The document discusses cash management. It defines cash and describes cash management as managing cash flows in and out of a firm, within a firm, and cash balances. There are four facets of cash management: cash planning, managing cash flows, optimal cash level, and investing surplus cash. Firms hold cash for transaction, precautionary, speculative, and compensating motives. The objectives of cash management are to meet payment schedules and minimize idle cash. Methods to manage cash include accelerating collections and controlling disbursements. The Baumol and Miller-Orr models provide frameworks for determining optimal cash levels.

1. CASH
MANAGEMENT
Prabhjot Singh Longia
Prince Kaushal
Puneet Walia
Shubhpreet Kaur
LMTSOM THAPAR UNIVERSITY

2. WHAT IS CASH?
• In narrow sense: currency and generally accepted
equivalents of cash like cheques, drafts etc.
• In broad sense: includes near-cash assets, such as
marketable securities and time deposits in banks.
– They can be readily sold and converted into cash.
– Can serve as a reserve pool of liquidity.
– Also provide short term investment outlet for excess cash.

3. Cash management
• Cash management is concerned with the managing
of:
– cash flows into and out of the firm,
– cash flows within the firm, and
– cash balances held by the firm at a point of time by
financing deficit or investing surplus cash

4. Four Facets of Cash Management
• Cash planning
• Managing the cash flows
• Optimum cash level
• Investing surplus cash

5. Motives for holding cash
• Transaction motive
• Precautionary motive
• Speculative motive
• compensating motive

6. Transaction motive
• Holding of cash to meet routine cash requirements
to finance the transactions which a firm carries on in
the ordinary course of business.

7. Precautionary motive
• The cash balances held in reserve for random and
unforeseen fluctuations in cash flows.
• A cushion to meet unexpected contingencies.
– Floods, strikes and failure of imp customers
– Unexpected slowdown in collection of accounts
receivable
– Sharp increase in cost of raw materials
– Cancellation of some order of goods
• Defensive in nature

8. Speculative motive
• Is a motive for holding cash/near-cash to quickly take
advantage of opportunities typically outside the
normal course of business.
• Positive and aggressive approach
• Helps to take advantage of:
– An opportunity to purchase raw materials at reduced price
– Make purchase at favorable prices
– Delay purchase on anticipation of decline in prices
– Buying securities when interest rate is expected to decline

9. Compensating motive
• Is a motive for holding cash/near-cash to
compensate banks for providing certain services or
loans.
• Clients are supposed to maintain a minimum balance
of cash at the bank which they cannot use
themselves.

10. Objectives of cash management
• Meeting payments schedule
– It prevents insolvency
– relationship with bank is not constrained
– Helps in fostering good relationships
– Cash discount can be availed
– Strong credit rating
– Take advantage of business opportunities
– Can meet unanticipated cash expenditure with a minimum
of strain.
• Minimizing funds committed to cash balances
– High level of cash: large funds remain idle
– Low level of cash: failure to meet payment schedule

11. Managing Cash Collections and
Disbursements
• Accelerating Cash Collections
• Controlling Disbursements

12. Accelerating Cash Collections
1. Decentralised Collections
 number of collection centres
 Collection centres will collect cheques from customers and
deposit in their local bank accounts
 They will deposit the funds to a central bank

13. Accelerating Cash Collections
Contd…….
2. Lock-box System
– Collection centers are established considering the customer locations
and volume of remittances
– At each centre the firm hires a post office box
– Remittances are directly picked from the bank whom the firm gives
the authority
Advantages of lock-box system are
– cheques are deposited immediately upon receipt of remittances
– Eliminates the period between the time cheques are received by the
firm and the time they are deposited in the bank for collection

14. Controlling Disbursements
It means delay the payments as much as possible. Can help
the firm in conserving cash and reducing the financial
requirements.
Disbursement or Payment Float

15. The size of the minimum cash balance depends on:
• How quickly and cheaply a organization can raise cash when
needed.
• How accurately managers can predict cash requirements.
Cash budget helps in this .
• How much precautionary cash the managers need for
emergencies.

