bank or some other agency to collect the payments and credit to the firm’s account as quickly as possible. of payments being received in a particular area. The firm may instruct the customers to mail their payments to a regional collection centre/ bank rather than to the central office. A firm may open collection centres (banks) in different parts of the country to save the postal delays.  Under the lock box system. the collection centres are opened as near to the debtors as possible. The lock box system is economical only if there is a relatively large no. Under this system. So concentration banking as a tool of controlling inflows may be availed by big firms only. collection etc. This results in saving of time and hence better cash management. hence reducing the time in dispatch. as the expenses attached for maintaining the system may be significant. .

 Controlling outflows: an effective control over cash outflows or payments also help a firm in better cash management and reducing cash requirements. This time gap is known as float. there is usually a time gap between the time the cheque is written and when it is cleared. 2) processing time: time between the cheque is received by the payee and the deposit of the cheque in the bank account of the payee. For the payee firm.  Playing the float: when a firm receives or makes payments in the form of cheques etc. through banking system. So float refers to the funds that have been dispatched by a payer (the firm making the payment) but are not in a form that can be spent by the payee (the firm receiving the payment). . and 3) collection time: amount of time for transferring funds.  Float has 3 components: 1) Mail time: it is the time between the issue of cheque and its receipt by the payee. from the payer’s account to that of the payee. However care must be taken that goodwill and credit rating of the firm is not affected. float refers to the time between the receipt of the cheque and the availability of the funds in its account.. A financial manager shd try to slow down the payments as much as possible. The float for the paying firm refers to the time that elapses between the point when it issues a cheque and the time at which the funds underlying the cheque are actually debited to the bank account.

 Illustration 2: Tiffin services Ltd.  Solution 2: different floats for the firm: disbursement =3.000 = Rs.000 per day and receives cheques of Rs. The difference between the payment float and receipt float is known as net float. rather the bank reduces the balance only when the cheque is presented to it either personally or through the clearing system.4. .000 per day.000*2= Rs. rather the banks credit the cheque only when it is cleared by the paying bank. but not yet cleared.17.000-4.17.000 net floats=21. When a cheque is issued by the paying firm. The amount of cheques deposited into the banks. The amount of cheques issued but not presented for payment is known as the payment float. find out different floats for the firm.000 So the firm’s net book balance is Rs.21.2.000 collection= 2. The payment float is 7 days while receipt float is 2 days on an avg. issues cheques of Rs.000 less than the actual balance available in the bank. is known as receipt float.  When the firm receives a cheque from the customer and deposits the cheque in the firm’s account the amount is not immediately credited to the firm’s account.3. the bank balance of the firm is not immediately reduced.000*7=Rs.

the problem of determining optimum cash balance for a firm implies a trade-off between risk and return of maintaining cash balance.  Baumol’s Model: this model is the same as EOQ model of inventory mgmt. a firm keeps the least amount of cash in hand. Thus a firm has to deal with the holding cost as well as transaction cost. Each time the firm transacts in this way. commission etc.. This model attempts to balance the income foregone on the cash held by the firm against the transaction cost of converting cash into marketable securities or viceversa. there is always a cost involved in the form of brokerage. the firm can acquire cash by selling some of its marketable securities.  Holding cost: there is always a cost of holding cash by the firm. so it will like to transact as occasionally as possible. it bears transaction cost.  This model is based on the proposition that in order to reduce the holding cost. or vice-versa.  Transaction cost: whenever cash is to be converted into marketable securities. This cost maybe opportunity cost in terms of interest foregone on the investment of this cash. . This could be done by maintaining a higher cash level involving a high holding cost. However as the level of cash depletes.  Assumption: the Baumol’s model assumes that the firm uses cash at an already known rate per period and that this rate of use is constant. Optimum Cash Balance: Few Models.


As per Baumol’s model. of investment as well as the maturity period. 2. the firm should start each period with the cash balance equaling ‘C’ and spend gradually until its balance comes to zero. the firm shd replenish the cash equaling ‘C’ from the sale of marketable securities. The optimum cash balance is found by controlling the holding cost as well as transaction cost so as to minimize the total cost of holding cash.  Model can be presented as follows: C= √(2FT)/r where C = cash required each time to restore balance to minimum cash F= total cash required during the year. The model assumes a constant rate of use of cash. T= cost of each transaction between cash and marketable securities r= rate of interest on marketable securities. Generally the cash outflows in any firm are not regular and hence this model may not give correct results. The transaction cost will be difficult to measure since this depends upon the type . At this time.  Limitations: 1.

