Management of Cash Maroof Hussain Sabri
Cash Management Cash management:  the collection, concentration, and disbursement of funds Float:  funds that have been se...
Costs of Holding Cash C * Costs of holding cash Size of cash balance The investment income foregone when holding cash. Tra...
The Baumol Model <ul><li>F  = The fixed cost of selling securities to raise cash </li></ul><ul><li>T  = The total amount o...
The Baumol Model <ul><li>F  = The fixed cost of selling securities to raise cash </li></ul><ul><li>T  = The total amount o...
The Baumol Model C * Size of cash balance The optimal cash balance is found where the opportunity costs equals the trading...
The Baumol Model Opportunity Costs = Trading Costs The optimal cash balance is found where the opportunity costs equals th...
The Miller-Orr Model <ul><li>The firm allows its cash balance to wander randomly between upper and lower control limits. <...
The Miller-Orr Model Math <ul><li>Given  L , which is set by the firm, the Miller-Orr model solves for  Z  and  H </li></u...
Implications of the Miller-Orr Model <ul><li>To use the Miller-Orr model, the manager must do four things: </li></ul><ul><...
Implications of the Miller-Orr Model <ul><li>The model clarifies the issues of cash management: </li></ul><ul><ul><li>The ...
Cash Position Management <ul><ul><li>Management of short-term investing if the company has a surplus of funds and borrowin...
Collections Primary objective:  speeding up collections Collection systems: function of the nature of the business Maroof ...
Collections Perform cost-benefit analysis to determine if lockbox system worth using Maroof Hussain Sabri Lockbox system (...
Funds Transfer Mechanisms BACS / Chaps/ Swift transfers <ul><ul><li>Electronic communication that, via bookkeeping entries...
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Management Of Cash

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  • Multiply both sides by 2C, divide by K. Take a square root.
  • Management Of Cash

