ICAN REVISION- CASH MANAGEMENT- CAP-II

Cash Management
A) Treasury Management
Meaning
Treasury Management is defined as ‘the corporate handling of financial matters, the generation of
external and internal funds for business, the management of currencies and cash flow and the
complex, strategies, policies and procedures of corporate finance”.

B) Functions of Treasury Department

a. Cash Management:
The efficient collection and payment of cash both inside the organization and to thirds
parties is the function of the treasury department. The involvement of the department with
the details of receivables and payables will be a matter of policy.

b. Currency Management:
The treasury department manages the foreign currency risk exposure of the company.

c. Funding management:
Treasury department is responsible for planning and sourcing the company’s short, medium
and long term cash needs. Treasury department will also participate in the decision on
capital structure and forecast future interest and foreign currency rates.

d. Banking:
It is important that a company maintains a good relationship with its bankers. Treasury
department carry out negotiations with bankers and act as the initial point of contract with
them.

e. Corporate Finance:
Treasury department is involved with both acquisition and divestment activities within the
group. In addition it will often have responsibility for investor relations. The latter activity
has assumed increased importance in markets where share-price performance is regarded
as crucial and may affect the company's ability to undertake acquisition activity or if the
price falls drastically, render it vulnerable to a hostile bid.

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C) The Need for Cash

 Transaction need:
 Speculative needs:
 Precautionary needs:

E) Cash Management Strategies

In order to synchronies the cash receipt and payment. A firm needs to develop appropriate
strategies for cash management viz.
(i) Cash Planning: Cash budget, cash flow statement
(ii) Managing the cash flow: The cash inflow should be accelerated, while as far as
possible, the out flow should be decelerated.
(iii) Optimum cash level:
(iv) Investing surplus cash: (1) Safety (3) Maturity (2) Liquidity

F) Cash planning

Cash budget:

Format of Cash Budget

Cash Budget
From ……………… to ………………
Jun
Jan Feb March April May e
Particulars Rs Rs Rs Rs Rs Rs
A. Opening Cash Balance XXX XXX XXX XXX XXX XXX
B. Receipts
Cash Sales XXX XXX XXX XXX XXX XXX
Collection from debtors XXX XXX XXX XXX XXX XXX
Total Receipts (B) XXX XXX XXX XXX XXX XXX

C. Total Cash Payments:

Cash Purchases XXX XXX XXX XXX XXX XXX
Payments to creditors XXX XXX XXX XXX XXX XXX
Wages & Salaries XXX XXX XXX XXX XXX XXX
Interest on Debn XXX XXX XXX XXX XXX XXX
Tax Payment XXX XXX XXX XXX XXX XXX

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Total Payments (C ) XXX XXX XXX XXX XXX XXX

C. Surplus (Defict)[A+B-C] XXX XXX XXX XXX XXX XXX

Investment/Financing
D Temp. investments After keeping minimum
Realisation of temporary Investments to
E. maintain
F. Temporary loan
G Repayments of temporary loan
H Closing Cash Balance XXX XXX XXX XXX XXX XXX

Question No. 1
Prepared monthly cash budget for six months beginning from April 2015 in the basis of the
following information:-
i) Estimated monthly sales are follows:
Rs. Rs.
January 100,000 June 80,000
February 120,000 July 100,000
March 140,000 August 80,000
April 80,000 September 60,000
May 60,000 October 100,000

ii) Wages and salaries are estimated to be payable as follows:

Rs. Rs.
April 9,000 July 10,000
May 8,000 August 9,000
June 10,000 September 9,000
iii) Of the sales 80% is on credit and 20% for cash. 75% of the credit sales are collected within
one month and balance in two months. There are no bad debt losses.
iv) Purchases amount to 80% of sales and are made and paid for in the month preceding the sales.
v) The firm has 10% debentures of Rs. 1, 20,000. Interest on these has to be paid quarterly in
January, April and so on.
vi) The firm is to make an advance payment of tax of Rs 5,000 in july 2015.
vii) The firm had a cash balance of Rs 20,000 on April 1, 2015, which is the minimum desired
level of cash balance. any cash surplus/deficit above/below this level is made up by temporary

