CHAPTER THREE

CASH MANAGEMENT
Cash is the medium of exchange that clients will accept
in transactions related and affected in business.
It is an asset which is ready to cover immediate
obligations
The term “cash” with reference to cash management is
used in two senses. In a narrow sense, it is used to cover
currency and generally accepted equivalents of cash,
such as cheques, drafts and demand deposits in banks.
The broad view of cash includes near-cash assets, such
as marketable securities and time deposits in banks.
 
more specifically, the characteristics of cash is;
Used as a medium of exchange
Most liquid asset
Used to acquire other assets
measure/express other assets, and
Exposed for embezzlement
Cont’d
The following are some activities which are increases
or decreases the cash balance;
Activities that increase cash balance
(Cash Inflows)
Increasing long-term debt
Increasing equity (selling some stocks)
Increasing current liabilities
Decreasing current assets other than cash
Decreasing fixed assets (selling assets)
Activities that decrease cash balance (Cash Outflows)
Decreasing long-term debt
Decreasing equity
Decreasing current liabilities
Increasing current assets other than cash (buying some
inventories etc)
Increasing fixed assets (purchasing Building, Furniture
etc.,)
Cont’d
Motives for Holding Cash (Reasons for Holding Cash)
There are three primary motives (reasons) for maintaining
cash balances:
1. Transaction motives: This refers to the holding of cash
to meet routine cash requirements to finance the
transactions which a firm carries on in the ordinary course
of business.
A firm enters into a variety of transactions to accomplish its
objectives which have to be paid for in the form of cash.
For example, payments for purchases, wages, operating
expenses, financial charges like interest, taxes, dividends,
and so on.
2. Precautionary Motive: In addition to the non-coincide of
anticipated cash receipts and payments in the ordinary
course of business, a firm may have to pay cash for
purposes which cannot be predicted or anticipated.
The unexpected cash need at short notice may be result of:
Floods, strikes and failure of important customers;
Bills may be presented for settlement earlier than expected;
Unexpected slowdown in collection of accounts receivables;
Cancellation of some order for goods as the customer is not
satisfied; and Sharp increase in cost of raw materials.
The cash balances held in reserve for such random and
unforeseen fluctuations in cash flows are called as
precautionary balances.
3.Speculative Motive: It refers to the desire of a firm to
take advantage of opportunities which present themselves
at unexpected moments and which are typically outside the
normal course of business. Firms aim to exploit profitable
opportunities and keep cash in reserve to do so. It helps to
take advantage of;
 An opportunity to purchase raw materials at reduced
price on payment of immediate cash
A chance to speculate on interest rate movements by
buying securities when interest rates are expected to
decline
Benefits of Holding Adequate (Sufficient) Cash Balance
The important advantages of holding adequate cash
balances are:
It prevents insolvency or bankruptcy arising out of the
inability of a firm to meet its obligations.
The relationship with the bank is not strained (worried).
It helps in developing good relations with trade creditors
and suppliers of raw material, as prompt payment may
help their own cash management.
To take advantage of favorable business opportunities
that may be available periodically
The firm can meet unanticipated cash expenditure, such
as strikes, fires or a new marketing campaign
 Cont’d
Objectives of Cash management
Cash management should always aims to achieve the
following objectives:
Liquidity: Business units should satisfy the primary
objective of cash availability for all business needs.
Safety: Cash availability will always imposes risk of loss;
therefore the second objective of cash management is to
avoid the risk of loss, or thefts.
Profitability: the final objective of cash management is
earn a highest possible return after satisfying the above two
objectives.
 Cont’d
Factors Determining Cash Needs
The factors that determine the required cash balances are: (1)
Synchronization of cash flows, (2) Short Costs, (3) Excess
cash balance, (4) Procurement and Management and (5)
Uncertainty.
1.Synchronization of Cash flows: The need for maintaining
cash balances arises from the non-synchronization of the
inflows and outflows of cash; if the receipts and payments of
cash perfectly coincide or balance each other, there would be
no need for cash balances.
2. Short Costs: Another general factor to be considered in
determining cash needs is the cost associated with a
shortfall in cash needs. The cash forecast presented in the
cash budget would reveal periods of cash shortages.
Expenses incurred as a result of shortfall are called “Short
Cost”. Included in the short costs are: Transaction costs,
Borrowing Costs, Loss of cash discount, Penalty rates.
3. Excess Cash Balance Costs: The cost of having
excessively large cash balances is known as the Excess
Cash Balances Cost. If large funds are idle, the implication
is that the firm has missed opportunities to invest those
funds has thereby lost interest which it would otherwise
have earned. This loss of interest is primarily the “Excess
Cost”.
 Cont’d
4. Procurement and Management: These are the
costs associate with establishing and operating cash
management staff and activities. They are generally
fixed and are mainly accounted for by salary,
storage, handling of securities, and so on.
5. Uncertainty: Finally, the impact of uncertainty on
cash management strategy is also relevant as cash
flows cannot be predicted with complete accuracy.
Cont’d
DETERMINING THE OPTIMUM CASH BALANCE
As we discussed increasing cash balance, reduces
transaction cost but increased the opportunity cost,
which may reduce the profitability of the firm. That
means the liquidity objective of the firm is achieved
but profitability declines. On contrary, limited cash
balance held reduces the opportunity cost but the
transaction cost, like acquiring funds at the time of
shortage, increases. That means, profitability is
achieved but not liquidity. Therefore, the intersection
point of transaction curve with opportunity cost
curve, yields the desired optimum cash balance.
cost opportunity cost curve

transaction cost curve

c cash balance
 Cont’d
Cash Management Strategies
The basic strategies that can be employed to do the
needful are as follows:
Stretching Accounting Payables(delaying disbursement)
Efficient Inventory-Production Management
Speedy Collection of Accounts Receivables(accelerating
collection)
Stretching Accounts Payables: a firm should pay its
accounts payable as late as possible without damaging its
credit standing. It should, however, take advantage of the
cash discount available on prompt payment.
Efficient Inventory-Production Management:

Another strategy is to increase the inventory

turnover, avoiding stock units. This can be done in
the following ways:
Increasing the raw materials turnover by using
more efficient inventory control techniques.
Decreasing the production cycle through better
production planning, scheduling and control
techniques.
Increasing the finished goods turnover through
better forecasting of demand and a better planning
of production.
Cont’d
Speeding Collection of Accounts Receivable:

Yet another strategy for efficient cash management

is to collect accounts receivables as quickly as
possible without losing future sales because of
high-pressure collection techniques. The average
collection period of receivables can be reduced by
changes (i) credit terms, (ii) credit standards, and
(iii) collection policies.
 Speedy Cash Collection Techniques Slowing Disbursements Techniques

 Prompt Payment by Customers  Avoidance of Early Payments

 Early Conversion of Payments into cash  Centralized Disbursements
 Lock-Box System  Paying from Distant Bank
 Concentration Banking  Cheques-Encashment Analysis
Thank you for . . . . !!!