CASH

MANAGEMEN
T
 WHAT IS CASH?

• In narrow sense: currency and generally accepted

equivalents of cash like cheques, drafts etc.
• In broad sense: includes near-cash assets, such as
marketable securities and time deposits in banks.
– They can be readily sold and converted into cash.
– Can serve as a reserve pool of liquidity.
– Also provide short term investment outlet for excess cash.
 Cash management

• Cash management is concerned with the managing

of:
– cash flows into and out of the firm,
– cash flows within the firm, and
– cash balances held by the firm at a point of time by
financing deficit or investing surplus cash
 Objectives of cash management

• Meeting payments schedule

– It prevents insolvency
– Relationship with bank is not constrained
– Helps in fostering good relationships
– Cash discount can be availed
– Strong credit rating
– Take advantage of business opportunities
– Can meet unanticipated cash expenditure with a minimum of strain.

• Minimizing funds committed to cash balances

– High level of cash: large funds remain idle
– Low level of cash: failure to meet payment schedule
 Four Facets of Cash Management

• Cash planning
• Managing the cash flows
• Optimum cash level
• Investing surplus cash
 Motives for holding cash

• Transaction motive
• Precautionary motive
• Speculative motive
• compensating motive
 Transaction motive

• Holding of cash to meet routine cash

requirements to finance the transactions which
a firm carries on in the ordinary course of
business.
 Precautionary motive

• The cash balances held in reserve for random and

unforeseen fluctuations in cash flows.
• A cushion to meet unexpected contingencies.
– Floods, strikes and failure of important customers
– Unexpected slowdown in collection of accounts receivable
– Sharp increase in cost of raw materials
– Cancellation of some order of goods

• Defensive in nature
 Speculative motive
• Is a motive for holding cash/near-cash to quickly
take advantage of opportunities typically outside
the normal course of business.
• Positive and aggressive approach
• Helps to take advantage of:
– An opportunity to purchase raw materials at reduced
price
– Make purchase at favorable prices
– Delay purchase on anticipation of decline in prices
– Buying securities when interest rate is expected to
decline
 Compensating motive

• Is a motive for holding cash/near-cash to

compensate banks for providing certain services
or loans.
• Clients are supposed to maintain a minimum
balance of cash at the bank which they cannot use
themselves.
 Cash Management Models

1.
Example - 1
 Example - 2
• M/s.Modi chemials Limited(Surat) estimates its total cash requirement as Rs.4 crore next year.
The company’s opportunity cost of funds is 15% per annum. The company will have to incur
Rs.300 per transaction when it converts its short-term securities to cash. Determine the
optimum cash balance. How much is the total annual cost of the demand for the optimum
cash balance? How many deposits will have to be made during the year?
Solution:-

OPTIMUM CASH BALANCE “C” = =

2PU/S (2*300*4,00,00,000/0.15)

C =Rs.4,00,000
Hence , Annual cost or Total Cost = Holding cost + Transaction cost
a)Holding cost = S*U/2
= 0.15* 4,00,000/2 = 30,000
b)Transaction cost = P*U/C
= 300 * 4,00,00,000/4,00,000 = 30,000
c)TOTAL COST = 30,000+30,000 = Rs. 60,000
NUMBER OF DEPOSITS TO BE MADE IN A YEAR = U/C
= 4,00,00,000/4,00,000 = 100
2.
 Formulae
• (Upper limit- Lower Limit)=( 3/4 x transaction cost X variance of cash flows )1/3
interest rate

Symbolically (Z)= ( 3/4 x cσ²) 1/3 / i

• Upper Limit= Lower Limit + 3Z
• Return Point= Lower Limit + Z
• Average Cash Balance = Lower Limit + 4/3 Z
 Example
• ABC Company has a policy of maintaining cash balance of Rs. 5,00,000.
The variance of company’s daily cash flow is Rs 2,00,000. The Annual
Interest Rate is 14%. Transaction cost of buying or selling is Rs. 150 per
transaction.
Solution:-

(Z)= ( 3/4 x 150x2,00,000²) 1/3 = Rs 2,27,227

.14/365

Upper limit =Lower limit +3Z=5,00,000+3(2,27,227)= Rs 11,81,680

Return Point=Lower limit +Z=5,00,000+2,27,227= Rs 7,27,227

Avg. Cash Balance =Lower limit +4/3Z

=5,00,000+4/3(2,27,227)= Rs 802,969
Factors determining Cash Management
• Synchronization of cash flows
• Short costs
– Transaction costs
– Borrowing costs
– Loss of cash discounts
– Cost associated with deterioration of the credit rating
– Penalty rates
• Excess cash balances costs
• Procurement and management
• Uncertainty and cash management
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