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investments/liquidation of temporary investments or temporary borrowings at the end of each

month (interest on these to be ignored)
Solution :
Monthly Cash Budget for the six months from Apr. to Sep
Rs. In "000"
Apri Jun
l May e July Aug Sept
Particulars Rs Rs Rs Rs Rs Rs
A. Total Cash Available
Opening Cash Balance 20 20 20 20 20 20
Cash Sales 16 12 16 20 16 12
Collection from debtors 108 76 52 60 76 68
144 108 88 100 112 100

B. Total Cash Payments:

Purchases 48 64 80 64 48 80
Wages & Salaries 9 8 10 10 9 9

Interest on Debn 3 - - 3 3 -
Tax Payment
60 72 90 82 57 89

84 36 (2) 18 55 11

C. Surplus (Defict)[A-B]
D. Investment/Financing
Temp. Investments After
keeping minimum

Cash balance of Rs 20,000 (64) (16) - - (35) -

Realisation of temporary
E. Investments to maintain

Cash balance of Rs 20,000 - - 22 2 - 9

F. Closing Cash Balance (C+D+E) 20 20 20 20 20 20

Working Notes:
i) Schedule of Collections from debtors : (Rs. "000")

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Particulars Feb Mar Apr May June July Aug Sept

Total Sales 120 140 80 60 80 100 80 60
Credit Sales(80% of total
sales) 96 112 64 48 64 80 64 48
Collection:
One month(75%) 72 84 48 36 48 60 48
Two month (25%) 24 28 16 12 16 20
Total Collections 108 76 52 60 75 68

(ii) Schedule of Payments to Trade Creditors: (Rs. "000")

Jun
Particulars Apr May e July Aug Sept Oct
A. Total Sales 80 60 80 100 80 60 100
B. Purchasing being 80%of
sales of next month 48 64 80 64 48 80

Question No. 2
From the following information relating to a departmental store, you are required to prepared for
the three months ending 31st March, 2015:-
Month wise cash budget on receipts and payments basis and

It is anticipated that the working capital at 1st January, 2015 will be as follows:
Rs. In’000’
Cash in hand and at bank 545
Short term investments 300
Debtors 2,570
Stock 1,300
Trade creditors 2,110
Other creditors 200
Dividends Payable 485
Tax due 320
Plant 800
Budgeted profit statement:
Rs. In’000’
January February March
Sales 2,100 1,800 1,700
Cost of sales 1.635 1,405 1,330

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Gross profit 465 395 370

Administrative, Selling and 315 270 255
Distribution expenses
Net profit before tax 150 125 115

Budgeted balances at the end of each month:

Rs. In’000’
31st Jan. 29th Feb. 31st March
Short term investment 700 - 200
Debtors 2,600 2,500 2,350
Stock 1,200 1,100 1,000
Trade creditors 2,000 1,950 1,900
Other creditors 200 200 200
Dividends payable 485 - -
Tax due 320 320 320
Plant (depreciation ignore) 800 1,600 1,550

Depreciation amount to Rs. 60,000 is included in the budgeted expenditure for each month.

(ii) Managing the cash flow:

Accelerating cash collections:

A firm can conserve cash and reduce its requirements for cash balances if it can speed up
its cash collections by issuing invoices quickly and taking other necessary steps for cash
collection. It can be accelerated by reducing the time lag between a customer pays bill and
the cheque is collected and funds became available for the firm’s uses. A firm can
decentralized collection system known as concentration banking and lock box system to
speed up cash collection and reduce float time.
a) Concentration banking:
 In concentration banking the company establishes a number of strategic
collection centers in different regions instead of a single collection center at the
head office.
 This system reduces the period between the times a customer mails in his
cheques and the time when they-became spendable funds with the company.
 Payment received by the different collection centers are deposited with their
respective local banks which in turn transfer all surplus funds to the
concentration bank of head office.

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 The concentration bank with which the company has its major bank account is
generally located at the headquarters concentration banking is one important.
b) Lock Box System:
 While concentration banking, cheques are received by a collection centre and deposited
in the bank processing. The purpose of lock box system is to eliminate the time between
the receipts of remittances by the company and deposited in the bank.
 A lock box arrangement usually is on regional basis which a company chooses according
to its billing patterns.