    1. 1. Management of Cash Maroof Hussain Sabri
    2. 2. Cash Management Cash management: the collection, concentration, and disbursement of funds Float: funds that have been sent by the payer but not yet usable funds to the company Maroof Hussain Sabri Cash manager responsible for <ul><ul><li>Cash management </li></ul></ul><ul><ul><li>Financial relationships with banks </li></ul></ul><ul><ul><li>Cash flow forecasting </li></ul></ul><ul><ul><li>Investing and borrowing </li></ul></ul><ul><ul><li>Development and maintenance of information systems for cash management </li></ul></ul>Mail float Processing float Availability float Clearing float Time
    3. 3. Costs of Holding Cash C * Costs of holding cash Size of cash balance The investment income foregone when holding cash. Trading costs increase when the firm must sell securities to meet cash needs. Maroof Hussain Sabri Opportunity Costs Trading costs Total cost of holding cash
    4. 4. The Baumol Model <ul><li>F = The fixed cost of selling securities to raise cash </li></ul><ul><li>T = The total amount of new cash needed </li></ul><ul><li>K = The opportunity cost of holding cash, a.k.a . the interest rate. </li></ul>Time 1 2 3 Maroof Hussain Sabri C C 2 – If we start with £ C , spend at a constant rate each period and replace our cash with £ C when we run out of cash, our average cash balance will be . C 2 – The opportunity cost of holding is C 2 – C 2 – × K
    5. 5. The Baumol Model <ul><li>F = The fixed cost of selling securities to raise cash </li></ul><ul><li>T = The total amount of new cash needed </li></ul><ul><li>K = The opportunity cost of holding cash, a.k.a . the interest rate. </li></ul>Time As we transfer £ C each period we incur a trading cost of F each period. 1 2 3 Maroof Hussain Sabri C C 2 – – T C If we need £ T in total over the planning period we will pay £F times . The trading cost is × F – T C
    6. 6. The Baumol Model C * Size of cash balance The optimal cash balance is found where the opportunity costs equals the trading costs Maroof Hussain Sabri Trading costs F K T C   2 * Opportunity Costs K C  2
    7. 7. The Baumol Model Opportunity Costs = Trading Costs The optimal cash balance is found where the opportunity costs equals the trading costs Multiply both sides by C Maroof Hussain Sabri F C T K C    2 F T K C    2 2 K F T C    2 2 K TF C 2 * 
    8. 8. The Miller-Orr Model <ul><li>The firm allows its cash balance to wander randomly between upper and lower control limits. </li></ul>£ Time When the cash balance reaches the upper control limit H cash is invested elsewhere to get us to the target cash balance Z . When the cash balance reaches the lower control limit, L, investments are sold to raise cash to get us up to the target cash balance. Maroof Hussain Sabri H Z L
    9. 9. The Miller-Orr Model Math <ul><li>Given L , which is set by the firm, the Miller-Orr model solves for Z and H </li></ul><ul><li>where  2 is the variance of net daily cash flows. </li></ul><ul><li>The average cash balance in the Miller-Orr model is </li></ul>Maroof Hussain Sabri
    10. 10. Implications of the Miller-Orr Model <ul><li>To use the Miller-Orr model, the manager must do four things: </li></ul><ul><ul><li>Set the lower control limit for the cash balance. </li></ul></ul><ul><ul><li>Estimate the standard deviation of daily cash flows. </li></ul></ul><ul><ul><li>Determine the interest rate. </li></ul></ul><ul><ul><li>Estimate the trading costs of buying and selling securities. </li></ul></ul>Maroof Hussain Sabri
    11. 11. Implications of the Miller-Orr Model <ul><li>The model clarifies the issues of cash management: </li></ul><ul><ul><li>The best return point, Z , is positively related to trading costs, F , and negatively related to the interest rate K . </li></ul></ul><ul><ul><li>Z and the average cash balance are positively related to the variability of cash flows. </li></ul></ul>Maroof Hussain Sabri
    12. 12. Cash Position Management <ul><ul><li>Management of short-term investing if the company has a surplus of funds and borrowing arrangements if company has a temporary deficit of funds </li></ul></ul>Cash position management : collection, concentration, and disbursement of funds on a daily basis Smaller companies set target cash balance for their current (Checking) accounts. Maroof Hussain Sabri Bank account analysis statement <ul><ul><li>Bank provides report to its customers to show recent activity in firms’ accounts. </li></ul></ul><ul><ul><li>Banks cannot pay interest on corporate Current (checking) account balances. </li></ul></ul><ul><ul><li>Firms use earnings credit for balances to offset charges. </li></ul></ul>
    13. 13. Collections Primary objective: speeding up collections Collection systems: function of the nature of the business Maroof Hussain Sabri Field-banking system <ul><ul><li>Collections are made over the counter (retail) or at a collection office (utilities). </li></ul></ul>Mail-based system <ul><ul><li>Mail payments are processed at companies’ collection centers. </li></ul></ul>Electronic payments <ul><ul><li>Becoming increasingly popular because they offer advantages to both parties. </li></ul></ul>
    14. 14. Collections Perform cost-benefit analysis to determine if lockbox system worth using Maroof Hussain Sabri Lockbox system (USA) <ul><ul><li>Speeds up collections because it affects all components of float. </li></ul></ul><ul><ul><li>Customers mail payments to a post office box. </li></ul></ul><ul><ul><li>Firm’s bank empties the box and processes each payment and deposits the payments in the firm’s account. </li></ul></ul><ul><ul><li>Lockboxes reduce mail and clearing time. </li></ul></ul><ul><ul><li>FVR = float value reduction in dollars </li></ul></ul><ul><ul><li>r a = cost of capital </li></ul></ul><ul><ul><li>LC = annual operating cost of the lockbox system </li></ul></ul>
    15. 15. Funds Transfer Mechanisms BACS / Chaps/ Swift transfers <ul><ul><li>Electronic communication that, via bookkeeping entries, removes funds from the payer’s bank and deposits the funds in the payee’s bank. </li></ul></ul><ul><ul><li>Bacs – bankers automated clearing system (4 days) </li></ul></ul><ul><ul><li>Chaps Clearing Houses Automated payment system (Same day transfers) </li></ul></ul><ul><ul><li>Swift – International Payments Mechanism </li></ul></ul>Maroof Hussain Sabri Depository transfer checks (USA) <ul><ul><li>Unsigned check drawn on one of the firm’s bank accounts and deposited in another of the firm’s bank accounts </li></ul></ul>Automated direct debit transfers <ul><ul><li>Preauthorized electronic withdrawal from the payer’s account </li></ul></ul><ul><ul><li>Settle accounts among participating banks. Individual accounts are settled by respective bank balance adjustments. </li></ul></ul><ul><ul><li>Transfers clear in one day. </li></ul></ul>

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