Krizza A.

Dalisay

BSA-3

1.) What role do cash balances play in the firm's operation?

Companies need to hold cash for a variety of reasons including handling the firm's transactions,

maintaining compensating balances, serving as a contingency reserve, and being available for

potential investment or speculative opportunities.

Firms need daily cash balances to conduct their business transactions. These balances are used

to meet cash outflow requirements for operational or financial obligations and to serve as

temorary depositories for cash inflows from sales customers.

Usually, firm's cash balances are held by commercial banks. These banks provide the conduit for

collecting and disbursing cash and can also be a source of short-term financing which can be

very favorable to the firm. Nevertheless, commercial banks charge for their services and also

receives an indirect fee through compensating balances. Compensating balances are the

amount of cash the amount the banks require the firm to leave in its checking accounts. They

give banks additional compensation because they can be used to satisfy reserve requirements.

Most firms hold extra cash to handle unexpected problems or contingencies. To what extent this

extra cashust be depends on the predictability of the cash flows which, sometimes, the firm

can't accurately do so some end up holding more cash as precautionary reserves. Such amount

of cash are not actually part of the firm's normal operations so usually firms invest such
reserves to marketable securities to be useful and beneficial while it is is being unused as just a

reserve.

Opportunities may arise and the same may lead to the whole success of the firm or if not,

would greatly help the firm in its current operation, should such opportunities arise, the firm

gets prepared by means of allowing excess cash reserves to flow for potential investments and

speculations.
2.) How do managers manage cash?

The cash collection and disbursement processes provide a firm two areas in which it can

economize on cash holdings. Cash collection and disbursement policies are designed to reduce a

firms liquid asset balances (cash and marketable securities) by exploiting imperfections in the

collection and payment process. The objective is to speed up collections and slow down

disbursements. Financial managers should be aware that policies designed to speed up

collections and slow down disbursements are highly competitive. If all firms were to employ the

same procedures, the net benefit would be zero.Thus, incremental benefits associated with

procedures designed to control collections and disbursements will accrue only to the most

aggressive and progressive firms. Similarly, cash managers who do not do at least as much as

the average firm in speeding up collections and slowing disbursements will find their firms at a

competitive disadvantage.

In speeding up cash receipts, managers tend to reduce negative float, that is, knowing first the

source(s) of float. A firms cash balance as shown on the banks books generally differs from that

shown on the firms own books. This difference is known as float and represents the net effect

of the delays in the payment of checks a firm writes and the collection of checks a firm receives.

Checks written by a firm result in disbursement, or positive, float; that is, an excess of bank net

collected balances over the balances shown on a firms books.

In contrast, collection float, or negative, float arises from the delay between the time a

customer writes a check to a supplier or other payee and the time the payee actually receives

these funds as collected balances (which are spendable). Using lockboxes, local collection,
preauthorized checks, and other modern electronic funds transfer procedures are other more

ways to speed up cash receipts of the firms. Electronic payment systems, in particular, is a

means to make the float of less importance over time.

Several ways in which a firm can slow disbursements and keep funds in the bank for longer

periods of time includes scheduling and centralizing payments. A firm should pay bills on time

not before or after they are due. Centralizing payments from disbursement accounts

maintained at a concentration bank helps minimize the amount of idle funds a firm must keep in

local field offices and divisional bank accounts.

Financial managers are confronted with legal and ethical issues as they make cash collection and

disbursement decisions. For example, a large firm, such as General Motors (GM) might be tempted to

systematically be a few days late in making payments to a small supplier.GM managers may be confident

that the small firm will not risk damaging its supply relationship with GM over payment delays of a few

days. Similarly, a cash manager may take advantage of weak control mechanisms in its banks and make

short-term investments using uncollected funds.

3.) How much cash should the firm hold?

Cash is a nonproductive asset which means it earns no return and for that reason alone the firm

should hold as little cash as possible. On the other hand, the firm must have a certain amount of

cash to function and how much cash this certain amount is becomes the dilemma. To note,

many sources have elaborated the reasons and effects of having too much cash and too little

cash being held by firms. Each have ad vantages and disadvantages on its own and none of the

two is exceptional and could be considered as optimal and safe for a firm.

According to one source, in actual practice, the level of safe money is the amount of money in

which a company can operate without sales or collection. Normally, 3 months of working capital

based on fixed costs. How much exactly that amount of money is was not specified, the

statement implies that it should be estimated. New problem arise and that is, by what means do

we estimate such amount? Where do we base?

Textbooks say that each firm has its own appropriate cash level, and companies ought to keep

just enough cash to cover their interest, expenses and capital expenditures; plus they should

hold a little bit more in case of emergencies. The current ratio and the quick ratio help investors

determine whether companies have enough coverage to meet near-term cash

requirements.Theory also holds that any extra cash over and above those levels should be

redistributed to shareholders either through dividends or share buybacks. If the company then

discovers a new investment opportunity, managers should turn to the capital markets to raise

the needed funds. Nevertheless, such theory does not answer a specific amount as well.
The closest question to answer to solve the dilemma is knowing the means of getting the

optimal level of cash balances, that is the best estimate of the level of cash the firm should hold

based on the firm's current standing and needs. Methods of knowing so is explained by some

books. To conclude, a book said: "The optimal level of cash balances is determined as the larger

of of (1) the sum of transactions and precautionary balances or (2) compensating balance

requirements." In determining the two cases, mathematical models are laid out such as the

inventory model and the Miller-orr model.

4.) What are marketable securities? How are they used by the firm?

Marketable securities are financial instruments that are very liquid and can be quickly converted

into cash at a reasonable price. The liquidity of marketable securities comes from the fact that

the maturities tend to be less than one year, and that the rates at which they can be bought or

sold have little effect on prices. Examples of marketable securities include commercial paper,

banker's acceptances, Treasury bills and other money market instruments.

Typically, firms hold cah in excess of what it requires for transactions, precautionary balances,

and compensating balances which may or may not be of use currently. Cash, as earlier said, is a

nonproductive asset and considering such excess to be invested in marketable securities may

not be idea as investment will surely yield a return which will obviously redound to the benifit

of the firm. As to what type of marketable securities should the firm invest, there are usually

three important characteristics to consider the risk, marketability and term of maturity. How

high the return on such investments are not of the most importance, what is important is to

recover the principal of the excess cash investments even though the yield or return is relatively

low.

Marketable securities may be used by the firm in engaging in its operations. Being highly liquid,

marketable securities are as good as cash so it can easily be negotiated and used in normal and

commercial transactions.
References

Financial Management textbook by

http://www.investopedia.com/articles/fundamental/03/062503.asp

http://www.investopedia.com/terms/m/marketablesecurities.asp

http://www.investinganswers.com/financial-dictionary/financial-statement-

analysis/marketable-securities-549

http://www.smith-howard.com/resources/articles/5-ways-speed-collections

https://www.wisdomjobs.com/e-university/financial-management-tutorial-289/controlling-the-

collection-and-disbursement-of-cash-6687.html