 Under this arrangement, to the company rents the local post-office box and authorizes its
bank at each of the location to pick up remittances in the boxes customers are billed with
instruction to mail their remittances in the boxes.

 The bank picks up the mail and deposits the cheque in the company’s account.

 The cheques cleared after collection.

 The company receives a deposit slip and lists all payments together with any other
materials in the envelope.

 This procedure frees the company from handling and deposited with banks sooner and
become collected funds sooner than if they were processed by the company prior deposit.
In other words lag between the time cheques are received by the company and they are
actually deposited in the bank is eliminated.

 The bank provides a number of services in addition to usual clearing of cheques and
requires compensation for them. Since the cost is almost directly proportional to the
number of cheques deposited. Lock box arrangements are usually not profitable if the
average remittance is small.

 The appropriate rule for deciding whether or not to use a lock box system or for that
matter, concentration banking is simply to compare the added cost of the most efficient
system with the marginal income that can be generated from the released funds.

 Its costs are less than income, the system is profitable, if the system is not profitable, it
is not worth undertaking.

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Different kinds of float with reference to management of cash:

The term float is used to refer to the periods that affect cash as it moves through the different
stages of the collection process. Four kinds of float with reference to management of cash are:
 Billing float: The time between the sales and the mailing of invoice is the billing float.
 Mail Float: This is the time when a cheque is being processed by post office, messenger
service or other means of delivery.
 Cheque processing float: This is the time required for the seller to sort, record and deposit
the cheque after it has been received by the company.
 Banking processing float: This is the time from the deposit of the cheque to the crediting
of fund in the sellers account.

II) Controlling Payments: A firm can increase its net float by speeding up collections. It can
also increase the net float by delayed disbursements of funds from the bank by increasing the
mail time. A company may make payment to its outstation suppliers by a cheque and send it
through mail. The delay in transit and collection of the cheque, will be used to increase the
float.

Question No. 3
National Inc. has grown from a small Regional firm with customers concentrated in Kathmandu
to a large, national wide firm serving customers through out the country. It has however, kept
its central billing system in Regional. On average, 5 days elapse from the time customers mail
payments until National is able to receive, process and deposit them. To shorten the collection
period, National is considering the installation of a lock box system consisting of 30 local
depository banks or lockbox operators and 8 regional concentration banks. The fixed cost of the
operating system are estimated to be Rs. 14,000 per month. Under this system, customer’s checks
would be received by the lock box operator 1-day after they are mailed, and daily collections
should average Rs. 30,000 at each location. The collection would be transferred daily to the
regional concentration banks. One transfer mechanism involves having the local depository banks
use “mail depository transfer checks, ‘or DTCs, to move the funds to the concentration banks;
the alternative would be to use electronic (wire) transfers. A DTC would cost only Rs. 0.75, but it
would take 2 days before funds were in the concentration bank and thus available to national.
Therefore, float time under the DTC system would be 1 day for mail plus 2 days for transfers or
3 days total, down from 5 days. A wire transfer would cost Rs. 11, but funds would be available
immediately, so float time would be only 1 day. If National’s opportunity cost is 11 percent, should
it initiate the lockbox system? If so, which transfer method should be used? (Assume that there
are 52x5=260 working days in a year)

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Question No. 4
Star Ltd. is a manufacturer of various electronic gadgets. The annual turnover for the year
2075/76 was Rs. 73 million. The company has a wide network of sales outlets all over the country.
All sales are for credit and are spread evenly throughout the year. All invoicing of credit sales is
carried out at the head office in Kathmandu. Sales documentation is sent by post, daily from each
location to the head office. Delays in preparing and dispatching invoices have come to the notice
of management.

