FINANCIAL MANAGEMENT

CASH AND MARKETABLE

SECURITIES MANAGEMENT
CHAPTER 18
1. Understand the concept of cash management.
2. Learn the objectives of cash management.
3. Identify the reasons for holding cash balances.
4. Know how to determine the target cash balance using
a. Cash Budget
b. Cash Break-even Chart
c. optimal Cash Balance
5. Understand the other factors that influence the
target cash balance.
6. Know the cash management techniques to manage
properly the cash flows of the firm.
7. Understand the objective of marketable
securities management.
8. Realize the reason for holding marketable securities.
9. Identify the factors influencing the choice of
marketable securities.
10. Learn the types of marketable securities.
 CASH
MANAGEMENT
CASH MANAGEMENT
Cash management involves
control over the receipt and
payments of cash so as to
minimize nonearning cash
balances.
 OBJECTIVES OF CASH
MANAGEMENT

A financial officer can use the following strategies in monitoring cash

balances:

• Accelerate cash inflows by optimizing mechanisms for collecting cash.

• Monitor the cash disbursement needs or payments schedule.
• Minimize the amount of idle cash or funds committed to transactions
and precautionary balances; and
• Avoid misappropriation and handling losses in the normal course of
business.
 OBJECTIVES OF CASH
MANAGEMENT

Effective cash management generally compasses proper management of

cash flows which entails among others the following:

• Improving forecasts of cash flows

• Using floats
• Synchronizing cash inflows and outflows
• Accelerating collections
• Controlling disbursements
• Obtaining additional funds when and where they are needed.
 REASONS FOR HOLDING
CASH BALANCES

• Transaction Facilitation
• Precautionary Motive
• Compliance with Creditor's
Covenant
• Investment Opportunities
 DETERMINING THE TARGET
CASH BALANCE

• Cash Budget 2. Cash Break-even 3. Optimal Cash

Chart Balance using the
a) Baumol Model
b) Miller-Orr Model
 CASH BUDGET

Cash Budget is the tool used to

present expected cash inflows and
cash ouflows.
 CASH BREAK-EVEN CHART

This chart shows the relationship

between the company's cash
needs and cash sources. It
indicates the minimum amount of
cash that should be maintained to
enable company to meet its
obligation.
ILLUSTRATION
XYZ Company manufactures plastic which it sells to other industrial users.
The monthly production capacity of the company is 1,200,000 kilos. Selling
price is P2 per kilo.

Its cash requirements have been determined as follows:

a) Fixed monthly payments amounting to P250,000 while
b) Variable cash payments are 50% of sales.

Required:
• Determine the Cash Break-even point(mathematical approach)
• Prepare a Cash Break-even Chart to project the relationship between the
company's cash needs and cash sources.
SOLUTION:
• CASH BREAK-EVEN POINT
Fixed Monthly Payments
Variable Cost
Sales
Sales
250,000
50%
100%
100%
250,000
50%

P500,000 or 250,000 kilos

SOLUTION: Figure 18-1. Cash Break-even Point

2. 1,750
Total Cash Receipts
1,500
P
E 1,250 Total Disbursement
Cash Break-even
S 1,000 Point

O
S 750
(000's)
500 Cash Variable Cost

250
Cash Fixed Cost

0
125 250 375 500 625 800 925

VOLUME (000's KILOS)

 OPTIMAL CASH BALANCE

THE BAUMOL MODEL

This model balances the opportunity cost of
holding cost against the transactions cost
associated with replenishing the account by
selling off marketable securities or by
borrowing.
SOLUTION:
The optimal cash balance can be found by using the following
variables
• CASH and equations:
BREAK-EVEN POINT

• The total costs of cash balances consist of a holding (or opportunity)

cost plus a transaction cost:

Transation Cost
Holding Cost + Transaction Cost
 Costs of Holding Cash
(P)

Total Costs of Holding Cash

Opportunity Cost

Figure 18-2. Transactions Cost

Determination of
the Target Cash
0
Balance Cash Ordered (P)

Optimal
Cash
ILLUSTRATION 1: Determination of the Target Cash Balance
To illustrate, consider a business with total payments of P10 million for one
year, cost per transaction of P100, and the interest rate on marketable
securities is 8 percent. The optimal cash balance is calculated as follows:

P158,114

Optimal average
cash balance

P79,057
 OPTIMAL CASH BALANCE

THE MILLER-ORR MODEL

This model takes a different approach to
calculating the optimal cash management
strategy. It assumes that the distributions of
daily net cash flow is normally distributed
an allows for both cash inflows and
outflows.
ILLUSTRATION II: Calculaion of Optimal Return Point and
Upper Limit for Miller-Orr Model

Suppose that ABC Inc., would like to maintain its cash account
at a minimum level of P100,000, but expects the standard
deviation in net daily cash flows to be P5,000; the effective
annual rate on marketable securities will be 8 percent per year,
and the trading cost per sale or purchase of marketable
securities will be P200 per transaction. What will be ABC"s
optimal cash return point and upper limit?
P126,101.72
 OTHER FACTORS INFLUENCE
THE TARGET CASH BALANCE
1 Options to incur short-term
borrowing to meet unexpected
demand for cash.

