Cash Management

What is cash?
cash includes:
• coins and notes
• money in current accounts and short-term deposits
• any unused bank overdraft facility
• foreign currency and deposits that can be quickly
converted to your currency
It does not include:
• long-term deposits (if these cannot be withdrawn)
• money owed by customers
• stock
 Motives for holding cash
• Transactions motive: day to day
operations
• Precautionary motive: meet
contingencies
• Speculative motive: investing in
profit making opportunities
 Cash Management
It is concerned with the managing of :
(i) Cash flows into and out of the firm
(ii) Cash flows within the firm and
(iii) Cash balances held by the firm at a point of
time by financing deficit or investing surplus
cash
 Cash Management Cycle
Cash
Business collections
Operations

Information Deficit Borrow

and control
surplus Invest

Cash
payments
 Facets of Cash Management
• Cash planning
• Managing the cash flows
• Optimum cash level
• Investing surplus cash
 Cash Planning
It is a technique to plan and control the use of
cash. It helps to anticipate the future cash
flows and needs of the firm and reduces the
possibility of the idle cash balances (which
lowers firms profitability) and cash deficits
(which can cause the firms failure).
 Cash Forecasting and Budgeting
Cash budget: it is a device for the control of
receipts and payments of cash and summary
statement of expected cash inflows and
outflows over a projected time period.

Cash forecasts:
• Short term forecasts
• Long term forecasts
 Short Term Forecasts
Functions of short term forecasts are:
• To determine operating cash requirements
• To anticipate short term financing
• To manage investment of surplus cash
 Uses of short term forecasts
• Planning reductions of short and long term debt
• Scheduling payments in connections with
capital expenditures programmes
• Planning forward purchases of inventories
• Checking accuracy of long range cash forecasts
• Taking advantage of cash discounts offered by
suppliers
• Guiding credit policies
 Short term forecasting methods

• Receipt and disbursements

method
• Adjusted net income method
 Receipt and disbursements method

• In this method the receipts and payments of

cash are estimated.

The qualities of this method are:

• Complete picture of all the items of expected
cash flows
• Sound tool of managing daily cash operations
This method suffers from following limitations:

• Its reliability is reduced due to uncertainty of

cash forecasts. For example collection may be
delayed or unanticipated demand may cause
large disbursements
• It fails to highlight the significant movements
in the working capital items
 Net adjusted method
This method helps in projecting the
company's need for cash at some
future date and to see whether the
company will be able to generate
sufficient cash internally, and if not,
how much will have to be borrowed
or raised in the market.
Analysis of adjusted net income method

Benefits
• It highlights movements in the working capital
items
• Helps in anticipating a firms financial
requirements
Drawbacks
• Fails to trace cash flows so its utility in
controlling daily cash operations is limited
 Long term Cash Forecasting
These are done to give an idea of the
company's financial requirements in the
distant future. It reflects the impact of
growth, expansion or acquisitions and
also indicates financing problems arising
from these developments.
 Uses of long term forecasting
• Indicates a company's future financial needs,
especially working capital requirements
• Helps to evaluate proposed capital projects
and points out their cash requirement
• Helps to improve corporate planning so that
each division plans for future and formulate
projects carefully
From the following forecast of income and expenditure prepare
a cash budget for the months January to April, 2010
Year Months Sales Purchases Wages Manufac Admn. Selling
(Credit) turing Expenses expenses
expenses
2004 Nov. 30,000 15,000 3,000 1,150 1,060 500

Dec. 35,000 20,000 3,200 1,225 1,040 550

2005 Jan 25,000 15,000 2,500 990 1,100 600

Feb. 30,000 20,000 3,000 1,050 1,150 620

Mar. 35,000 22,500 2,400 1,100 1,220 570

April 40,000 25,000 2,600 1,200 1,180 710

• The customers are allowed a credit period of 2
months
• A dividend of Rs.10,000 is payable in April
• Plant purchased on 15th Jan for Rs. 5,000. A
building has been purchased on 1st march and
the payments are to be made in monthly
installments of Rs. 2,000 each.
• Creditors are allowing a credit of 2 months
• Wages are paid on 1st of the next month
• Lag in payment of other expenses is one month
• Balance of cash 1st jan 2005 is Rs. 15000
 Cash Budget for the month from January to April 2005
Details January February March April
Receipts
Opening balance of cash 15,000 18,985 28,795 30,975
Cash recd from debtors 30,000 35,000 25,000 30,000
Cash available 45,000 53,985 53,795 60,975
Payments
Suppliers 15,000 20,000 15,000 20,000
Wages 3,200 2,500 3,000 2,400
Manufacturing expenses 1,225 990 1,050 1,100
Administrative expenses 1,040 1,100 1,150 1,220
Selling expenses 550 600 620 570
Payment of dividend 10,000
Purchase of plant 5,000
Installment of building loan 2,000 2,000
Total payments 26,015 25,190 22,820 37,290
Closing balance
 Prepare cash budget from April -
June
2005 Sales Purchases Wages