An analysis of the delay in invoicing, being the interval between the date of sale and the date of
dispatch of the invoice, indicated the following pattern:
No. of days of delay in invoicing 3 4 5 6
% of weeks’ sales 20 10 40 30
A further analysis indicated that the debtors take on an average 36 days of credit before
paying. This period is measured from the day of dispatch of the invoice rather than the date
of sale.
It is proposed to hire an agency for undertaking the invoicing work at various locations. The
agency has assured that the maximum delay would be reduced to three days under the
following pattern:
No. of days of delay in invoicing 0 1 3
% of week’s sales 40 40 20
The agency has also offered, additionally, to monitor the collections which will reduce the
credit period to 30 days. Star Ltd. expects to save Rs. 4,000 per month in postage costs. All
working funds are borrowed from a local bank at simple interest rate of 20 % p.a.
The agency has quoted a fee of Rs. 200,000 p.a. for the invoicing work and Rs. 250,000 p.a.
for monitoring collections and is willing to offer a discount of Rs. 50,000 provided both the
works are given.
Required:
Advise Star Ltd. about the acceptance of agency’s proposal.
(December 2019, 7 Marks)

Solution:
Average Annual Sales (Rs in Million) 73
Number of Days in a Year 365
Average Daily Sales (Rs.) (73,000,000÷365) 200,000

Invoicing Function:
Average Days delay in Invoicing (Days) 4.8
(3*0.20+4*0.10+5*0.40+6*0.30)
Average Delay after Agency's Service (Days) 1
(0*0.40+1*0.40+3*0.20)

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Annual Saving in Invoicing Days 3.8

Release of Fund (Rs.) [ 3.8 Days * Rs 200,000] 760,000
Annual Saving in Opportunity Cost [ Rs 760,000 *20%] 152,000
Additional Saving on Collection Cost (Postage) (12*Rs
4,000) 48,000
Total Gross Saving under Invoicing Function (Rs) 200,000

Collection Function:
Annual Saving in Collection Days (36 Days - 30 Days) 6
Release of Fund (Rs.) [ 6 Days * Rs 200,000] 1,200,000
Annual Saving in Opportunity Cost [ Rs 1,200,000*20%] 240,000

Analysis of Offer of Agency

Work Saving (Rs) Cost of Decision
Agency (Rs)
Invoicing 200,000 200,000 Indifference
Collection 240,000 250,000 Reject
440,000 450,000
Discount (50,000)
Total Work 440,000 400,000 Accept

Question No. 7
ABC Ltd. operates four restaurants in Eastern and Western Region of Nepal. The manager of each
restaurant transfers funds daily from the local bank to the company’s principal bank in Kathmandu.
There are approximately 250 business days during a year in which transfers occur. Several methods
of transfer are available. A wire transfer results in immediate availability of funds, but the local
banks charge Rs. 5 per wire transfer. A transfer through an automatic clearing house involves next-
day settlement, or a 1-day delay, and costs Rs. 3 per transfer. Finally, a mail-based depository
transfer cheque arrangement costs Rs. 0.30 per transfer, and mailing times result in a 3-day delay
on average for the transfer to occur. This experience is the same for each restaurant. The company
presently uses depository transfer checks for all transfers. The restaurants have the following daily
average remittance:

Restaurant 1 Restaurant 2 Restaurant 3 Restaurant 4

Rs. 3,000 Rs. 4,600 Rs. 2,700 Rs. 5,200

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Required: (4+4=8 Marks)

i) If the opportunity cost of funds is 10 percent, which transfer procedure should be used for each
of the restaurants?
ii) If the opportunity cost of funds were 5 percent, what would be the optimal strategy?
[December 2018]
Answer:
i) If the opportunity cost of fund is 10%
Restaurant
1 2 3 4
Option I - Wire Transfer
Annual Transfer Cost [ 250 Transfer × Rs. 5] 1,250 1,250 1,250 1,250
Cost of Fund Blocked - - - -
Total Cost under Wire Transfer 1,250 1,250 1,250 1,250
Option II - Automated Clearing House [ ACH]
Annual Transfer Cost [ 250 Transfer × Rs. 3] 750 750 750 750
Cost of Fund Blocked (Avg. remittance × 10% 300 460 270 520
Total Cost under ACH 1,050 1,210 1,020 1,270
Option III - Mail Based Transfer Cheque
Annual Transfer Cost [ 250 Transfer × Rs. 0.3] 75 75 75 75
Cost of Fund Blocked (Avg. remittance×3×10%) 900 1380 810 1560
Total Cost Under Mail based transfer system 975 1,455 885 1,635
Option Option Option Option
Preferred Transfer Method for each Restaurant III II III I

ii) If the opportunity cost of fund is 5%

Restaurant
1 2 3 4
Option I - Wire Transfer
Annual Transfer Cost [ 250 Transfer × Rs 5] 1,250 1,250 1,250 1,250

