Cash Management

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.

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 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.
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 Motives for maintaining cash
1. Transaction motive
2. Precautionary motive
3. Speculative motive
4. Compensating motive

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

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

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

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 Compensating motive

1. Holding cash/near-cash to compensate

banks for providing certain services or
loans
2. Example: compensation balances-
i. An absolute minimum
ii. A minimum average balance

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

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 Factors determining cash needs

1. Synchronization of cash flows

2. Short cost
3. Excess cash balance
4. Procurement and management
5. Uncertainty
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 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.
• 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

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• 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.

• 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.

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• 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

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 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.

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 Determining cash need
1. Minimizing cost cash
model
2. Cash budget model
3. Baumol model
4. Miller-orr model
5. Orgler’s model

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 Baumol model
1. Provides for cost-efficient transactional balances
2. Assumes that the demand for cash can be predicted
with certainty
3. Determines the optimal conversation size/lot
4. Total cost associated with cash management has
two elements-
i. Cost of converting marketable securities into cash
ii. 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

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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.
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 Total Opportunity/hold
ing costs
costs cost

Transaction costs

Optimum cash
balance

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 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

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 Miller and Daniel Orr model
1. Provides for cost-efficient transactional balances
2. Assumes uncertain cash flows
3. 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

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 Orgler’s model
1. Provides for integration of cash management
with production and other aspects of the firm
2. Comprises three sections-
I. Selection of appropriate planning horizon
II. Selection of appropriate decision variables
i. Payment schedule
ii. Short-term financing
iii. Transaction of marketable securities
iv. Cash balance
III. Formulation of cash management strategy itself

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 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”
1. Identifies the excess or shortage of cash
2. It pinpoints the period/ds
3. Assists in drawing capital financial plan
4. 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

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Cash management: basic strategies
1. Cash cycle
2. Cash turnover
3. Minimum operating cash
a) Stretching accounts payable
b) Efficient inventory-production management
c) Speedy collection of accounts receivable
d) Combined cash management strategies

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