CASH

MANAGEMENT
Prabhjot Singh Longia
Prince Kaushal
Puneet Walia
Shubhpreet Kaur

LMTSOM THAPAR UNIVERSITY

 WHAT IS CASH?
• In narrow sense: currency and generally
accepted equivalents of cash like cheques,
drafts etc.
• In broad sense: includes near-cash
assets, such as marketable securities and
time deposits in banks.
– They can be readily sold and converted into
cash.
– Can serve as a reserve pool of liquidity.
– Also provide short term investment outlet for
excess cash.
 Cash management
• Cash management is concerned with the
managing of:
– cash flows into and out of the firm,
– cash flows within the firm, and
– cash balances held by the firm at a point of
time by financing deficit or investing surplus
cash
 Four Facets of Cash Management

• Cash planning
• Managing the cash flows
• Optimum cash level
• Investing surplus cash
 Motives for holding cash
• Transaction motive
• Precautionary motive
• Speculative motive
• compensating motive
 Transaction motive
• Holding of cash to meet routine cash
requirements to finance the transactions
which a firm carries on in the ordinary
course of business.
 Precautionary motive
• The cash balances held in reserve for
random and unforeseen fluctuations in
cash flows.
• A cushion to meet unexpected
contingencies.
– Floods, strikes and failure of imp customers
– Unexpected slowdown in collection of
accounts receivable
– Sharp increase in cost of raw materials
– Cancellation of some order of goods

• Defensive in nature
 Speculative motive
• Is a motive for holding cash/near-cash to
quickly take advantage of opportunities
typically outside the normal course of
business.
• Positive and aggressive approach
• Helps to take advantage of:
– An opportunity to purchase raw materials at
reduced price
– Make purchase at favorable prices
– Delay purchase on anticipation of decline in
prices
– Buying securities when interest rate is
 Compensating motive
• Is a motive for holding cash/near-cash to
compensate banks for providing certain
services or loans.
• Clients are supposed to maintain a
minimum balance of cash at the bank
which they cannot use themselves.
 Objectives of cash
management
• Meeting payments schedule
– It prevents insolvency
– relationship with bank is not constrained
– Helps in fostering good relationships
– Cash discount can be availed
– Strong credit rating
– Take advantage of business opportunities
– Can meet unanticipated cash expenditure with
a minimum of strain.
• Minimizing funds committed to cash
balances
– High level of cash: large funds remain idle
– Low level of cash: failure to meet payment
schedule
Managing Cash Collections
and Disbursements

• Accelerating Cash Collections

• Controlling Disbursements
 Accelerating Cash
Collections
1. Decentralised Collections

 number of collection centres

 Collection centres will collect cheques from
customers and deposit in their local bank
accounts
 They will deposit the funds to a central bank
 Accelerating Cash
Collections Contd…….
2. Lock-box System
– Collection centers are established considering the
customer locations and volume of remittances
– At each centre the firm hires a post office box
– Remittances are directly picked from the bank whom
the firm gives the authority

Advantages of lock-box system are

– cheques are deposited immediately upon receipt of
remittances
– Eliminates the period between the time cheques are
received by the firm and the time they are deposited in
the bank for collection
Controlling Disbursements

It means delay the payments as much as

possible. Can help the firm in conserving cash
and reducing the financial requirements.

Disbursement or Payment Float

 The size of the minimum cash balance
depends on:
• How quickly and cheaply a organization can raise
cash when needed.

• How accurately managers can predict cash

requirements.
Cash budget helps in this .

• How much precautionary cash the managers

need for emergencies.
 The organization’s maximum cash balance
depends on:

• Availability of (short-term) investment

opportunities
– e.g. money market funds, CDs, commercial
paper

• Expected return on investment opportunities.

– e.g. If expected returns are high, organizations
should be quick to invest excess cash

• Transaction cost of withdrawing cash and making

an investment

• Demand for Cash for daily transactions

BAUMOL MODEL
Bumol recognized the similarities between
cash and inventory management. He
extended the economic order quantity
(EOQ) model to examine its implications to
cash management. The Baumol model
assumes the cash manager invests excess
funds in interest bearing securities and
liquidates them to meet the firm’s demand
for cash. As investment returns increase,
the opportunity cost of holding cash
increases and the cash manager
decreases cash balances. As transaction
costs (cost of liquidating short-term
investments) increase, the cash manager
decreases the number of times he
liquidates securities, leading to higher
cash balances.
It has certain assumptions as
follows
(c)The firm can predict its future cash requirements
with certainty.

