Question No. 3 : How much cash should the firm hold ?

Once the financial manager understands the objective of cash management, it is necessary

for him to know the specific factors in order to determine the firms required balance. These

general factors are the synchronization of cash inflows and cash outflows , the costs associated

with a shortfall in the firms cash needs, the costs associated with managing the firms cash

balances and marketable securities, and the last one is the associated uncertainties.

In order to synchronize the cash flows , it is necessary to examine such cash inflow

characteristics as the seasonal and cyclical pattern of the firms sales, its collection of outflow

accounts receivable and its borrowings. In addition, it needs also to examine cash outflow

characteristics as the firms payroll, raw material costs , interest payments, accounts payable, debt

amortization and taxes. This is also done through the use of a cash budget which reflects the

financial officers forecasting accuracy for each of the sub periods within the planning horizon.

Furthermore, in order to determine the second factor, the financial manager has to examine

the firms transaction costs of raising cash, its borrowing costs, the forfeiture of trade discounts

and other valuable opportunities. We saw that short costs arose whenever the firm failed to

maintain an adequate level of cash to meet its payments schedule and had to draw down its

checking account balance below the required compensating balance level, convert some

marketable securities to cash or borrow.

In order also to determine the cost associated with the maintaining excess idle cash, it has

to examine the missed opportunities from which the firm could have profited if it had invested

those funds, particularly the interest passed up on marketable securities. Lastly , to determine the

operating costs associated with the cash management, it has to examine the cost of maintaining a
staff and of buying and storing the securities. Actually , there is no exact amount stated how much

amount of cash the firm will hold. Thats why we have these factors to help us determine the

required balances of an entity.