Meaning and importance of Cash
Cash includes coins, currency notes, cheques in hand and balance held in bank account. Cash is the basic input needed to keep the business running on continuous basis.

How to finance deficit (i. directing and controlling of cash. excess of estimated cash outflows over estimated cash inflows)? 3. organizing. y It provides an answer to the following basic questions: 1. How to invest surplus (i. excess of estimated cash inflows over estimated cash outflows)? .e.Meaning of Cash Management y Cash management means planning. How much to maintain cash balance? 2.e.

Cash balances held by firm . Cash flows within the firm iii. Cash inflows and outflows of the firm ii.Facets of cash management Cash management is concerned with the managing of: i.

To meet cash payment needs. To maintain minimum cash balance .Objectives of Cash Management Objectives of cash management is to maintain optimum cash balance 1. and 2.

y Precautionary motive It is the need to hold cash for contingencies y Speculative motive It relates to the holding cash for investing in profitmaking opportunities as and when they arise. .Motives for holding cash y Transaction motive It requires a firm to hold cash to conduct its business in the ordinary course.

weekly or monthly basis. y It involves: 1. 2. y It is the technique to plan and control the use of cash.Cash Planning y Cash planning is the first step in the cash management. . Cash Flow Statements and Cash Budgets are required to be prepared. y For this purpose. Estimating the timings and amount of expected cash inflows and cash outflows. y It may be done on daily. Estimating the timings and amount of cash deficit and surplus cash.

y Cash forecasting is needed to prepare the cash budgets. Generally it is prepared for a year. It may be prepare on short term or long term basis. This helps the finance manager to determine the future cash needs of the firm. weekly.Cash Budget and forecasting y Cash budget is summary of statement of all cash inflows and outflows in the projected period of time. . monthly depending upon the firm to firm. Cash budgets may be daily.

Short term cash forecasting y The important functions of short-term cash forecasts y y y To determine operating cash requirements To anticipate short-term financing To manage investment of surplus cash. . y Short-term Forecasting Methods y The receipt and disbursements (payments) method y The adjusted net income method.

The Receipt and Disbursements Method y The method is generally known as cash budgets. collections may be delayed. suffers from the following limitations: Its reliability is reduced because of the uncertainty of cash forecasts. however. y This method. For example. or unanticipated demands may cause large disbursements. . y The virtues of the receipt and payment methods are: It gives a complete picture of all the items of expected cash flows. It fails to highlight the significant movements in the working capital items. It is a sound tool of managing daily cash operations.

y The major limitation of this method is: It fails to trace cash flows. its utility in controlling daily cash operations is limited. y The benefits of the adjusted net income method are: It highlights the movements in the working capital items.The Adjusted Net Income Method y The method is sometimes called as Sources and uses approach. . It helps in anticipating a firm s financial requirements. It is tabular form of statement stating uses of cash on one side and sources of cash on other side. and thus helps to keep a control on a firm s working capital. and therefore.

Long-term cash forecasts compel each division to plan for future and to formulate projects carefully. It pinpoints the cash required to finance these projects as well as the cash to be generated by the company to support them.Long term cash forecasting The major uses of the long-term cash forecasts are: y It indicates as company s future financial needs. y It helps to improve corporate planning. especially for its working capital requirements. y It helps to evaluate proposed capital projects. .

Managing cash collections and disbursement y Accelerating Cash Collections y Decentralised Collections y Lock-box System y Controlling Disbursements y Disbursement or Payment Float .

Contd . y A decentralized collection procedure is called concentration banking. y Concentration banking is a system of operating through a number of collection centers in different regions instead of a single collection center centralized at the head office.Decentralized Collections y A large firm operating over wide geographical areas can speed up its collections by following a decentralized collection procedure.

They deposit the collected cheques in their local bank accounts. y The collection centers perform the following functions: 1. They transfer surplus funds to the concentration bank each day. 3.y The purpose of concentration banking is to minimize the gap between the mailing time from customers to the firm and the time when the funds become available for use. 2. Contd . They collect cheques from customers.

.Concentration Bank y The concentration bank is the one with which the company has its major account and is usually located at the head office.

Lock Box System y The purpose of lock box system is to eliminate the time gap between the receipt of cheque and its deposit into the bank. y The working of lock box system is as follows: 1. 3. Contd . The firm instructs its customers to mail their remittances to the lock boxes. The firm hires a local post office box at each center. 2. The firm establishes a number of collection centers considering customer s location and volume of remittances.

5.4. The bank fixes up the mail several times a day and deposits the cheques in firm s bank account. . The firm authorizes its local bank at each center to pick up their remittance from local box.

y The period during which cheques issued are expected to be presented for encashment is called float period. . company has a payment float of ` 1 lakh available for 7 days.Float y The difference between the total amount of cheques drawn and the bank balance as per bank books is called float. Example: Bank balance as per company s books ` 10 lakh Bank balance as per bank s books ` 10 lakh Issue of an outstation cheque for ` 1 lakh (expected to be presented on 8th day) Reduction in Bank balance as per company s books on issue of cheque for ` 1 lakh Thus.

Optimum Cash Balance Cash Balance under Certainty: Baumol s Model y Optimum Cash Balance under Uncertainty: The Miller Orr Model y Optimum .

Cash payments (disbursement) of the firm occur uniformly over a period of time and is known with certainty. Assumptions: Firm knows its cash needs with certainty. y y y y .Baumol s Model The cash management model that determines optimum cash balance on the basis of EOQ concept. Opportunity cost of holding cash is known and it remains stable over time. Transaction cost is known and remains stable.

divided by the cash balance. the return foregone on the marketable securities. The per transaction cost is assumed to be constant. then the total transaction cost will be: Transaction cost = c (T / C ) y The total annual cost of the demand for cash will be: Total cost = k (C / 2)  c (T / C ) y The optimum cash balance. It is an opportunity cost. that is. If the opportunity cost is k. C.Baumol s Model y The firm incurs a holding cost for keeping the cash balance.. i. T/C.e. The formula for the optimum cash balance is as follows: 2cT C* ! k . is obtained when the total cost is minimum. then the firm s holding cost for maintaining an average cash balance is as follows: Holding cost = k (C / 2) y The firm incurs a transaction cost whenever it converts its marketable securities to cash. If per transaction cost is c. T. C*. Total number of transactions during the year will be total funds requirement.

Baumol¶s Model: Optimum Cash Balance Opportunity Cost (Interest Cost) Total cost Cost Conversion (Transaction) cost Cash Conversion size .

y If the firm s cash flows fluctuate randomly and hit the upper limit. when the firm s cash flows wander and hit the lower limit. then it buys sufficient marketable securities to come back to a normal level of cash balance (the return point). .The Miller Orr Model y The MO model provides for two control limits the upper control limit and the lower control limit as well as a return point. y Similarly. it sells sufficient marketable securities to bring the cash balance back to the normal level (the return point).

) Sale of securities Lower Control Limit (LCL) Behaviour of Cash Balance .The Miller Orr Model Upper Control Limit (UCL) Purchase of securities Return point (RP) Cash (Rs.

The Miller Orr Model y The formula for determining the distance between upper and lower control limits (called Z) is as follows: ( pper Limit ± Lower Limit) = (3/ 4 × Transaction Cost × Cash Flow Variance / Interest Rate)1 / 3 pper Limit = Lower Limit + 3Z Return Point = Lower Limit + Z The net effect is that the firms hold the average the cash balance equal to: Average Cash Balance = Lower Limit + 4/3Z .

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