(b) The cash disbursements (outflow payments) are

spread uniformly over the period.

(c) The interest rate (which is the opportunity cost

of holding cash) is fixed.

(d) The firm will pay a fixed transactions cost each

time it converts marketable securities into cash.
Explanation
• The firm incurs a holding cost for
keeping the cash balance. It is an
opportunity cost; that is, the return Holding Cost = i*C/2
foregone on the marketable securities.
If the opportunity cost is (i), then the
firm’s holding cost for maintaining an
average cash balance is as follows:

• The firm incurs a transaction cost Transactional cost=

whenever it converts its marketable
securities to cash. Total number of b*T/C
transactions during the year will be
total funds requirement, T, divided by
the cash balance, C, i.e., T/C. The per
transaction cost is assumed to be
constant. If per transaction cost is b,
then the total transaction cost will be: Total Cost = i*C/2 + b*T/C
• The total annual cost of the demand
for cash will be: C=SQRT (2b*T/i)
• The optimum cash balance, C*, is
obtained when the total cost is
minimum. The formula for the
optimum cash balance is as follows:
Optimum Cash Balance under Certainty:
Baumol’s Model

GRAPHICAL REPRESENTATION
 EXAMPLE to clarify Baumol’s
Model
• JAYSHREE CHEMICAL Limited estimates its total cash requirement
as Rs 4 crore next year. The company’s opportunity cost of funds
is 15% per annum. The company will have to incur Rs 300 per
transaction when it converts its short-term securities to cash.
Determine the optimum cash balance. How much is the total
annual cost of the demand for the optimum cash balance? How
many deposits will have to be made during the year?

OPTIMUM CASH BALANCE = SQRT (2bT/i)

= SQRT (2*300*4,00,00,000/0.15)
=4,00,000 rs

Annual cost = Holding cost + Transaction cost

Holding cost = i*C/2
= 0.15* 4,00,000/2 = 30,000

Transaction cost = b*T/C

= 300 *
4,00,00,000/4,00,000 = 30,000

TOTAL COST = 30,000+30,000 = Rs.

60,000

NUMBER OF DEPOSITS TO BE MADE IN A

YEAR = T/C =
4,00,00,000/4,00,000 = 100
limitations of the Baumol
model

 Assumes a constant disbursement rate

 Ignores cash receipts during the period
 Doesn't allow for safety cash reserves
Miller-Orr Model
Allows Daily Cash Flow Variation

Provides two control limits

4)Upper Control Limit
5)Lower Control Limit
& Return Point

The Difference depends upon

9) The Transaction Cost (c)
10) The Interest Rate (i)
11) The Standard Deviation of net cash flow (σ)
 Formulae
(Upper limit- Lower Limit)=( 3/4 x transaction cost X variance of
cash flows )1/3
interest rate

Symbolically (Z)= ( 3/4 x cσ²/i )1/3

Upper Limit= Lower Limit + 3Z

Return Point= Lower Limit + Z

Average Cash Balance = Lower Limit +4/3 Z

Example
• Xyz Company has a policy of maintaining cash balance of
Rs. 5,00,000. The Standard deviation of company’s daily
cash flow is Rs 2,00,000. The Annual Interest Rate is 14%.
Transaction cost of buying or selling is Rs. 150 per
transaction.

• (Z)= ( 3/4 x 150x2,00,000²) 1/3 = Rs 2,27,227

.14/365

Upper limit =Lower limit +3Z=5,00,000+3(2,27,227)= Rs

11,81,680

Return Point=Lower limit +Z=5,00,000+2,27,227= Rs

7,27,227

Av. Cash Balance =Lower limit +4/3Z

Investing Surplus Cash in
Marketable Securities
• Selecting Investment
Opportunities:
– Safety
– Maturity
– Marketability
Thank You