The model assumes (i) out of the 2 assets i. and (ii) transfer of cash to marketable securities and vice. cash and marketable securities the latter has a marginal yield. . The cash balance of a firm may fluctuate irregularly over a period of time.e. Miller-Orr model: they have expanded Baumol’ s model which is not applicable if the demand for cash is not steady. They argue that changes in cash balance over a given period are random in size as in direction.versa is possible without any delay but at a cost.


L. . No transaction between cash and marketable securities is undertaken so long as the cash balance is between the 2 limits of H and L. If the cash level reaches the upper control limit. H. An upper limit. beyond which cash balance need not be allowed to go and a lower limit. then sufficient marketable securities shd be sold to realize cash so that the cash balance is restored to the return level. R. R. The cash balance shd be allowed to move within these limits. The model has specified two control limits for cash balance. If the cash balance reduces below the lower level. H. then at this point a part of the cash shd be invested in marketable securities in such a way that the cash balance comes down to a pre-determined level called the return level . L. below which the cash level is not allowed to reduce.

on the basis of the foll info for the six months commencing April. balance 30% and 10% in the two months thereafter.00.000 p.333 16.33.8. rent payable Rs.000 12.00..00.000 2007 Jun Jul Aug Sep Oct Amount 8.m 6) Capital expenditure expected in September is Rs.00. Illustration 3: prepare a cash budget of XYZ Ltd.000.4. No bad debts are anticipated.00.00. 60% of the credit sales are collected in the month following the sales.00. 2) Cash sales are 25% of the total sales and the balance 75% will be credit sales.000 12. 2007 1) Cost and prices remain unchanged and firm maintains a minimum cash balance of Rs.000 4) Gross profit margin 20% 5) Quarterly interest payable Rs. 3) Sales forecasts are as follows: 2007 Jan Feb Mar Apr May Amount 12.000 8.20.000 13.000 for which bank overdraft may be availed if required.000 8.000.000 10.000 6. .00.

40.60.000 6.7) Anticipated purchases and wages for 2007 are: Purchases April May June July August September Rs.000 1.000 Wages 1.000 1.60.000 2.000 2.000 6.000 .40. 6.000 9.000 8.60.

92 10.92 (4.08 8.60 2.60 .85 8.607.30 .60 6.15 8.40 1.08 7.08 6.30 9.00 6.14 6.85 8.31 3.80 9.80 9.40 .08 8.00 5.50 11.15 9.20 .00 8.00+ 12.40 1.30 4.20 .08 7.30 2.00 .80 10.08 12.98 10.00 2. Cash inflows: sales realization cash sales credit sales (working note) Total Inflows B.30 6.40 1.60 1. In lacs Apr May Jun Jul Aug Sept A.08 2.00 7.14 2.31 5.10 12.68 4.52 .50 7.08 11.08 5.08 10.58 7.30 1.00 7.30 6.08 8.00 . Cash outflows: Materials wages Interest payable Capital expenditure Rent payable Total Outflows Opening balance Closing balance 1.60 . Solution 3: Cash Budget– April to September 2007 Rs.68) 2.

5 5.60 1. Working notes solution 3: collection from credit sales: Apr Credit sales 4.40 1.60 7.50 Credit sales-collections: 60% of preceding month 7.20 6.2 30% of next preceding month 3.80 0.30 Jun 6.60 1.00 2.90 Total collections 11.00 3.70 3.80 0.80 Sep 6.15 Jul 9.35 1.00 3.70 0.80 .45 5.00 4.00 7.00 10%of next preceding month 0.50 2.85 Aug 7.10 May 6.60 1.60 7.

What would these be if cash held is Rs.15.a What are the opportunity costs of holding cash.000/2) Rs.40.000?  Solution 4: optimum cash balance as per Baumol’s Model is: C= √(2FT)/r =√(2*2.000 or Rs.2. Illustration 4: find out the optimum cash balance as per Baumol’s Model for the foll: Annual cash needed Transaction cost Interest rate Rs.12% p.20.40.200+1. cash balance Interest cost@12% No.000) Transaction cost(Rs.2.12 =Rs.1.100*12) Total cost (Rs.200 12 Rs. .000/20.100 per conversion Rs.10.2.000 Avg. of transaction(Rs.200) Rs.000*100)/.000 (20. the transaction cost and the total cost.000 Rs.200 Rs.40.

1.15.460  In both cases the total cost is more than the cost as per Baumol’s Model.600 Rs.500 Interest cost @12% No of transactions Transaction cost @Rs.000 Average cash Rs.1.2. If cash held is Rs.25.15.500 Rs.900 16 Rs.000.960 Rs.12.500 Rs.100 each Total cost Rs.500 9.7.6 Rs.25. different costs would be: Cash balance Rs.2.00 or Rs. .000 Cash balance Rs.

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