Cash is the most liquid asset and referred to as “life blood of a business enterprise”, it is very important

for the daily operation of a business

Proportion of corporate assets held in the form of cash -1-4%, thus its efficient management is crucial to
the solvency of the firm

Facets of cash management

Cash planning- cash outflows and inflows should be planned to project cash surplus or deficit for each
period of the planning period. Cash budget should be prepared for this purpose

Managing the cash flows- the flow of cash should be properly managed. The cash in-flows should be
accelerated while, as far as possible, the cash out flows should be deaccelerated.

Optimum cash level- the firm should decide about appropriate level of cash balances. The cost of excess
cash and danger of cash deficiency should be matched to determine the optimum level of cash balances.

Investing surplus cash- the surplus cash balances should be properly invested to earn profits. The firms
should decide about the division of the cash balance between alternative short term investment
opportunities such as bank deposits, marketable securities or inter-corporate lending.

Why do firm need cash?

Transaction motive-to meet transaction needs, the collection of cash (from sales of goods/services, sales
of assets etc) does not match payments (purchase of goods & services, acquisition of capital assets and
meeting other obligations. Hence cash balance is required as a buffer

Precautionary motive- because there is an uncertainty in the cash inflows and cash outflows. To protect
itself from such uncertainty.

Speculative motive- taping profit making opportunities arising from fluctuations in commodity prices,
security prices, interest rates and foreign exchange rates.

CASH BUDGETING

Cash budgeting or short term Cash forecasting is the principal tool of cash management. A cash budget
is a summary statement of the firm’s expected cash inflows and out flows over a projected time period.
It gives information on the timing and magnitude of expected cash flows and cash balances over the
projected period. This is useful in 1 estimating cash requirements 2 planning short term financing 3
scheduling payments in connection with capital expenditure projects 4 planning purchases of materials
5 developing credit policies 6 checking the accuracy of long term forecasts

The commonly used designs for short term cash forecasts are 1 one year divided in to quarters or
months 2 one quarter divided into months and 3 one month divided into weeks.

A firm which doesn’t want to face liquidity problems may even provide a weekly divided into days
forecasts.
The most commonly use methods of short term cash forecasting is the receipts and payments methods
& rarely the adjusted net income method which is usually use for the long term cash forecasting

RECEIPTS & PAYMENT METHOD of Cash budgeting

This methods shows the timing and magnitude of receipts and payments over the forecast periods.

Elements such as estimated sales, production plan, purchasing plan, financing plan and capital
expenditure budget are taken in to consideration.

Deviations from expected cash flows

The actual cash flows are likely to deviate from the estimates provided in the cash budget, the degree of
deviation depends mainly on the vitality of the cash flows of the business.

Because of the uncertainity arising from business operations its is advisable to prepare additional
forecast based on different assumptions. The 3 possible scenarios are pessimist scenario, normal
scenario and optimistic scenario.

Summary cash forecast

Evaluation the receipts and payments method of cash forecasting has two advantages1 provides a
complete picture of expected cash flows 2 it is a sound vehicle/carrier for exercising control overday
today transactions

Disadvantage-1 its reliability is impaired by delays in collection or sudden demand for large payments
and other similar factors 2 it fils to provide a clear picture of important changes in the firm’s working
capital movement, such as inventories and receivables.

LONG TERM CASH FORECASTING

Short term-1 yr, long term 2-5 yrs

Theoretically it can be done by receipts and payment methods but the adjusted net income method is
more convenient.

This method seeks to estimate the firm’s need for cash at some future date and indicate whether this
need can be met from internal sources or not.

Format of the adjusted net income method

CASH REPORTS

Are mainly used for controlling purposes

Provides a comparison of actual with the forecasted figures and ther by can be controlled and revised
for cash forecasting on a continual basis.
Daily cash reports. Shows the opening balance, receipts, payments and the closing balance on a daily
basis

Daily treasury report: an amplification or a bigger picture of the daily cash report. This report provides a
comprehensive picture of change in cash, marketable securities, debtors and creditors

Monthly cash report: shows the actual receipts and payments on a monthly basis. The actual are
compared with the budgeted figures and variances are calculated.

CASH COLLECTION & DISBURSEMENT

FLOAT: the cash balance shown by a firm on its books is called book or ledger balance, whereas the
balance shown in its bank account is called the available or collected balance. The difference between
the available balance and the ledger balance is referred to as the float

1 Disbursement float

Cheques issued by a firm create disbursement float. Eg. ABC ltd has a book balance as well as available
balance of RS 8 lac with HDFC ltd as on 31 march. On April 1, it pays Rs 2 lac by cheque to one of its
supplier and hence reduces its book balance by Rs 2 lacs.

