Cash & liquidity management


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Cash & liquidity management

  1. 1. Cash & Liquidity Prabhat Mittal 1
  2. 2. Session Outline • Cash & Cash Management • Motives of holding cash • Cash Budget • Methods of Budgeting • Cash Management Models • Money Market Investment OptionsPut your queries on 2
  3. 3. Cash & Cash Management • Cash Planning • Cash Forecasting: Cash Management o Receipt & Disbursement Method Cash means Liquid o Adjusted Net Income Method Assets that a Business Owns. It includes Cheques, Money Orders • To meet Cash Disbursement as per & Bank Drafts Payment Schedule Objectives of Cash • To meet Cash Collection as per Cash Management Management Repayment Schedule means efficient • To minimize funds locked up as Cash Collection & Balance by maintaining optimum cash Disbursement of cash balance and any Temporary Investment of Cash • Transaction Motive Motives of Holding Cash • Speculative Motive • Precautionary MotivePut your queries on
  4. 4. Motives of holding cash Need for cash Cash facilitates the meeting of the day-to-day expenses Transaction Need and other debt payments. Cash may be held in order to take advantage of Speculative Needs profitable opportunities Cash may be held to act as for providing safety against Precautionary Needs unexpected events.Put your queries on 4
  5. 5. Cash Budget • Helpful in Planning • Controlling Cash Expenditure Functions • Testing the Influence of Proposed /Importance of Expansion Cash Budget Cash Budget means • Basis of Long Term Planning & Co- estimation of Cash ordination Receipt and Cash Disbursement during a future period of Time Methods of • Receipts & Payment Method Preparing Cash • Adjusted Profit & Loss Account Method Budget Cash Budget is a forecast of future Cash Receipts and Cash Disbursement over various intervals of • Treasury Bills Time Investment of • Inter-Corporate Deposits Surplus Cash • Investment in Market Securities • Short term FD’sPut your queries on 5
  6. 6. Methods of Budgeting • Receipts and Payments Method: In this method all the expected receipts and payments for budget period are considered. All the cash inflow and outflow of all functional budgets including capital expenditure budgets are considered (used for short term forecasting) • Adjusted Income Method: In this method the annual cash flows are calculated by adjusting the sales revenues and cost figures for delays in receipts and payments (change in debtors and creditors) and eliminating non-cash items such as depreciation (used for long term forecasting)Put your queries on 6
  7. 7. Illustration You are given below the Profit & Loss Accounts for two years for a company, Sales are expected to be ` 12,00,00,000 in year 3. As a result, other expenses will increase by `50,00,000 besides other charges. Only raw materials are in stock. Assume sales and purchases are in cash terms and the closing stock is expected to go up by the same amount as between year 1 and 2. You may assume that no dividend is being paid. The Company can use 75% of the cash generated to service a loan. How much cash from operations will be available in year 3 for the purpose?Put your queries on 7
  8. 8. IllustrationPut your queries on 8
  9. 9. Illustration … project profit and loss accountPut your queries on 9
  10. 10. Illustration………Cash Flow Available for servicing the loan: 75% of ` 2,54,00,000 or ` 1,90,50,000Put your queries on 10
  11. 11. Controlling of Cash Flows Accelerate Cash Flows Decelerating Cash Flows Cash Flows means Paying on Last Date • Prompt Payment by Customers • Cash Inflows and Cash • Payable through Draft Outflows Adjusting Payroll Funds • Quick conversion of payment • into Cash • Centralization of Payments If Cash Inflows are Making use of Float • Decentralized Collection • more than Cash Outflows, it is Positive Cash Flow and vice- versaPut your queries on 11
  12. 12. Float The term float is used to refer to the periods that affect cash as it moves through the different stages of the collection process. Four kinds of float with reference to management of cash are: Billing Float Mail Float The time between the sale and the mailing This is the time when a cheque is being of the invoice is the billing float. processed by post office, messenger service or other means of delivery. Cheque Processing Float Banking Processing Float This is the time required for the seller to This is the time from the deposit of the sort, record and deposit the cheque after it cheque to the crediting of funds in the has been received by the company. sellers account.Put your queries on 12
  13. 13. Cash Management Models The purpose of cash management models is to ensure that cash does not remain idle unnecessarily and at the same time the firm is not confronted with a situation of cash shortage. All these models can be put in two categories:- • Inventory type models; and • Stochastic models. Inventory type models (economic order quantity ) applies equally to cash management problems under conditions of certainty or where the cash flows are predictable. However, where cash flows are not predictable, Stochastic models are used.Put your queries on 13
  14. 14. Baumol’s EOQ Model According to this model, optimum cash level is that level of cash where the carrying costs and transactions costs are the minimum. The formula for determining optimum cash balance is:Put your queries on 14
  15. 15. EOQ ModelPut your queries on 15
  16. 16. Illustration A firm maintains a separate account for cash disbursement. Total disbursement are ` 1,05,000 per month or ` 12,60,000 per year. Administrative and transaction cost of transferring cash to disbursement account is ` 20 per transfer. Marketable securities yield is 8% per annum. Determine the optimum cash balance according to William J. Baumol model. The optimum cash balance C =Put your queries on 16
  17. 17. Miller-Orr Cash Model This model is designed to determine the time and size of transfers between an investment account and cash account. In this model control limits are set for cash balances. These limits may consist of h as upper limit, z as the return point; and zero as the lower limit. • When the cash balance reaches the upper limit, the transfer of cash equal to h – z is invested in marketable securities account. • When it touches the lower limit, a transfer from marketable securities account to cash account is made. • During the period when cash balance stays between (h, z) and (z, 0) i.e. high and low limits no transactions between cash and marketable securities account is made.Put your queries on 17
  18. 18. Miller-Orr Cash Model According to this model the net cash flow is completely stochastic. 3𝑏𝑏𝜎𝜎 2 � + 𝐿𝐿𝐿𝐿 3 4𝐼𝐼 UL = 3RP – 2LL where: RP = return point b = fixed cost per order for converting marketable securities into cash. I = daily interest rate earned on marketable securities σ 2 = variance of daily changes in the expected cash balance LL = the lower control limit UL = the upper control limitPut your queries on 18
  19. 19. Money Market Investment Options for Surplus Funds Investment Description Maturity Liquidity 91 days, 182 days Treasury Bills Issued by GOI, sold at discount Very liquid and marketable And 364 days Offers interest higher then the Liquid, penal interest charged Fixed Deposits 15 days to 5 years Treasury bills on premature cancellation Large value, issued by banks at Certificate of Deposits (CD) 7 to 365 days Fairly Liquid discount Unsecured debt issued by Commercial Paper (CP) 7 to 365 days Secondry market is not liquid companies Inter Corporate Deposits mad by one firm with 90 to 180 days Illiquid Deposits (ICD) another. Mutual funds investing in liquid, No minimum Money Market Mutual Funds Liquid Short-term securities periodPut your queries on 19