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1. Importance of Cash
When planning the short or long-term
funding requirements of a business, it is
more important to forecast the likely cash
requirements than to project profitability

Bear in mind that more businesses fail

for lack of cash than for want of profit.
• Important because:
2. Liquid
3. Used for immediate payments

• Insufficient (discharging its liabilities)

• Extreme (uneconomic investments)

• Count cash in the form of currency ,

cheque, drafts, D.D s.
• Also includes marketable securities,
short term, deposits with the banks.
Motives / purposes for holding cash
1. Transaction motive

3. Precautionary motive

5. Speculative motive

7. Compensation motive
2. Cash vs Profit
Sales and costs and, therefore, profits do not
necessarily coincide with their associated cash
inflows and outflows.

The net result is that cash receipts often lag cash

payments and, whilst profits may be reported, the
business may experience a short-term cash shortfall.

 For this reason it is essential to forecast cash

flows as well as project likely profits.
Income Statement: Month 1

Sales ($000) 75

Costs ($000) 65

Profit ($000) 10

CFs relating to Month 1: Month 1 Month 2 Month 3 Total

Amount in ($000)

Receipts from sales 20 35 20 75

Payments to suppliers etc. 40 20 5 65

Net cash flow (20) 15 15 10

(20) (5) 10 10
Cumulative net cash flow
Objectives of cash management
Ensure that a firm should have right quantity and right
quality from the right sources at a right place and at a
right time.
• Meeting the cash outflows (meet the obligations):
sufficient cash to make the payments schedule and
disbursements. It will help in :
A. avoiding the chances of default.
B. availing the opportunities of getting cash discounts
by making prompt payments.
C. meeting expected cash outflows without much
• Minimizing the cash balance :
A. Idle cash balance must be reduced.
1. Cash cycle : refers to the time between the payments for purchase
for purchase of raw materials & receipts of sales revenue.
2. Cash inflows and cash outflows: Cash balance is required to fill up
the gap arising out of difference in timings & quantum of inflows and
If the inflows are appearing just at the time when cash is required for
payment, then no cash balance is required to be maintained by the
firm, but this seldom happens. Thus,
there should be synchronization between cash inflows and cash
3. Cost of cash balance: cost of maintaining excess cash balance or to
meet the shortages of cash.
4. Other considerations: uncertainties of certain trade, staff required for
cash management
Operating cycle and Cash cycle
Sell Receive
Product Cash
On credit
Pay for

Inventory conversion
Conversion period

Cash conversion
Deferral period


• Cash planning
• Cash forecasts and budgeting
Receipts and Disbursements Method Adjusted Net
Income Method (Sources and Uses of Cash)
• Managing cash flows
a. methods of accelerating cash inflows
b. method of slowing cash outflows
Methods of accelerating cash
1. Prompt payments by customers
2. Quick conversion of payment into cash
3. Decentralized collections (Concentration)
4. Lock box system
Speed up collections
Customer mailing company company cash
The cheque receives the deposits available
cheque the cheque

mailing processing availability
time delay
Cash inflows can be improved by cash collecting
2. Postal float: mailing time i.e. time taken by post
office for transferring cheque from customers
to the firm.
3. Lethargy: time taken in processing the cheque
within the organization and sending it to bank
for collection.
4. Bank float: collection time within the bank i.e.
time taken by the bank for collecting the
payment from the customer s’ bank.
Deposit float = postal + lethargy + bank
Lock box system
1. Under this system, customers are advised to mail their
payments to special post office boxes , called lock
boxes which are attending by the local collecting
banks, instead of sending them to corporate H.Q.
2. Local banks collects the cheque once or more a day
from the lock box, deposits the cheque directly into the
local bank a/c of the firm & gives the details to the firm.
3. Helps in:
A. cuts down the mailing time as the cheque
are received at a nearby P.O. instead of H.Q.
B. reduces the
processing time as the company does not have to
open the envelopes & deposits the cheque for
collection. C.
shorten the availability delay as the cheque are
typically drawn on local banks.
Cash balance shown by the firm on its books is
called book / ledger balance.
Balance shown in its bank account is called
available / collected balance.
Difference between the available balance and the
ledgers balance is referred as float

• Disbursement float: cheque issued by a firm

create disbursement float.
• Collection float : Cheque received by a firm
lead to collection float.
Collection float
• A company has a book balance as well as
available balance of Rs. 5 million as on 30th
April. On 1st may , company receives a cheque
for 1.5 million.
However, this amount is not available to a
company until its bank presents the cheque to
the customers bank’s and suppose it will
present on 5th May.
Collection Float= Available balance – Book
= 5 million – 6.5 million
Disbursement Float
• A company has a book balance as well as available
balance of Rs. 4 million with its bank , SBI, as on March
On 1st April , firm pays Rs. 1 million by cheque to one of its
supplier & reduce the book balance by Rs. 1 million.
SBI, however, will not debit the company till the cheque has
been presented for payment and it is presented on 6th
Hence between 1st April & 6th April , Disbursement float = 1
Disbursement float = firms’ available balance – firms’ book
Net Float = disbursement float + collection

Positive = available balance is greater then

the book balance
Negative = available balance is less than
the book balance
Slow down - payments
1. Paying on last date
2. Payment through drafts
3. Centralized collections
4. Making use of float (Disbursement)
Investment alternatives
1. Marketable securities
2. Treasury bills
3. Certificates of deposits
4. Commercial papers
5. Repo agreements
(Money market instruments)
• It is same as E.O.Q for the inventory

• This attempts to balance the income

foregone on cash held by the firm against
the transactions cost of converting cash
into marketable securities and vice versa.
Assumptions :
• That a firm uses cash at an already known rate
per period & this will remain constant.
Two terms:
• Holding cost: there is always a cost of holding cash by the
firm. This cost may be known as opportunity cost (interest
foregone) on the investment of this cash.
2. Transaction cost: whenever a cash is converted into
marketable securities or vice versa. (commission,
brokerage etc.)
• An optimum cash balance is found by
controlling the holding cost so as to
minimize the total cost of holding cash.

• In other words, we can say, the cash is

recovered by selling marketable securities
in such a way that the transaction cost is
optimally balanced with the holding cost of
• This model is based on the proposition that in
order to reduce the holding cost the firm should
reduce / keep the least amount of cash in hand.
• However the cash level depletes , the firm can
acquire cash by selling out some marketable
• But every time, firm transacts in this way, it
bears transaction cost (which a firm will try to do
occasionally, as possible). And this could be
done by maintaining a higher cash level
involving a high holding cost.
• Thus a firm has to deal with the holding cost as
well as transaction cost.
1. Constant rate of use of cash.
(hypothetical assumptions), the cash
outflows in any firm is not regular.
2. The transaction cost will be difficult to
measure since it depends upon the type
of investment and the maturity period.
• (In 1966) this is the extension of Baumol model which
is not applicable if the demand of cash is not steady.
• It argues that changes in cash balance over a given
period are random in size as well as in direction.
• Assumption:
4. Out of two assets i.e. cash & marketable (through later
there is a expectation of yield)
5. Transfer of cash to marketable securities & vice versa
is possible without delay. (but of course at some cost).

• sell

H: upper limit (beyond which cash level is not allowed

to go)
L: not allowed to reduce.
• If cash level reaches H, part of cash
should be invested in marketable
securities in such a way that cash balance
comes down to a predetermined level
• If the cash balance reduces below L then
sufficient marketable securities should be
sold to realize so that the cash balance is
restored at a return level R