Management of Cash

1. Management of Cash
• It is the responsibility of the finance manager
to provide adequate cash to the firm
• He has to also ensure that funds are also not
blocked and thus remains idle
• The term cash is understood in two ways
– In narrower sense it is considered only as coins,
currency notes etc
– In broader term it also includes the assets that can
be readily convertible in to cash like marketable
securities, bank deposits etc

2. Management of Cash
• Objectives of Cash Management
• Two basic objectives of cash management
1. To meet the requirement of disbursement need as
per the payment schedule
1. Payment for wages, purchases, taxe, bills etc
2. Have minimum amount of the cash that is locked
up in the cash balance
– both these objectives are mutually contradictory
and thus it is very difficult for the to maintain a
balance between the two

3. Management of Cash
• Cash Management involves the following 4
problems
1. Controlling the level of cash
2. Controlling the level of inflow of cash
3. Controlling the level of outflow of cash
4. Optimum investment of surplus cash

4. Management of Cash
• Cash Management involves the following 4
problems
1. Controlling the level of cash
• The Level of cash locked up in the cash balances should
be only that amount which is required.
• This is achieved by preparing what is called the “ Cash
Budget”
• Cash Budget
– Cash budget is the cash forecast which involves the future projection of
the cash receipts as well as the cash disbursement
– It reveals the “timing” and “amount” of cash inflow and outflow over a
period studied and thus is a tool by which the finance manager is able to
plan things in a better way

5. Management of Cash
• Cash Budget
• Cash budget is prepared by estimating the cash receipts from
various sources and the cash payments to different agencies
• The cash receipts and payments are divided in to 2 categories
• Cash Receipts
1. Capital Receipts
• All the money that is coming by way of capital fund raising like issue
of shares, loan raised by issuing debentures or preference shares
• Cash received when some long term asset has been sold
2. Revenue Receipts
• Cash received by sales of goods /services
• Commisions

6. Management of Cash
• Payments
1. Capital Payment
• The amount given to the bond holders on the maturity of the bonds
• Payment of long term loan
• Purchase of some long term fixed assets like plant or machinery etc
2. Revenue Payment
• Payment for raw materials purchases
• Payment of wages, bills, rents
• Payment of interest on long term loans
• Payment of dividends on shares etc.

7. Management of Cash
• Preparing the cash balance ( for a specific time period)
• Three basic steps
1. Opening Balance
2. Add cash receipts and deduct the payments made
3. Prepare the closing balance( which will be the opening balance for the
next time period)

8. • Example
• Estimate the cash budget for the month of January 1998
from the following
– Cash in hand ( on 1.1.1998) = Rs 20,000
– Sales ( December 1997) = Rs 50,000
– Sales ( January 1998) (estimated) = Rs 80,000
– 80% of amount is recovered in the month of sales and the
balance in the received in the subsequent month
– A sales commission of 5% is paid in cash in the month of sales
itself
– Purchases
• For December 1997 = Rs 20,000
• For January 1998 = Rs 30,000 (estimated)
• No credit policy is allowed by the suppliers

9. • Example ( solution)
– Opening balance as on 1.1.1998 = Rs 20,000
– ADD Receipts
• Sales ( December 1997) = 20% of 50,000 = Rs 10,000
• Sales ( January 1998) = 80% of Rs 80,000 = Rs 64,000
• Total Cash = Rs 94,000
– Less Payments
• Sales commission ( for January 1998)= 5% of 80,000 = Rs 4,000
• Purchases ( for January 1998) = Rs 30,000
• Total Payments = Rs 34 000
– Closing cash balance as on 31.1.1998 = Rs 60,000

10. Management of Cash
1. Prepare the cash budget for the month of May and June 1999 from the
following information
2. Cash balance as on 1 May 1999 is Rs 8000
3. Advance tax of Rs 8000 each is payable in March and June
4. A Plant costing Rs 16,000 is due in July
5. Period of credit allowed
1. Suppliers = 2 months
2. To customers = 1 month
6. Lag in the payment of manufacturing expenses = 0.5 month
7. Lag in the payment of office and selling expenses = 1 ,month
Month Credit Sales Credit
Purchase
Wages Manufacturing
Expenses
Office
Expenses
Selling
Expenses
March 60,000 36,000 9000 4000 2000 4000
April 62,000 38,000 8000 3000 1500 5000
May 64,000 33,000 10,000 4500 2500 4500
June 58,000 35,000 8500 3500 2000 3500

11. Month May June
Opening Balance 8000 13,750
Estimated Cash Receipts 62,000(sales of April
realized in May)
64000 ( sales of May
realized in June)
Total 70,000 77,500
Estimated Cash Payments
(Credit Purchase)To suppliers ( 2
months)
36,000 38000
Wages( No Condition) 10000 8500
Manufact. Expenses 1500+2250= 3750 1750+2250= 4000
Office Expenses 1500 2500
Selling Expenses 5000 4500
Plant Expenditure Nil NIL
Advance Tax payment Nil 8000
Total 56,250 65,500
Closing Balance 13,750 (as on
31.5.1999)
12,250 (As on 30.6.1999)

