Noida Institute of Engineering and Technology, Greater

Noida
Cash & Marketable Securities Management

Unit: 2

WORKING CAPITAL MANAGEMENT

Dr. Riyazuddin
(AMBAFM0412)
Assistant Professor
MBA
MBA IV Sem

DR. Riyazuddin AMBAFM0412 UNIT 1 1

 Content

Cash & Marketable Securities Management

1. Meaning of Cash, Motives for holding cash.
2. Objectives of cash management
3. Factors determining cash needs
4. Cash Management Models, Cash Budget
5. Cash Management: basic strategies,
6. Techniques and processes,
7. Lock Box system and concentration banking, compensating
balances
8. Marketable Securities: Concept, types, reasons for holding
marketable securities
9. Alternative strategies, choice of securities; Cash Management
Practices in India.

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 Cash Management

Cash

• Cash is a medium of exchange of goods and services.

Cash Management

• Cash management is the process of managing cash inflows and

outflows. Cash monitoring is needed by both individuals and
businesses for financial stability.

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 Cash Management

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 Objectives of Cash Management

Objectives of Cash Management

 Planning of Cash Flows

 Synchronizing Cash Flows
 Optimizing Cash Holding
 Investing Idle Cash

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 Motives for Holding Cash

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 Problem in Cash Management

Problem in cash management has been identified in these

four areas:
 Controlling Level of Cash
 Controlling in-flow of cash
 Controlling out-flow of cash
 Optimal investment of excess cash

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 Summary
• Cash is the most vital asset in any organization.

• Cash is like blood in the body of a firm.

• Cash should be managed with the clear understanding of

various motives to hold it.

• Firm should critically examine the factors affecting the

cash needs.

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 Quiz
1. Define the Cash.
2. Discuss the importance of cash in any firm.
3. Why cash is needed to managed with great caution?
4. Explain the difference between profit and cash.
5. Discus the precautionary motive to hold the cash.
6. Explain why cash in hand and current account balances produce
zero yield.
7. State the reason to hold the cash under transaction motive.
8. Describe the significance of liquidity in a firm.
9. Why firms hold the cash under speculative motive.
10. Explain the compensation motive to hold the cash.

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 1. Controlling Level of Cash

Some discrepancies in business organizations are predictable

comes from discrepancy between in-flow and out-flow of cash
 Predictable Discrepancies
 Unpredictable discrepancy
 Source of Fund
 Relationship with bank

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 2. Controlling of In-flow of cash

Adequate control on cash in-flow is also problematic area It

is concerned with speedy collection of cash and also
with preventing fraudulent diversion of cash in-flow.

For speedy Collection

• Lock- Box System: This system of collection of in-flow cash is
very popular in USA. Company has opened deposit accounts in
several banks in different geographical locations.
• Collection through regional branch offices

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 3. Controlling Out-flow of cash

All payments from regional branch office is transferred to head

office and head office in turn pay the bills directly to the
parties.

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 4. Optimal Investment of Excess cash

• The proper investment of excess cash in company at short notice

is also a problem area.
• Finance manager use its prudence and discretion for
investment of excess cash.

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 Factors Determining Cash Needs

 Cash flow forecasts

 Credit policy
 Accounts receivable
 Cost savings
 Inventory
 Accounts payable
 Collection period of receivables
 Credit terms
 Lowering expenses

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Factors Determining Cash Needs

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 Cash Planning and Cash Control

Tools for cash Control

 Cash budget report

 Cash Flow statement
 Ratio Analysis

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 Cash Management Model

• A number of mathematical model have been to develop to

determined the optimal cash balance.
• Two of such model are as follow;
a) William J. Baumol's inventory model
b) M. H. Miller and Daniel Orr’s Stochastic model

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 William J. Baumol's Inventory model

Baumol ’s Model of cash management-

 Trades off between opportunity cost or carrying cost or holding
cost & the transaction cost. As such firm attempts to minimize
the sum of the holding cash & the cost of converting
marketable securities in to cash.
 Helps in determining a firm's optimum cash balance under
certainty

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 William J. Baumol's Inventory model

Opportunity Cost
Total Cost

Transaction Cost

Optimum Cash Balance

(Baumol’s Model : Tradeoff Between Holding cost and transaction cost)

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 William J. Baumol's Inventory model

Assumptions

 Cash needs of the firm is known with certainty

 Cash Disbursement over a period of time is known with
certainty
 Opportunity cost of holding cash is known and remains
constant
 Transaction cost of converting securities into cash is known
and remains constant.

