Cash Management

1. Cash Management

2. Cash • Cash is one of the current asset • It is needed at all times in the business • Business should always keep sufficient cash for meeting its obligations. • Cash is the most unproductive of all the assets. The cash in hand will not add anything to the concern.

3. Nature of Cash • Only currency – Cash in hand and cash at bank and also includes marketable securities too as part. • It does not produce goods or services • It is a medium to acquire other assets • It help the business in producing cash • There is a gap between cash inflows and cash out flows.

4. Motives for maintaining cash • Transaction motive • Precautionary motive • Speculative motive • Compensating motive

5. Transaction motive • To meet routine cash requirements to finance transaction in the ordinary course of business • To balance current receipts and disbursement • Example: Cash payment for purchasing, operating expenses, financial charges

6. Precautionary motive • Defensive in nature • Holding cash/near-cash as a cushion to meet unexpected contingencies/demand for cash • Floods, strikes and failure of important customers • Earlier settlement of bills • Unexpected slow down in collection of accounts receivable • Cancellation of some orders • Sharp increase in cost of row materials

7. Speculative Motive • Holding cash/near-cash to quickly take advantage of opportunities typically outside the normal course of business • Positive and aggressive approach • Examples- • An opportunity to purchase raw materials • A chance to speculate on interest rate movements • Make purchase at favorable prices

8. Compensating motive • Holding cash/near-cash to compensate banks for providing certain services or loans • Example: compensation balances- • An absolute minimum • A minimum average balance

9. Objectives of cash management • To meet cash disbursement needs (payment schedule) • To minimize funds committed to cash management

10. Factors determining cash needs • Synchronization of cash flows • Short cost • Excess cash balance • Procurement and management • Uncertainty

11. Strategies require for effective Cash Management • Cash Planning – A technique to plan and control. A projected cash flow statement will help to determine the possible uses of cash.

12. Cash Forecasting and Budgeting – It is a technique or device for the control of receipts and payments of cash. It is an analysis of flow cash in a business over a future, short or long period of time. It is a forecast of expected cash intake and outlay. Long term and short term forecasts may be made with the help of the following methods. • Receipts and disbursements method • Adjusted net income method

13. Managing cash flows: Cash management will be successful only if cash collections are accelerated and cash disbursements as far as possible delayed. The following methods of cash management will help.

14. Methods of accelerating cash inflows • Make the customers to pay promptly • Convert the payments which is in the form of Cheques or DD into cash quickly • Big firms operating in different areas can have collection centers in those area (Decentralized collections) • Lock Box system – firm hires post box from post office and the parties are asked to send the Cheques to that post box number.

15. Methods of slowing cash outflows: • Delaying the payments till last date • Making payments through drafts • Adjusting the payroll funds by making the weekly payment in to month etc. • Cheques shall be issued from the main office then it will take time for the Cheques to be cleared through post. • Inter – bank transfers shall be made to make efficient use of cash

16. Determining Optimum Cash Balance • The two approaches to determine the optimum cash balance are i. Minimizing Cost models ii. Preparing Cash budget • Cash budget is the most important tool for cash management.

17. Determining cash need • Minimizing cost cash model • Cash budget model • Baumol model • Miller-orr model • Orgler’s model

18. Baumol model • Provides for cost-efficient transactional balances • Assumes that the demand for cash can be predicted with certainty • Determines the optimal conversation size/lot • Total cost associated with cash management has two elements- • Cost of converting marketable securities into cash • The lost opportunity cost Total conversion cost per period= Tb/C T- total transaction cash needs for the period b- cost per conversion C- value of marketable securities sold at each conversion

19. It is used in inventory management but has its application in determining the optimal cash balance also. It involves trade off between opportunity cost or cost of borrowing or holding cash and the transaction cost. The optimal cash balance is reached at appoint where the total cost is the minimum. The figure shows the optimum cash balance.

20. Opportunity/holding costs costs Transaction costs Optimum cash balance Total cost

21. Baumol’s Model Assumptions • The cash needs of the firm are known with certainty • The cash disbursements of the firm occurs uniformly over a period of time and is known with certainty • The opportunity cost of holding cash is known ad it remains constant • The transaction cost of converting securities into cash is known and remains constant. • C =  2AF/O • C = Optimum balance • A = Annual or monthly cash disbursements • F = Fixed cost per transaction • O = Opportunity cost of holding cash

22. Miller and Daniel Orr model • Provides for cost-efficient transactional balances • Assumes uncertain cash flows • Determines an upper limit and return point for cash balances (optimum cash balance level) C= bE (N)/t + iE (M) b- the fixed cost per conversion E(N)- the expected numbers of conversions t- the number of days in the period i- the lost opportunity cost E(M)- the expected average daily cash balance C- total cash management costs

23. Orgler’s model • Provides for integration of cash management with production and other aspects of the firm • Comprises three sections- • Selection of appropriate planning horizon • Selection of appropriate decision variables • Payment schedule • Short-term financing • Transaction of marketable securities • Cash balance • Formulation of cash management strategy itself

24. Case budget: management tool “Cash budget is a statement of the inflows and outflows of cash that is used to estimate its short-term requirements” • Identifies the excess or shortage of cash • It pinpoints the period/ds • Assists in drawing capital financial plan • Helps in saving from cash crunch Elements/preparation of cash budget- • Planning horizon • Selection of factors: • Operating cash flows • Financing cash flows Cash receipts Cash disbursements

25. Cash management: basic strategies • Cash cycle • Cash turnover • Minimum operating cash • Stretching accounts payable • Efficient inventory-production management • Speedy collection of accounts receivable • Combined cash management strategies

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