CASH MANAGEMENT

LEARNING OBJECTIVES
• Give the nature of cash.
• List out the motives for holding cash.
• Discuss the objectives of cash management.
• Narrate the aspects of cash management.
• Explain the factors determining cash needs.
• Give the meaning of cash budget, procedure, purpose of cash budget.
• Discuss the types of cash forecasting.
• Know the strategies for accelerating cash inflows, and slowing down
payments.
• Determine optimum cash balance.
• Explain the models of cash management.
• Identify the investment avenues for investing surplus cash.
• Analyse the performance of cash management
 Cash Management and Nature of Cash
• Cash Management: It involves in minimizing idle cash
without impairing liquidity of a firm
Nature of Cash:
• Narrow sense
• Broader sense
 Motives for holding Cash

• Transaction motive
• Precautionary motive
• Speculative motive
 Objectives of Cash Management

Objective of cash management is to maintain optimum cash

balance
1. To meet cash payment needs, and
2. To maintain minimum cash balance
 Facets of Cash Management

• Cash planning
• Cash flows management
• Determining optimum cash balance
• Investment of surplus cash
 Factors Determining Cash Need
1. Synchronisation of cash flows
2. Short costs
Cost of transaction
Cost of borrowing
Cost of determination of credit rating
Cost of loss of cash discount
Cost of penalty rates
3. Surplus cash balance costs
4. Management costs
 Cash Budget and Its Purpose
• Cash Budget: It is a statement showing the estimated cash
inflows and cash outflows over a planning period
• Purpose of cash budget
• Estimating cash requirements
– Planning short-term finance planning
– Scheduling payments, in respect of acquiring capital goods
– Planning and phasing the purchase of raw materials
– Evolving and implementing credit policies
– Checking and verifying the accuracy of long-term cash
forecasting
 Preparation of Cash Budget
1. Selection of period of budget
2. Selection of factor that has bearing on cash flows:
• Operating cash flows
• Financial cash flows
 Management of Cash Flows
A. Accelerating cash collections
– Prompt billing and cash discount
– Minimising deposit float
– Concentration banking
– Lock-box system
B. Slowing cash payments
– Paying on last date
– Centralised payments
– Paying the float
Optimum Cash Balance [Baumol Model]

Baumol Model: The cash management model that determines

optimum cash balance on the basis of EOQ concept
Assumptions
– Firm knows its cash needs with certainty
– Cash payments (disbursement) of the firm occur
uniformly over a period of time and is known with
certainty
– Opportunity cost of holding cash is known and it
remains stable over time.
– Transaction cost is known and remains stable.
 Baumol Model [contd.]

• Elements of total cost = Conversion cost + opportunity cost

(a) Conversion cost =
Cost per conversion × [Expected cash need Amount of marketable
securities]
(b) Opportunity cost =
Interest lost x [Average cash balance]
 Baumol Model [contd.]

Opportunity
Total cost Cost (Interest
Cost)

Cost

Conversion
(Transaction) cost

Cash Conversion size

Baumol Model: Optimum Cash Balance

 Baumol Model [contd.]

• Economical (optimal) Conversion lot size

ECL = √2FC ÷ O
where ECL = Economic Conversion Lot
F = Expected cash need for future period (annually query; Hy)
C = Cost per conversion
O = Opportunity cost
 Miller and Orr Model

Upper Control Limit

(UCL)
Purchase of securities

Return point (RP)

Cash (Rs.)
Sale of securities

Lower Control Limit

(LCL)

Behaviour of Cash Balance

 Miller and Orr Model [contd.]

Z
3C 2
(RP)
3  LCL
4O

Where Z = Control limit of cash balance (or) return point

C = Transaction cost
 = SD of net cash flow
LCL = Lower control limit
O = Opportunity cost or interest rate earned on marketable
security
UCL = 3RP – 2LCL
 Basis of Selecting Investment Avenues

• Safety
• Marketability
• Yield
• Maturity
 Money Market Instruments
• Units of MFs
• Treasury bills
• Certificate deposits
• Inter-corporate deposits
• Bills discounting
• Repos
• Commercial papers
• Banker’s acceptance
• Badla financing
 Analysis of Cash Management

• Size of cash
• Current ratio
• Quick ratio
• Net cash flows to current liabilities
• Coverage of current liabilities
• Cash turnover ratio