2 Transactions Costs and Time

Element

3 Many firms must keep certain average

minimum balances in their deposit
account as part of borrowing
agreements with their bank.
 CASH
MANAGEMENT
TECHNIQUES
1 Synchronizing Cash Flows
Situation in which inflows coincide with outflows
thereby permitting a firm to hold low transactions
balances.
2 Using Floats
Float is defined as the difference between the
balance shown in a firm's books and the balance
on the banks record.
3 Disbursement Float
Represents the value of checks the firm has
written but which are still being processed and
thus have not been deducted from the firm's
account balance by the bank.
4 Collection Float
Represents the amount of checks that have been
received but which not yet been credited to the
firm's account by the bank.
 ACCELLERATING CASH
COLLECTIONS
1 Prompt billing and periodic statements

2 Incentives such as trade and cash

discounts
3 Prompt Deposit

4 Direct deposit to firm's bank account

5 Electronic depository transfer or payment

by wire
6 Maintenance of regional collection office
 SLOWING DISBURSEMENT

1
Centralized processing of payables.
2 Zero balance accounts (ZBA)

3 Delaying Payments

4 "Play the float"

5 Less frequent payroll

 REDUCING THE NEED FOR
PRECAUTIONARY BALANCE

1
More accurate cash
budgetting
2 Lines of Credit
3 Temporary Investments
 ILLUSTRATION III: Acceleration of Cash Receipts

Abubot Fashion Designs is evaluating a special processing system as a

cash receipts acceleration device. In a typical year, this firm receives
remittances totaling P7 million by check. The firm will record and
process 4,000 checks over the same time period. First National Bank
has informed the management of Abubot Fashion Designs that it will
process checks and associated documents through the special
processing system for a unit cost of P0.25 per check. Abubot Fashion
Designs' financial manager has projected that cash freed by adoption
of the system can be invested in a portfolio of near-cash assets that
will yield an annual before-tax return of 8 percent. Abubot Fashion
Designs' financial analysts use a 365-day year in their procedures.
Required:
What reduction in check collection is necessary for Abubot Fashion Designs
a) to be neither better nor worse off for having adopted the proposed system?

How would your solution to (a) be affected if Abubot Fashion Designs could
b) invest the freed balances only at an expected annual return of 5.5 percent?

What is the logical explanation for the differences in your answers to (a)
c) and (b) above?

Solution:
a) The average check size is
The daily opportunity cost of carrying cash is

The days saved in the collection process

or
b) The daily opportunity cost of carrying cash is

For Abubot Fashion Designs to break-even, should it choose to install the

special processing system, cash collections must be accelerated by 0.9480
days, as follows:

c)
The break-even cash-acceleration period of 0.9480 days is
greater than the 0.6517 days found in (a).
 ILLUSTRATION
SOLUTION: IV: VALUING FLOAT REDUCTION
Next
• CASHyear,BREAK-EVEN
Miguel MotorsPOINT
expects its gross revenues from sales to be P80
million. The firm's treasurer has projected that its marketable securities
portfolio will earn 6.50 percent over the coming budget year. What is the
value of one day's float reduction to the company? Miguel Motors uses a
365-day year in all of its financial analysis procedures.

Solution:
Sales

The company will earn P14,247 6.5%. 7 per year if it is able to

invest its one day sales at 6.5%.
MARKETABLE
SECURITIES
MANAGEMENT
 OBJECTIVES OF MARKETBLE
SECURITIES MANAGEMENT

Realistically, the management of cash and marketable securities cannot be

separated. Management of one implies management of the other.

The firm may hold excess funds in anticipation of a cash outlay. When funds
are being held for other than immediate transaction purposes, they should
be converted from cash into interest-earning marketable securities.
Marketable securities which should be of the highest investment grade
usually consist of treasury bills, commercial paper, certification of time
deposit from commercial banks and money market notes.
 REASONS FOR HOLDING
MARKETABLE SECURITIES
1
They serve as a substitute for cash
balances.

2 They are held as a temporary

investment.

3 They are built up to meet known

financial requirement.
 FACTORS INFLUENCING THE CHOICE
OF MARKETABLE SECURITIES

1 Risks such as
• Default Risk
• Interest Rate Risk
• Inflation Risk
• Marketability(liquidity)
Risk
• Event Risk
2 Maturity

3 Yield or return on securities

 TYPES OF MARKETABLE
SECURITIES
1 Money Market Instruments
• Discount Paper
• Interest-Bearing Securities
2 Treasury Bills

3 Other Short-term Commercial

Paper Issued by Finance
Companies, Banks and Other
Corporations
 TYPES OF MARKETABLE
SECURITIES
4 Negotiable Certificates of Deposit

5 Repurchase Agreements
(REPOS)
6 Banker's Acceptance

7 Money Market Mutual Fund