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 William J. Baumol's Inventory model

Algebraic representation of William J.

Baumol's Inventory model
C = √ 2A*F
√o

C = Optimum Balance
A = Annual Cash Distribution
F = Fixed Cost Per Transaction
O = Opportunity Cost Of Holding

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 M. H. Miller and Daniel Orr’s Stochastic Model

Overview

 The Miller and Orr model of cash management is one of the

various cash management models in operation.
 It is an important cash management model as well.
 It helps the present day companies to manage their cash while
taking into consideration the fluctuations in daily cash flow.

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 M. H. Miller and Daniel Orr’s Stochastic Model

Description

• As per the Miller and Orr model of cash management the

companies let their cash balance move within two limits
a) Upper Control limit
b) Lower Control Limit

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 M. H. Miller and Daniel Orr’s Stochastic Model

Miller – Orr Cash Management Model

Cash
Upper Control Limit : Buy Security
h
Curve representing Cash Purchase Market
Security Balance

Return
Z
Point

Sale of market
security
O
Lower Control Limit : Buy Security

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 M. H. Miller and Daniel Orr’s Stochastic Model

Explanation For the Diagram

 Along with a return point when the cash balance touches the
upper Control limit (h), the marketable security is purchased
to the extend till it reaches normal cash balance (Z)+
 In the same manner when the cash balance touches lower limit
(o), the firm Will Sell the Marketable security to the extent till
it reaches normal cash Balance (Z)

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 M. H. Miller and Daniel Orr’s Stochastic Model

Computation of Miller – Orr Model of Cash

Management

1/3
Spread (Z)= (3/4 * Transaction cost *Variance of Cash Flow)
Interest Rate
Return Point = Lower limit + Spread (Z)
3
2 2
Variance of Cash Flow = (Standard Deviation) or ( )

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 Quiz
1. Define the Upper control limit.
2. Discuss the Lower control limit.
3. Elaborate the holding cost for cash.
4. Explain the return point for better cash needs determination.
5. Explain the Miller-Orr concept of cash managment.
6. What are the distinct features of the Stone’s cash management
model?
7. How optimum cash balance is determined using the Baumol’s
model .
8. What is meant by transaction cost.
9. Discuss the inner and outer control limits.
10. How cash cycle is calculated using the cash cycle method?

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 Recap
• Baumol’s model of cash management is based on the inventory
management concept.

• Miller-Orr Model talks about the UCL, LCL and return point for
better management of cash and determining its need.

• Stones’s model takes into account the Outer and Inner UCL &
LCL.

• Cash cycle Method is based on the time parameter to determine

the cash needs of the firm.

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 Cash Budget
 A cash budget is a detailed plan that outlines a company’s
projected cash inflows and outflows over a specific period.

 This financial tool is used to assess whether a business has

sufficient cash to operate or whether it needs additional funding.
 Unlike other types of budgets, a cash budget strictly focuses on
actual cash transactions, ignoring non-cash items
like depreciation.
 It’s an operational plan that ensures a company can meet its short-
term obligations and avoid liquidity issues.

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 Cash Budget
The process involves several key steps:

 Estimating cash receipts

 Forecasting cash disbursements
 Determining net cash flow
 Considering opening and closing balances

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 Cash Budget

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 Marketable securities

Marketable securities are assets that can be liquidated to

cash quickly. These short-term liquid securities can be bought
or sold on a public stock exchange or a public bond exchange.
Marketable securities include common stock, Treasury bills,
and money market instruments, among others.

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 Marketable securities

Accounting for marketable securities

Short-term liquid securities are classified differently when it comes
to their accounting, based on the purpose for which they are
bought.
There are three different classifications of marketable securities:
 Available for sale
 Held for trading
 Held to maturity

These classifications are dependent on certain criteria, but also on

the history of transactions any given investor or firm has employed
in their past accounting practices.

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 Marketable securities
Types of marketable securities
Marketable Equity Securities
 Common Stock: Represents ownership in a company, potential for
dividends and capital gains
 Preferred Stock: A hybrid security with fixed dividend payments, taking
priority over common stockholders.

Marketable Debt Securities

 Treasury Bills (T-bills): Short-term government-issued debt securities,
considered very safe investments
 Treasury Notes (T-notes): Intermediate-term government-issued debt with
maturities of 2-10 years.
 Treasury Bonds (T-bonds): Long-term government-issued debt with
maturities of over 10 years.

