Cash Management

Cash Cycle
Factors that influence the desired level
of cash
Optimal cash inventories
Short-term investment strategies
 Managing an entity’s Resources
The Manager

Life cycle effects,

Resource Decisions Cash Management Business cycle,
Inventory Management public events,
Working Capital Management etc.
Investment Decisions Investment in Human Capital
Long-term Assets
Accounts Receivable
Operating
Decisions
Recruitment, Selection
Cash Inflows
Human Resources Training, Productivity
Performance Appraisal
Decisions
Compensation
Unions & Labor Relations Value
Creation
Economics of Information
Information Database Management
Decisions Data Modeling Discount Rate
IS Planning & Development

Financing Decisions Cost of Financial

Debt vs. Tax Financing
Capital Markets
 Overview
ST fin’l planning = deals w/ short-lived assets and liabilities
(working capital management);

concerned w/ 1) size of investment in CA like cash, A/R,

Inventory…a tool is cash budget analysis and 2) how to
finance ST assets…a tool is performing credit analysis
 Managing WC involves determing:

• How much to invest in CA?

- CA vs. FA
- Nature of activities/programs
• In each CA?
- Cash, A/R, Inventory
- Cash Mgt
- A/R is Credit Mgt
- Inv = POM & Cash balance models
 Our objectives
• Learn about the Cash Cycle
• Understand the factors that influence the
desired level of cash
• Learn two models that calculate the optimal
level of cash
• Gain an overview of what factors/areas are
inputs to a cash budget and how they affect
the cash balance
Objectives of Public Money
Managers

Bringing the entity’s cash

resources within control
Achieving optimum
conservation and utilization of
the funds
 Key areas of Public Cash
Management
Organization
Collection and disbursement of funds
Netting of interagency payments
Investment of excess funds
Optimal level of cash balances
Cash planning and budgeting
Bank relations
Treasury Management of
Cash Balances
Operate with smaller amount of
cash
Supervision is centralized
Better service from banks
Proper allocation of funds
 How much cash should a
organization keep on hand?
• Enough cash to make payments when
needed. (transactions motive)
– (Daily or Weekly Cash Budget helpful)

• Additional cash may be held for unexpected

requirements. (precautionary motive)
 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 helpful)

• How much precautionary cash the managers need

for emergencies.
 The organization’s maximum cash
balance depends on:
• Available (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
– (Cash Budget helpful)
 Consider Cash an ‘Inventory’
Antrade-offs:
the inventory - holdapproach to Cash
little cash = invest
remainder in M/S to decisions:
Balance earn interest

Grantsville has a daily demand for cash of $10,000.

Grantsville’s treasurer
- if hold too invests
little cash excess
= incur cash in the state investment pool
transactions
that earns .01%
costs to meetper day.
cash In order to transfer funds from the state pool,
needs
Grantsville must pay a transaction cost of $20. How much cash should
it transfer when it runs out. (Grantsville can complete the cash
transfer electronically so - hold
it waits
lots until
of cash
the=cash
forgobalance
investing
is zero).
in M/S
and earning interest
Optimal Cash Balance via Baumol Model
50000000 1002 504 339.3333333 258 210

M = $10,000 r = .01%  .0001 TC = $20

Cost ($)

Z* √ [(2M*TC)/r]
Z*=
Total Costs
Z = $63,246
Holding Costs:
(Z/2)*r

Order Costs:(M/Z)*TC

Z* Order Quantity (Z)

 Problems with the Baumol Model

• Cash flows may not be very predictable, much less

constant

• Treasurers may want a ‘safety stock’ of cash

 The Miller - Orr Model
• The Miller-Orr Model provides a formula for
determining the optimum cash balance (Z), the
point at which to sell securities to raise cash
(lower limit L) and when to invest excess cash by
buying securities and lowering cash holdings
(upper limit H).
• Depends on:
– transaction costs of buying or selling securities
– variability of daily cash (incorporates uncertainty)
– return on short-term investments
 The Miller - Orr Model
Dollars in the Cash Account

Upper Limit Buy Securities

H

L
Lower Limit Sell Securities

Days of the Month

 The Miller-Orr Model
- Target Cash Balance (Z)
3
3 x TC x V
Z= +L
4xr
where: TC = transaction cost of buying
or selling securities
V = variance of daily cash flows
r = daily return on short-term
investments
L = minimum cash requirement
 The Miller-Orr Model
- Target Cash Balance (Z)
• Example: Suppose that short-term securities yield
5% per year and it costs the organization $50 each
time it buys or sells securities (TC). The daily
variance of cash flows is $1000 (V) and your bank
requires $1,000 minimum checking account
balance (L).*

3
Z= 3 x 50 x 1000 + $1,000
4 x .05/360

= $3,000 + $1,000 = $4,000

 The Miller-Orr Model
- Upper Limit
• The upper limit for the cash account (H) is
determined by the equation:
H = 3Z - 2L
where:
Z = Target cash balance
L = Lower limit
• In the previous example:
H = 3 ($4,000) - 2($1,000) = $10,000
 The Miller - Orr Model
Dollars in the Cash Account

Upper Limit Buy Securities

$10,000

$4000

$100
Lower Limit Sell Securities 0

Days of the Month

 Cash Pooling
Centralized cash management involves
transfer
of an agency’s cash in excess of minimal
operating requirements into a centrally
managed
account also known as a cash pool.
Procedure
and
Benefits
Investment of excess
funds
 The Collection & Disbursement of Public Funds

Managing Cash Balances Controlling Cash

• Safety
• Liquidity
• Maximize pool of funds
available for investment
– Concentration Accounts
– Zero-balance accounts
• Highest yield
Collection &
Disbursement
• Dual responsibility
• Receipts maintained in a
location separate from
cash & checks
• Certification of vouchers
 Collection of funds
Need for accelerating collections
How to accelerate collection of
receivables
 Disbursement of funds
Importance of disbursement of funds
Review of disbursements

Payment instruments being used (checks,

drafts, wire transfers, etc.)
Bank charges and internal costs
Techniques being used
Time involved for processing of
instruments
 Payments Netting in
Public Cash
Management
Need for payments netting
Procedure involved
Only netted amount is transferred (bilateral
netting)
Netting center (multilateral netting)
 Our objectives
• Learn about the Cash Cycle
• Understand the factors that influence the
desired level of cash
• Learn two models that calculate the optimal
level of cash
• Gain an overview of what factors/areas are
inputs to a cash budget and how they affect
the cash balance
Stop Here
 Payments netting in
Public Cash Management
(contd.)
 Payments Netting in
Public Cash Management
(contd.)
Cash Planning and
Budgeting
Cash Planning and Budgeting
(contd.)