CASH MANAGEMENT

Dr.Devendra Lodha
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 actor 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 lossed x [Average cash balance]
Baumol Model [contd.]

Opportunity Cost
Total cost (Interest Cost)

Cost

Conversion (Transaction)
cost

Cash Conversion size

Baumol Model: Optimum Cash Balance

Baumol Model [contd.]

 Economical (optimal) Conversion lot size

ECL =
2bT
I
where ECL = Economic Conversion Lot
b = Conversion Cost
I = Interest Rate Earned per planning period
T = Projected Cash Requirement
Miller and Orr Model

Upper Control Limit (UL)

Purchase of securities

Return point (RP)

Cash (Rs.)
Sale of securities

Lower Control Limit (LL)

Behaviour of Cash Balance

Miller and Orr Model [contd.]

3b 2
RP  3  LL
4I

UL  3RP  2LL
where RP = Return Point
b = Fixed cost per order for conversion of marketable securities
I = Daily Interest Rate
 2 = Variance of Daily change in expected cash balance
LL = Lower Control Limit
UL = Upper Control Limit
Analysis of Cash Management

 Size of cash
 Current ratio
 Quick ratio
 Net cash flows to current liabilities
 Coverage of current liabilities
 Cash turnover ratio
Thank You……!