Published on April 21, 2009
Unit-5 : Unit-5 CASH MANAGEMENT Meaning : Meaning Cash is a medium of exchange to purchase the goods and services and to discharge the liabilities. Cash management implies management of near cash assets which includes cash in hand , cash at bank, time deposits with banks and readily marketable securities . The main aim of cash management to determine the optimum cash balance . MOTIVES FOR HOLDING CASH : MOTIVES FOR HOLDING CASH Transaction Motives Precautionary Motives Speculative Motives Transaction motive : Transaction motive The transaction motive requires a firm to hold cash to conduct its business in the ordinary course. The firms needs cash primarily to make payments for purchases, wages and salaries, other operating expenses, taxes, dividends etc. Precautionary Motive : Precautionary Motive The precautionary motive is the need to hold cash to meet contingencies in the future. It provides a cushion or buffer to withstand some unexpected emergency. The precautionary amount of cash depends upon the predictability of cash flows. if cash flows can be predicted with accuracy , less cash will be maintained for an emergency. Speculative motive : Speculative motive The speculative motive relates to the holding of cash for investing in profit making opportunities as and when they arise . FACTORS DETERMINING THE LEVEL OF CASH : FACTORS DETERMINING THE LEVEL OF CASH Credit Policy Distribution channel Nature of product Duration of operating cycle Cash Budget : Cash Budget Opening of cash balance of each period is added to the receipts of that period to find out total receipts of each period. Similarly , payments of each period are totalled to find out total distribution of each period. Then the budget will show the cash position at the end of each control period . Example : Example Prepare a cash budget for three months ending on June 30, 2005. Months sales purchases wages Feb 90000 62400 6000 March 96000 72000 7000 April 54000 121500 5500 May 87000 123000 5000 June 63000 134000 7500 Slide 10: Additional information- Cash balance on 1st April 2005 was Rs 10000. 50% of the sales are released in the month following the sale and remaining sales in the second month following. Creditors will be paid in cash in the month of purchases. All sales are on credit. Optimum cash balance : Optimum cash balance The Baumols model of cash management provides a formal approach for determining a firms optimum cash balance under certainty. It considers cash management similar as inventory management problem. As such, the firm attempts to minimise the sum of the cost of holding cash (inventory of cash) and the cost of converting marketable securities to cash. Assumptions : Assumptions The firm is able to forecast its cash needs with certainty. The firm’s cash payments occur uniformly over a period of time . The opportunity cost of holding cash is known and its does not change over time. The firm will incur the same transaction cost whenever it converts securities to cash. The Miller Orr Model : The Miller Orr Model The limitation of the Baumol model is that it allows the cash flows to fluctuate. Firms in practice do not use their cash balance uniformly nor are they able to predict daily cash inflows and outflows. the Miller Orr Model overcomes this shortcoming and allows for daily cash flow variations.