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 Marketable securities
Types of marketable securities

Marketable Debt Securities

 Corporate Bonds: Debt securities issued by corporations to raise funds.

 Commercial Paper: Unsecured short-term debt issued by corporations for
operational financing
 Money Market Instruments: Highly liquid, short-term debt securities (e.g.,
certificates of deposit, banker's acceptances).

Other Marketable Securities

 Exchange-Traded Funds (ETFs): Baskets of securities that track an

index, sector, or theme.
 Derivatives: Futures and options contracts, their value is based on an
underlying asset.

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 Marketable securities
Key Characteristics of Marketable Securities

 Liquidity: Can be quickly converted to cash.

 Maturity: Most are short-term, usually a year or less.
 Risk: Generally low-risk but vary (government securities are
safer than corporate).
 Return: Offer potential for interest income, dividends, or
capital gains.

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 Cash Management Strategies for Small Businesses in
India

Cash Management Strategies for Small Businesses

 Finance Your Expensive Purchases to Save Cash

 Sell or Lease Equipment, Real Estate Not in Use
 Negotiate Your Payments with Vendors, Suppliers
 Expedite Recovery of Receivables
 Demand an Advance for Large Orders
 Reduce Expenses
 Increase Margins

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 Daily Quiz

• Define objectives of cash management.

• Explain Cash Management Models.
• Explain the marketable securities.
• Stately brief the main features of the cash budget ?
• Explain cash conversion cycle.

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 Weekly Assignment

1. Define cash management?

2. Explain the Baumol model of cash management.
3. What are the reasons for holding cash balance.
4. How is temporary cash surplus managed.
5. How do cash flow problem arise.

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 MCQs…contd.

1. Concentration banking
• increases idle balances.
• moves excess funds from a concentration bank to regional banks.
• is less important during periods of rising interest rates.
• improves control over corporate cash.

2.Which of the following marketable securities is the obligation of a

commercial bank?
• Commercial paper .
• Negotiable certificate of deposit
• Repurchase agreement
• T-bills
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 MCQs…contd.

3.Marketable securities are primarily

short-term debt instruments.
short-term equity securities.
long-term debt instruments.
long-term equity securities.

4. Time consumed in clearing a check through the banking system.

Processing float
Deposit float
Collection float
Availability float

5. Commercial paper is essentially

another term for a junk bond.
a short-term unsecured corporate IOU.
an intermediate-term corporate bond.
a certificate that may be exchanged for a share of common stock at a specified future date.

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 Glossary Questions

 Attempt all the parts: please pick the correct option from Glossary
Current Assets – Current Liabilities, Fixed, Is the amount of current assets
required to meet a firm's long-term minimum needs, Liquidity.

• _______ capital is durable.

• Working Capital _______
• Factors Affecting Working Capital Requirements
_____________.
• Permanent working capital ___________. ____________ .
• .___________ varies inversely with profitability.

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 Old Question Papers

• Discover the objectives of cash management.(AKTU 2019-

20)
• Inspect and explain the motives of holding cash. (AKTU
2017-18)
• Analyze and write the short notes on cash management..
(AKTU 2018-19)
• What are the factors determining the cash needs? (AKTU
2018-19)
• How will you decide whether or not to establish Lock- Box
System of Cash Collection? (AKTU 2019-20)
• Describe Baumol Model of Cash Management. (AKTU
2019-20)
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 Expected Questions for University Exam

• Define the cash budget method of working capital?

• What is marketable security?.
• What are the motives for maintaining liquidity in the form of
marketable securities?
• Discuss briefly the various types of marketable securities. .
• ‘Why do investors prefer marketable securities? .

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 Summary

• In this unit we have discussed the motives for holding cash

balance.
• We have discussed cash deficit/surplus situation and how this
can be contained through the use of various models..
• Cash planning and forecasting is an important component of
cash management and the principal tool for effective cash
management in cash budget.
• We have also examined collection float and payment float and
the ways and means to reduce collection float.
• We have also discuss that securities are classified differently
when it comes to their accounting, based on the purpose for
which they are bought.

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 References

• Text books
• Rustagi R P, Working Capital Management, Taxmann
• Bhalla V.K - Working Capital management, Text and cases,
Anmol Publication, Delhi , 11th edition

• Reference Books
• Bhattacharya H, Working Capital Management, PHI, 3rd Ed.
• Rangrajan K, Misra A.; Working Capital Management, Excel
Books
• Sagner J, Working Capital Management: Applications and
Case Studies, Wiley Publication

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 Thank You

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