Unit-5 Management of Cash

Meaning of cash - motives for holding cash -

Objectives of cash - management of cash -
Basic problems - preparations of cash budgets
• "Cash, like the blood stream in the human
body, gives vitality and strength to a business
enterprises”. Though cash hold the smallest
portion of total current assets.
• However, "Cash is both the beginning and end
of working capital cycle - cash, inventories,
receivables and cash.”' it is the cash, which
keeps the business going.
• Hence, every enterprise has to hold necessary
cash for its existence.‖
• Moreover, "Steady and healthy circulation of
cash throughout the entire business
operations is the basis of business solvency."
• Cash may be interpreted under two concepts.
1. In narrow sense, "Cash is very important business
asset, but although coin and paper currency can
be inspected and handled, the major part of the
cash of most enterprises is in the form of bank
checking accounts, which represent claims to
money rather than tangible property."
2. In broader sense, "Cash consists of legal tender,
cheques, bank drafts, money orders and demand
deposits in banks.
• "The concept of cash management is not new
and it has acquired a greater significance in
the modern world of business due to change
that took place in the conduct of business and
ever increasing difficulties and the cost of
borrowing."
 MEANING AND DEFINITION:
• The term cash management refers to the
management of cash resource in such a way
that generally accepted business objectives
could be achieved.
 Cash Management:
• It is the management of cash resource in such a
way that the objectives of business could be
achieved.
• Cash helps to establish equilibrium between
profitability and liquidity and ensures
undisturbed functioning of a firm. This in turn
facilitates a firm towards attaining its business
objectives.
• The basic objectives of cash management are:
Objectives of Cash Management
• To achieve the above objectives, proper planning
and forecast of cash flows is needed which is
presented in the form of cash budget. Effective cash
management requires proper management of cash
inflows and outflows which entails:
1. Improving cash flows forecasts
2. Synchronization of cash inflows and outflows
3. Acceleration of collections
4. Getting funds available where ever they are required
5. Control of  cash disbursements
What is the difference between Money and
Near-Money?
• 1. Definition:
– Money consists of coins, currency notes and demand
deposits of the banks. Near-money, on the other hand,
includes the financial assets, like time-deposits, bills of
exchange, bond, shares, etc.
• 2. Liquidity:
– Money possesses 100 per cent liquidity; i.e., it is
perfectly liquid or can be readily acceptable as a means
of payment. Near-money lacks 100 per cent liquidity, i.e.,
it involves time cost for its conversion into money.
• 3. Function:
– Money serves as a unit of account or a common measure
of value. All prices are expressed in terms of money. Near-
money on the other hand, does not perform such
functions. Rather, its own value is expressed in terms of
money.
• 4. Use in Transactions:
– Money is directly used for making transactions. Near-
money, on the other hand, is an indirect medium of
exchange; it has to be first converted into ready money
and then used for transactions.
• 5. Income-Yielding Quality:
– Money is not an income-yielding asset. On the
contrary, near-money assets are income yielding
assets.
 Motives for Holding Cash:
• Though cash as an asset, does not earn any
return for the business. It is the most liquid
financial asset.
• It is a non interest earning financial asset. But
cash should be held by every firm to meet its
routine expenditures.
• According to John Maynard Keynes, a renowned
economist, the motives of holding cash are as
follows:
 1. Transactions Motive:
• Cash is needed to meet day-to-day cash needs
in the routine course of business.
• An enterprise needs cash on day–to-day basis
for making payment for the purchase of raw
materials, components, payment of wages to
the labour, salaries to staff, taxes to the
government, interest on loans, etc. Without
cash, a firm cannot operate. All general
operating expenses are paid in cash.
• A firm receives cash from cash sales, collections from
debtors, return on investments etc. But there is not
perfect synchronization between cash inflows and
outflows.
• It means, cash inflows may not always be equal to inflows.
• At times, cash payments might be more than receipts
while at other times receipts may exceed payments.
• To ensure that the firm can meet its obligations when
payments become due at times when the disbursements
are in excess of the current receipts, it must have an
adequate cash balance. This requirement of cash balances
to meet routine cash needs is known as the transaction
motive.
 2. Precautionary Motive:
• Cash held to meet the unforeseen and unexpected
situations like strikes, lock outs, sudden increase in
the cost of raw materials etc. is known as
precautionary motive for holding cash.
• One can never be 100% sure about the future. It is
not possible to predict everything about the future in
advance.
• Thus, cash balance over and above what is required
is always held by the firm to meet any unforeseen
contingencies and to avoid breakdown of production.
• The amount of cash balance under precautionary motive
is influenced by two factors -
– a. Availability of Short Term Credit - If the firm cannot borrow
required cash balances at a short-notice, it will need
comparatively greater cash balances to meet contingencies
 and unforeseen situations or vice versa.
– b. Predictability of Cash Flows - The more predictable the cash
flow, the lesser the need for such cash balances and vice versa.
• Precautionary cash balances are generally invested in
marketable securities with the objective of earning
profits.
 3. Speculative Motive:
• Firms would hold cash to exploit the potential
profitable opportunities as and when they
arise. This motive of holding cash is known as
speculative motive.
• For example, the firm might expect that the
price of a certain material or a component to
fall in the future, then, the firm can delay the
purchases and make purchases in future when
the price actually declines.
• A firm might expect the prices to rise, and then
the firm would like to grab that opportunity to
purchase the material at a heavy discount, if
paid in cash immediately. 
• Similarly, in the hope of buying securities when
the interest rate is expected to decline, the
firm will hold cash. By and large, firms rarely
holds large amount of cash for speculative
purposes.
 4. Compensation Motive:
• Customers are required to maintain a minimum
cash balance at the bank. This balance cannot be
used by the customers for transaction purposes.
• This minimum cash balance may vary from Rs 1,000
to Rs 10,000. This amount remains as a permanent
balance with the bank as long as the current
account is operative.
• Cash balances are held by the firms to compensate
banks for providing certain services and loans.