CASH MANAGEMENT

GOLDEN BUCKETS CORPORATION: A

CASE OF POOR CASH MANAGEMENT

Liquidity management
Cash Management

Liquidity management
- is an aspect of current asset management
that relates to the management of the optimal
quantity of liquid assets (cash, marketable
securities,
and receivables) a firm should
have on hand.
Cash Management
- an aspect of liquidity management that
relates to optimizing mechanisms for
collecting and disbursing cash.

Cash Management
- an aspect of liquidity management that
relates to optimizing mechanisms for
collecting and disbursing cash.

WHAT ARE THE GOALS OF CASH

MANAGEMENT?
1. To have cash for transactions that affect
normal operations, yet not have any excess
because idle cash does not provide income to
the firm.

WHAT ARE THE GOALS OF CASH

MANAGEMENT?
2. To minimize the amount of cash enough for
the firm to maintain a "safety stock"; meet
its compensating balance requirements;
and to allow it to take advantage of
bargains and discounts.

TARGET CASH BALANCE

In order for the firm to meet its desired cash
level, there has to be a trade-off between the
opportunity costs of holding too much cash
(the carrying costs) and the costs of holding
too little cash (the adjustment costs or shortage
costs)

TARGET CASH BALANCE

If a firm tries to keep its cash balance too low, it
will run out of cash more often than is desirable
necessitating it to sell marketable securities
more frequently. This will result to high trading
costs. As the cash balance increases, the
trading costs will decrease.
In contrast, the carrying costs of holding cash
will be low if the cash balance is low. Carrying
costs will increase as the cash balance
increases. The opportunity costs of earning
interest income on Marketable Securities will
increase because the firm is giving-up the
opportunity to earn more interests by
maintaining more cash.

Most often, news breaks about a firm's cash

position because the company is running low on
cash. That wasn't the case for oil companies in
2001. The Royal Dutch/Shell Group, for example,
was earning $1.5 million in profit per hour and had
about $12 billion in the bank. ExxonMobil has $11
billion in cash, and the industry as a whole had a
$40 billion (and growing fast) stockpile according
to analysts.
These companies certainly had
enormous cash reserves. What happens when
these companies hold such large quantities of
cash? We can learn about cash management
using the simple case presentation in the next
slides.

THE CASE OF GOLDEN BUCKETS CORPORATION

Case Background:
On January 1, 2015, Golden Buckets Corporation has a
beginning cash balance of P1.8 Million. Each week, its cash
outflows exceed its cash inflows by an average of P900,000.
As a result, the cash balance drops to zero at the end of the
2nd week. Every end of the second week, Golden Buckets
replenishes its cash by depositing P1.8 Million.
The interest rate that can be earned if cash is invested in
Marketable Securities is 5% p.a. and the net cash outflows is
the same everyday and is known with certainty.
The cost per trading is P1,200.

GOLDEN BUCKETS' PRESENT CASH

MANAGEMENT STRATEGY:
To maintain a cash balance of P1.8 Million by
selling its Marketable Securities and
depositing to the bank the cash proceeds
from the sale in the amount of P1.8 Million
everytime its cash balance reaches zero.

THE CASE OF GOLDEN BUCKETS CORPORATION

Problem:
How can Golden Buckets
minimize the cost of maintaining
its cash and how much should be
the optimum cash balance that
Golden Buckets must maintain in
order to minimize its carrying
costs and opportunity costs?

CASE SOLUTION:
Using the BAT (Baumol-Allais-Tobin)
Model, a classic model for analyzing cash
management problems, we can determine
the factors affecting cash management and
solve Golden Bucket's poor cash
management problem.
FORMULA:

C* = (2TxF)/R

BAT MODEL:
Total Cost = opportunity costs + trading costs
Opportunity costs = (C/2) x R
Trading costs = (T/C) x F

where:
F = trading costs or fixed cost of making a
securities trade to replenish cash
T = total amount of new cash needed for
transaction purposes over the relevant planning
period, say one year.
R = interest rate of the marketable securities
C = cash balance

SOLUTION:
Step 1. By using different alternatives,
determine the peso value of the opportunity
cost of holding cash to determine how much
interest is forgone.
Formula: Opportunity Cost = (C/2) x R

In the previous slide, The last column

represents the interest income which
Golden Buckets could have earned as
the cash balance that it maintains
increases. The interest income that
the firm gives up because it holds
more cash instead of investing them
in Marketable Securities is called
opportunity costs.

SOLUTION:
Step 2. Determine the total trading costs for the
year by first determining how many times Golden
Buckets will trade within the year.
Formulae: T = C/2 x 52 weeks
Total Trading Costs = (T/C) x F

In the previous slide, The last column

represents the cost per trading
everytime Golden Buckets convert its
Marketable Securities into Cash. The
cost that it incurs everytime it trades
is called trading costs.

SOLUTION:
Step 3. Determine the cash balance with the
lowest total costs for the year by adding the
opportunity cost and trading costs.
Formula: Total Costs = (C/2) x R + (T/C) x F

Step 4. After determining the cash balance with

the lowest total costs for the year , determine the
exact amount of the cash balance that should be
maintained were the opportunity costs and trading
costs are equal.
FORMULA:
C*

( 2TF ) / R

C* = (2 x P42,800,000 x P1,200)/ 5%
= P1,498,800

SOLUTION:
Step 5. Check whether the cash balance that
should be maintained results to equal values in
opportunity costs and trading costs.

CONCLUSION:
1. Applying the BAT Model, we can determine the optimal cash balance
that must be maintained by the firm where the total cost of maintaining
cash is at its lowest value where the opportunity cost is equal to trading
cost.
2. The amount of cash balance that should be maintained will vary
depending on the interest rate of the Marketable Securities, the cost per
trading and the average cash balance per period.
3. In the case of Golden Buckets Corporation, the optimal cash balance
that they should maintain should be P1,498,800 where the opportunity
cost of P37,470 is equal to the trading cost of P37,470 or a total cost of
P74,940.
4. It is not enough for Golden Buckets to find a solution for determining its
optimal cash balance, but it must seek for ways where it can
prevent its cash flows to exceed its cash inflows by looking
into the effects of the other current assets to its cash flows.

Thank You

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