February 180000 124800 12000

March 192000 144000 14000
April 108000 243000 11000
May 174000 246000 10000
June 126000 268000 15000
• 50% of credit sales are realized in the month
following the sales and remaining 50% in the
second month following. Creditors are paid in
the month following the month of purchase.

• Cash at bank on 1.4.2005 Rs. 25,000

 Cash budget for the month s from April to June 2005

April May June

Receipts

Opening balance 25,000 53,000 -51,000

Sales 90,000 96,000 54,000

Amount recd from sales 96,000 54,000 87,000

Total receipts 2,11,000 2,03,000 90,000

Payments

Purchases 1,44,000 2,43,000 2,46,000

Wages 14,000 11,000 10,000

Total payments 1,58,000 2,54,000 2,56,000

Closing balance 53,000 -51,000 -1,66,000

 Managing cash flows
The flow of cash into and out of the business
over a period of time is referred to as cash
flow. Cash flow can be classified into three
heads:
Operating cash flows
Investing cash flows
Financing cash flows
 Managing cash collections and
disbursements

The objective of managing the cash flows

should be to accelerate cash collections as
much as possible and to delay cash
disbursements as much as possible.
 Accelerating Cash Collections
1. Prompt payment by customers
2. Quick conversion of payment into cash
3. Decentralized collections
4. Lock box system
 Controlling Disbursements
1. Paying on last date
2. Payments through drafts
3. Adjusting payroll funds
4. Centralization of payments
5. Inter bank transfer
6. Making use of float
Determining Optimum Cash Balance

If a firm maintains small cash balance, its

liquidity position weakens, but profitability
improves as the released funds can be invested
in profitable opportunities.

If the firm keeps high cash balance, it will have

strong liquidity position but profitability will be
low. So the firm should maintain optimum cash
balance.
 Optimum cash balance under certainty
Baumol’s Model
It considers cash management similar to an
inventory management problem i.e. EOQ a
trade off between carrying cost and ordering
cost.

According to this the firm attempts to minimize

the sum of the cost of holding cash and the cost
of converting marketable securities to cash.
 Assumptions
• Forecasting of cash needs with certainty
• Cash payments occur uniformly over a
period
• Opportunity cost of holding cash is
known and does not change over a
period of time
• Transaction cost is same on conversion of
securities to cash
 Algebra Representation
C= 2AF
O
C = optimum balance
A = annual cash disbursements
F = fixed transaction cost
O = opportunity cost of holding cash
 A chemical ltd. Estimates cash requirement as
Rs 2 crore. Opportunity cost of funds is 15% p.a.
Rs. 150 is the transaction cost. Determine
optimum cash balance.
C = Rs. 2,00,000
Optimum cash balance under uncertainty –
The Miller Orr Model
This approach assumes daily cash flow
variations. This model provides two control
limits- the upper limit and lower limit as well
as a return point. If the cash balance touches
upper limit marketable securities are
purchased and it touches lower limit
marketable securities are sold.
 The difference between lower and upper limit
depends on following factors:
• Transaction cost (c )
• Interest cost (i)
• Standard deviation of net cash flows (δ)
Formula for determining the distance between
upper and lower control limits (Z) =
(¾ * transaction cost * cash flow variance/interest
per day) 1/3
Z = (3/4 * C δ2 / I ) 1/3
 Investing Surplus Cash
For short term investment opportunities cash
can be invested in many securities. Three basic
features of security are to examined:
1. Safety
2. Maturity
3. Marketability
4. Return or yield
5. Liquidity
 Types of short term investment
opportunities
• Treasury bills
• Commercial papers
• Certificates of deposits
• Bank deposits
• Inter corporate deposits
• Money market mutual funds
• Bill discounting