16. The organization’s maximum cash balance depends on:
• Availability of (short-term) investment opportunities
– e.g. money market funds, CDs, commercial paper
• Expected return on investment opportunities.
– e.g. If expected returns are high, organizations should be
quick to invest excess cash
• Transaction cost of withdrawing cash and making an
investment
• Demand for Cash for daily transactions

17. BAUMOL MODEL
Bumol recognized the similarities between cash and
inventory management. He extended the economic
order quantity (EOQ) model to examine its
implications to cash management. The Baumol
model assumes the cash manager invests excess
funds in interest bearing securities and liquidates
them to meet the firm’s demand for cash. As
investment returns increase, the opportunity cost of
holding cash increases and the cash manager
decreases cash balances. As transaction costs (cost
of liquidating short-term investments) increase, the
cash manager decreases the number of times he
liquidates securities, leading to higher cash balances.

18. It has certain assumptions as follows
(a)The firm can predict its future cash requirements with
certainty.
(b) The cash disbursements (outflow payments) are spread
uniformly over the period.
(c) The interest rate (which is the opportunity cost of holding
cash) is fixed.
(d) The firm will pay a fixed transactions cost each time it
converts marketable securities into cash.

19. Explanation
• The firm incurs a holding cost for keeping the
cash balance. It is an opportunity cost; that is,
the return foregone on the marketable Holding Cost = i*C/2
securities. If the opportunity cost is (i), then the
firm’s holding cost for maintaining an average
cash balance is as follows:
• The firm incurs a transaction cost whenever it
converts its marketable securities to cash. Total Transactional cost= b*T/C
number of transactions during the year will be
total funds requirement, T, divided by the cash
balance, C, i.e., T/C. The per transaction cost is
assumed to be constant. If per transaction cost
is b, then the total transaction cost will be:
• The total annual cost of the demand for cash Total Cost = i*C/2 + b*T/C
will be:
• The optimum cash balance, C*, is obtained
when the total cost is minimum. The formula for C=SQRT (2b*T/i)
the optimum cash balance is as follows:

20. Optimum Cash Balance under Certainty: Baumol’s Model
GRAPHICAL REPRESENTATION

21. EXAMPLE to clarify Baumol’s Model
• JAYSHREE CHEMICAL Limited estimates its total cash requirement as Rs 4 crore next year.
The company’s opportunity cost of funds is 15% per annum. The company will have to
incur Rs 300 per transaction when it converts its short-term securities to cash. Determine
the optimum cash balance. How much is the total annual cost of the demand for the
optimum cash balance? How many deposits will have to be made during the year?
OPTIMUM CASH BALANCE = SQRT (2bT/i)
= SQRT (2*300*4,00,00,000/0.15)
=4,00,000 rs
Annual cost = Holding cost + Transaction cost

22. Holding cost = i*C/2
= 0.15* 4,00,000/2 = 30,000
Transaction cost = b*T/C
= 300 * 4,00,00,000/4,00,000 = 30,000
TOTAL COST = 30,000+30,000 = Rs. 60,000
NUMBER OF DEPOSITS TO BE MADE IN A YEAR = T/C
= 4,00,00,000/4,00,000 = 100

23. limitations of the Baumol model
 Assumes a constant disbursement rate
 Ignores cash receipts during the period
 Doesn't allow for safety cash reserves

24. Miller-Orr Model
Allows Daily Cash Flow Variation
Provides two control limits
1)Upper Control Limit
2)Lower Control Limit
& Return Point
The Difference depends upon
1) The Transaction Cost (c)
2) The Interest Rate (i)
3) The Standard Deviation of net cash flow (σ)

25. Formulae
(Upper limit- Lower Limit)=( 3/4 x transaction cost X variance of cash flows )1/3
interest rate
Symbolically (Z)= ( 3/4 x cσ²/i )1/3
Upper Limit= Lower Limit + 3Z
Return Point= Lower Limit + Z
Average Cash Balance = Lower Limit +4/3 Z

26. Example
• Xyz Company has a policy of maintaining cash balance of Rs. 5,00,000.
The Standard deviation of company’s daily cash flow is Rs 2,00,000. The
Annual Interest Rate is 14%. Transaction cost of buying or selling is Rs. 150
per transaction.
• (Z)= ( 3/4 x 150x2,00,000²) 1/3 = Rs 2,27,227
.14/365
Upper limit =Lower limit +3Z=5,00,000+3(2,27,227)= Rs 11,81,680
Return Point=Lower limit +Z=5,00,000+2,27,227= Rs 7,27,227
Av. Cash Balance =Lower limit +4/3Z
=5,00,000+4/3(2,27,227)= Rs 802,969

27. Investing Surplus Cash in
Marketable Securities
• Selecting Investment Opportunities:
– Safety
– Maturity
– Marketability

28. Thank You