HDFC ltd however will not debit ABC ltd account until the cheque has been presented for payment, say
April 6. Until that happens the firms available balance is greater than its book balance by Rs 2 lacs.
Hence between 1st and 6th april ABC ltd has a disbursement float of Rs 2 lacs.

Disbursement float= Firm’s available balance – Firm’s book balance

= Rs 8 lacs- Rs 6 lacs

= Rs 2 lacs

2 Collection float.

Cheques received by a firm lead to a collection float. Abc lts receives a cheque of 3 lacs from its
customer. Firm’s available balance on april 30 is 10 lacs

Collection float= Firm’s available balance-firm’s book balance

=10 lacs- 13 lacs

= -3 lacs

The net float is the sum of disbursement float and collection float. It is simply the difference between
the firm’s available balance and its book balance.

If net float is positive (negative) it means that the available balance is greater (lesser) than the book
balance.
Therefore it is important for a financial manager to maximize the net float and to strive to speed up
collection and delay disbursement

How to speed up collections

The collection time includes- mailing time, cheque processing delay and the bank’s availability delay

Customer mails the cheque company receives the cheque CO deposits cheque cash available

TimeI---------------------------------------------------I---------------------------------------I--------------------------------I

<……………..Mailing time……………………><…processing………………………..><…availability delay…….>

To speed up collection, companies may use lock boxes and concentration banking

Lock boxes. under this system, customer are advised to mail their payments to special post office boxes
called lockboxes, which are attended by local collecting banks, instead of sending them to corporate
headquarters.

The local bank collect the cheque from the lock box, deposits the cheque directly in to the local bank
account of the firm and furnishes details to the firm.

Advantages-cut down mailing time, because cheques are received at a nearby post office instead at a
corporate headquarter, 2 reduces the processing time because the company does not have to open
envelopes and deposits the cheques for collection and 3, shortens the availability delay because the
cheques are typically drawn on local banks.

When is it worthwhile to have a LB?

Eg. Average no of daily payments 50

Average size of payment 8000

Saving in mailing and processing time 2 days

Annual rental for the LB 3000

Bank charges for operating the LB 72000

Interest rate 15 %

The LB will increase the company’s collected balance by

50times a day X 8000 per item X 2 days saved=800000

The annual benefit in the form of interest saving on account of this is

800000X.15=120000
The annual cost of the box is

3000(rental) + 72000(bank charges)=75000

Interest is more than cost.. so it is advantageous to have a LB

Concentration banking.

In this system the company advised its customer to send their payments to a local branch office (not to
the corporate office). Cheques are deposits for collection in to a local bank account. Surplus funds from
various local bank accounts are transferred regularly or daily) to a concentration account at one of the
company’s principal banks. For effecting the transfer several options are available.

With the vast network of branches set up by banks, regional/local collection centres can be easily
established. To ensure the system of collection works according to plan, it is helpful to periodically audit
the actual transfers by collecting banks and see whether they are in conformity with the instructions
given or not.

Concentration banking can be combined with LB arrangement to ensure that the funds are pooled
centrally as quickly as possible.

Delaying payments.

Net float can be increase by speeding up collection as well as slowing down payments. One of these is to
increase the mail time.

Ensure payments are made only when they fall due and not early

Centralize disbursements. This help is consolidating funds at the head office, scheduling payments more
effectively, reducing unproductive cash balances at regional/ local offices and investing funds more
productively

Arrange with suppliers to set the due dates of their bills to match with company’s receipts.
Synchronization of cash out flows with inflows helps a company to get greater mileage from its cash
resources.

Electronic data interchange

EDI refers to direct electronic exchange of information between various parties. Financial Edi or FEDi,
involves electronic transfer of information and funds between transacting parties. FEDI leads to
elimination of paper invoices, cheques, mailing, handling and so on.

Under FEDI the seller bill electronically to the buyer, the buyer electronically authorizes its bank to make
payment, and the bank transfer funds electronically to the account of the seller at a designated bank.
One of the drawback of FEDi is that it is expensiveand complex to set up. Many parties may not be
willing to participate in it. How ever with advancement in technology and growth of internet and e-
comerce cost will fall down and this will induce more parties to participate in FEDI