Prepared by Priyanka Gohil






The firm should evolve strategies to manage cash in the best possible way. These can be broadly summarized as: 

Cash planning: Cash flows should be appropriately planned to avoid excessive or shortage of cash. Cash budgets can be prepared to aid this activity.  Managing cash flows: The flow of cash should be properly managed. Steps to speed up cash collection and inflows should be implemented while cash outflows should be slowed down. 

Optimum cash level: The firm should decide on the appropriate level of cash balance. Balance should be struck between excess cash and cash deficient stage.  Investing surplus cash: The surplus cash should be properly invested to earn profits. Many investment avenues to invest surplus cash are available in the market such as, bank short term deposits, T-Bills, inter corporate lending etc.

MOTIVES OF HOLDING CASH  There are four motives of holding cash. They are: 1) Transaction motive: 

This refers to a firm holding cash to meet its routine expenses which are incurred in the ordinary course of business. A firm will need finances to meet a plethora of payments like wages, salaries, rent, selling expenses, taxes, interests, etc. For transaction motive, a firm may invest its cash in marketable securities. Generally they purchase such securities whose maturity will coincide with payment obligations.

2) Precautionary motive:  This refers to the need to hold cash to meet some exigencies which cannot be foreseen.  The money held to meet such unforeseen fluctuations in cash flows are called precautionary balances.  Generally, such cash balances are invested in highly liquid and low risk marketable securities.

3)Speculative motive:  This relates to holding cash to take advantage of unexpected changes in business scenario which are not normal in the usual course of firm¶s dealings.  It may also result in investing in profit-backed opportunities as the firm comes across.

4) Compensating motive:  This is yet another motive to hold cash to compensate banks for providing certain services and loans. Banks provide a variety of services like cheque collection, transfer of funds through DD, MT, etc.

Objective of cash Management:

1)Meeting payments schedule: Ex. If the credit terms are say, 5\10, net 30. 2) Minimize funds committed to cash balances:

Factors for efficient cash management 

1)Prompt billing and mailing  2) collection of cheques and remittances of cash

Models for Determining Optimal Cash
1. Baumol Model 2. Miller-orr Model

1. Baumol¶s Model
The Baumol model is based on the following assumptions:

The firm is able to forecast its cash requirements in an accurate way.  The firm¶s pay-outs are uniform over a period of time.  The opportunity cost of holding cash is known and does not change with time.  The firm will incur the same transaction cost for all conversion of securities into cash.  A company will sell securities and realized cash and this is used to make payments.  As the cash balance comes down and reaches a point, the Finance Manager replenishes its cash balance by selling marketable securities available with it and this pattern continues






Optimal Cash Balance via Baumol Model
50000000 1002 504 339.3333333 258 210

C*= ˜ [2cT/k] Z* Total Costs Holding Costs:

Transaction Costs


EX. A firm¶s annual cash requirement is Rs. 20000000. The opportunity cost of capital is 15% per annum. Rs. 150 is the per transaction cost for the firm when it converts is short-term securities to cash. Find out the optimum cash balance. What is the annual cost of the demand for the optimum cash balance?

EX. Mysore Lamps Ltd. Requires Rs. 30 lakhs to meet its quarterly cash requirements. The annual return on its marketable securities which are of the tune of Rs. 30 lakhs is 20%. The conversion of the securities into cash necessitates a fixed cost of Rs. 3000 per transaction. Compute the optimum conversion amount.

2.The Miller - Orr Model

The Miller-Orr Model provides a formula for determining the optimum cash balance (Z), the point at which to sell securities to raise cash (lower limit L) and when to invest excess cash by buying securities and lowering cash holdings (upper limit H).

The Miller - Orr Model
Upper Limit Buy Securities


Lower Limit Sell Securities Days of the Month

Z= (3/4 *c


Where, c=Transaction cost 2=Cash flow variance i= Interest per day Upper control limit= lower limit + 3Z Return point= lower limit + Z Average cash balance= lower limit +4/3Z

EX. Mehta industries have a policy of maintaining Rs. 500000 minimum cash balance. The standard deviation of the company¶s daily cash flows is Rs. 2,00,000. The interest rate is 14%. The company has to spend Rs. 150 per transaction. Calculate the upper and lower limits and the return point as per MO model.

Methods of preparing cash budget:
(A) Receipts and Payments Method (B) Adjusted Earnings Method (C) Balance sheet Method (D) Working capital differential method

Cash Budget for three months from 1st Jan., 2007 to 31st March 2007.

Opening cash balance Add: Cash receipts: (1) Cash sales (2) Collection from debtors (3) Receipts from bills receivable (4) Interest and Dividend

January Rs.

February Rs.

March Rs.

(5) Sale of fixed asset (6) Receipts from loan, (7) Debentures etc. (8) Receipts from shares issued (9) Others

Total Receipts (a)

Less: Cash Payments: (1) Cash purchase (2) Payment of creditors (3) Wages and salaries (4) Administrative expenses (5)Selling expenses (6) Purchase of Fixed Asset (7)Repayment of loan (8) Payment of taxes Total Payments(b) Closing Cash Balance (a-b)

cash Budget for the period from 1st July to 31st December 2007 when the opening cash balance is expected to be Rs.. 50,000
Ex. 1 From the following data prepare



Purchases Wages

Factory expenses 12,000 14,000 10,000 13,000 14,500 11,000 9,500 10,000

Administr ative expenses 7,000 8,000 7,000 5,000 6,500 7,200 7,500 7,400

Selling expenses 8,000 9,000 8,000 8,500 8,600 9,300 7,800 6,500

May June July Aug. Sept. Oct. Nov. Dec.

2,00,000 1,80,000 2,10,000 1,70,000 1,75,000 2,20,000 2,,12,000 2,,50,000

90,000 95,000 94,000 94,000 85,000 72,000 75,000 65,000

18,000 20,,000 19,000 15,000 22,000 18,.000 21,000 20,000

Additional Information  Machinery to be purchased for Rs. 60,000 in July will be payable on delivery.  Credit period allowed by suppliers is 1 month and the same credit period is allowed to customers.  Wages are paid after one week, while Factory, Administrative and selling expenses are paid after one month in which they are incurred.  A sales commission of 2.5% on sales is paid two months after sales.  Machinery to be purchased in August for Rs. 1,80,000 is payabless in equal instalments in September and october.

Ex. 2 Modern Company wishes to arrange overdraft facilities with its bankers during the period April to June 2007 when it will be manufacturing mostly for stock. Prepare a cash budget for the above period from the following data indicating the extent of bank overdraft facilities the company will require at the end of each month.


Sales Rs.

Purchases Rs.

Wages Exp. Rs.

Mfg. Exp.. Rs.

Office Exp. Rs.

Selling Rs.

Feb. March Aapril May June July Aug.

1,80,000 1,92,000 1,08,000 1,74,000 1,,26,000 1,,40,000 1,60,000

1,24,800 1,44,000 2,43,000

12,000 14,000 11,000 12,000 15,000 17,000 18,000




4,000 3,000

1,000 1,500 2,000

4,000 2,000



5,000 4,000


5,000 5,500 6,000








Cash on hand as on 1-4-2000 (estimated) Rs. 25,000.  50% of credit sales are realised in the month following the sale and the remaining 50% in the second month. Creditors are paid in the month following the month purchase.  Lag in payment of manufacturing expenses ½ month.  Lag in payment of other expenses 1 month.

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