Cost of Fund Blocked - -

- -
Total Cost under Wire Transfer 1,250 1,250 1,250 1,250
Option II - Automated Clearing House [ ACH]
Annual Transfer Cost [ 250 Transfer × Rs 3] 750 750 750 750
Cost of Fund Blocked (Avg. remittance × 5%) 150 230 135 260
Total Cost under ACH
900 980 885 1,010

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Option III - Mail Based Transfer Cheque

Annual Transfer Cost [ 250 Transfer × Rs 0.3]
75 75 75 75

Cost of Fund Blocked (Avg. remittance ×3×5%) 450 690 405 780

Total Cost Under Mail based transfer system

525 765 480 855

Preferred Transfer Method for each Restaurant Option Option Option Option
III III III III

Determining the Optimum Cash Balance:

CASH MANAGEMENT MODELS

 Inventory type model

 Stochastic models.

Willian J. Baumol’s Economic Order Quantity Model:

According to the model, optimum cash level is that level of cash where the carrying costs and
transactions costs are the minimum. The carrying costs refers to the cost of holding cash, namely,
the interest foregone on marketable securities. The transaction costs refers to the cost involved
in getting the marketable securities converted into cash. This happens when the firm falls short
of cash and has to sell the securities resulting in clerical, brokerage, registration and other costs.
The optimum cash balance according to this model will be that point where these two costs are
minimum. The formula for determining optimum cash balance is:

C= √2UP/S

Total Cost =No. of transactions X cost per transaction + Optimal cash balance/2 X S

Where,
C= Optimum cash balance
U= Annual ( or monthly) cash disbursement
P= Fixed cost per transaction
S= opportunity cost of one rupee p.a ( or p.m)

The model is based on the following assumptions:

i) Cash needs of the firm are known with certainty
ii) The cash is used uniformly over a period of time and it is also known with certainty

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iii) The holding cost is known and it is constant

iv) The transaction cost also remains constant

Question No. 5
A firm maintains a separate account for cash disbursement. Total disbursement are Rs. 1,05,000
per month or Rs. 12,60,000 per year. Administrative and transaction cost of transferring cash to
disbursement account is Rs. 20 per transfer. Marketable securities yield is 8% per annum.
Determine the optimum cash balance according to William J. Baumol model.

Question No. 6
Precious Metal Company needs to make Rs.800000 cash payments for next month. The annual
yield available on marketable securities is 6.5%. The Company’s fixed cost per transaction is
Rs.85.
a) What is the optimal cash conversion size for the company?
b) What is the total cost of holding cash during the coming month?
c) Assuming a 30 days month, how often the company will have to make conversion?

Miler-orr Cash Management Model:

According to this model the net cash flow is completely stochastic. When changes in cash balance
occur randomly the application of control theory serves a useful purpose. The Miller-orr model is
one of such control limit models. This model is designed to determine the time and size of
transfers between an investment account and cash account. In this model control limits are set
for cash balances. These limits may consist of u as upper limit, z as the return point; and L as the
lower point. When the cash balance reaches the upper limit, the transfer of cash equal to u-z is
invested marketable securities account to cash account is made. During the period when cash
balance stays between (u,z) and (z,L) i.e. high and low limits no transactions between cash and
marketable securities account is made. The high and low limits of cash balance are set up on the
basis of fixed cost associated with the securities transactions, the opportunity cost of holding cash
and the degree of likely fluctuations in cash balances. These limits satisfy the demands for cash
at the lowest possible total costs.

Question No. 12
The Seito Company has estimated that the standard deviation of its daily cash flows is Rs. 2500.
The firm pays Rs. 50 in transaction costs to transfer funds into and out of commercial paper that
pays 7.465 percent annual interest. The firm uses the Miller-orr Model to set its target cash
balance. Additionally, the firm has decided to maintain Rs. 10,000 minimum cash balance(Lower
limit).

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a) What is the firm’s target cash balance?

b) What are the upper and lower limits?
c) What are the Seito’s decision rules?
d) What is the firm’s expected average cash balance?

**** *

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