12. • 2 Controlling the Inflow of Cash
– After preparing the cash budget the finance manager
should ensure that there is no deviation in the inflow
of the cash
– Any deviation from the expected cash inflow can lead
to upsetting of the whole budget activity
– The Finance manager needs to devise appropriate
techniques so that the cash coming to the firm should
not get diverted to anywhere else
– The cash should also come on time

13. Techniques to control the Inflow of Cash
– Concentration Banking
• Decentralized system of account receivables, for the firms
having their operations spread over a large geographical
area
• The firm establishes a large number of collection centers in
different geographical areas
• The collection centers deposit the cheques from the debtors
to the local branch of the bank
• The local bank transfers a certain amount of money on daily
basis to the Bank at Head office
• This results in the faster collection of the funds

14. – Advantages of Concentration Banking
– Reduction in Mailing Time
• The time required for the cheque from the customer to be
received by the firm is called mailing time. As a result if the
local collection centre the mailing time is reduced
considerably.
• Quicker collection of cash

15. Techniques to control the Inflow of Cash
– Lock Box System
• A further step in speeding up of the collection of cash.In
case of concentration banking the cheques are received by
the collection centers and then deposited in the bank by the
collection centers
• While in Lock Box System the firm hires the PO boxes and
gives the authority to the bank to pick the remittances
directly from the lock box and deposit in the forms account
directly.
• This reduces the gap further in the collection of check and
the deposit of the check
• The bank picks up the mail several times daily and deposit
the cheques in the firms account

16. • 3 Controlling the outflow of Cash
– This relates to the cash payment to be given to the
creditors
– Here the aim is totally opposite to what one has in
controlling the cash inflow
– Here we want to delay the payment as much as
possible and thus want to slowdown the process
– The combination of the faster collection and slow
disbursement leads to maximum availaiablity of funds

17. • How the Controlling the outflow of cash in done
– Decentralized system of disbursement
– Payment should be made only on the due date and
not earlier than due.

18. • 4 Investing the surplus cash
– There are 2 problems that the firm face while taking
the decision to invest the surplus cash
1. Where to invest
1. Which type of security
2. For how much time
3. Liquidity etc
2. Determine the amount of surplus cash in hand
– The cash in excess of what is considered the “normal cash
requirement” of the firm is called the excess cash.
– So FM needs to know what is the “ normal cash requirement”
– This “ normal cash requirement” is also called the safety level of
cash
– How to determine this “safety level of cash” ?
• How to determine the safety level of cash

19. • How to determine the safety level of cash
– Two cases
– Normal Period Safety level Cash
• Safety Level of cash = Desired days of cash X Avg daily cash outflow
• Example
– A FM feels that I should have sufficient funds to meet the cash requirement for 7
days and the average daily cash outflow for those 7 days is Rs 6000/day
– Safety Level of cash = 7 X 6000 = Rs 42,000
– Peak Period safety Level of cash
– Safety Level of cash = Desired days of cash X Avg daily cash outflow of
peak period
– Example : Avg daily cash outflow for the peak days was Rs 4000 and a FM
wants to have sufficient cash for the 5 peak days
– Safety Level of cash = 5X 4000 = Rs 20,000

20. • Models to determine the optimum level of cash
– Baumol Model
– Miller-Orr Model
• Baumol Model
– This model is based on minimization of 2 costs
• Carrying cost
– When the firm holds cash and it is not in circulation the firm is loosing the
opportunity to invest it somewhere. This is also called opportunity cost and in this
model it is called the carrying cost
• Transaction Cost
– When a firm has kept its cash in securities that can be converted in to cash , it has to
pay certain costs like commissions, admin costs etc. This is called the Transaction cost
– As per this model that amount of cash( both in hand and in
securities) is the optimum where total of the 2 costs in
minimum

21. • Models to determine the optimum level of cash
– Baumol Model
C = 2 X U X P
S
where
C = Optimum Cash Balance
P = Fixed cost per transaction
S = Opportunity cost of 1 Rs per annum( or per month)
U= Annual or monthly cash requirement
Example: Monthly cash requirement by the Firm Rs 60,000
Fixed cost per transaction = Rs 10
Interest rate on market securities/FD = 6% pa
Calculate the optimum cash balance

22. • Models to determine the optimum level of cash
– Baumol Model
C = 2U X P
S
C = 2 X 60,000X 10
0.005
C = Rs 15,942

23. • Models to determine the optimum level of cash
– Miller-Orr Model
– Baumol model is suitable where the cash outflow is steady and can be
predicted with accuracy in advance
– Where the cash flows are random Miller-Orr model is used
– This model consists of setting an upper limit, lower limit and return point for
the cash.
– Upper limit is represented = h
– Lower limit = O
– Return Point = z

25. • Models to determine the optimum level of cash
– Baumol Model
z = 3 3 b σ2
4 i
where
Z = Optimum Cash Balance
b = Fixed cost per transaction
σ2 = Variance of the daily net cash flow
i= interest rate on the marketable securities (per day)
This model thus also seeks to achieve the minium of the transaction and the
opportunity costs