This document provides an overview of cash management. It discusses the motives for holding cash, principles of cash management including collection and disbursement management, cash forecasting, and models for determining the optimal mix of cash and marketable securities. The Baumol and Miller-Orr models are described as approaches to determine the optimal level of cash holdings under conditions of certainty and uncertainty.

1. CASH MANAGEMENT
CHAPTER
24

2. CONTENTS
 Introduction
 Motives for Holding Cash
 Cash Flow Process and its Relevance
 Principles of Cash Management
 Collection and Disbursement Management
 Collection Float and its Impact on Profitability
 Cash Forecasting
 Cash vs. Marketable Securities
 Baumol Model
 Miller-Orr Model
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3. INTRODUCTION
 Cash is the most liquid but least productive
current asset.
 The higher the cash in hand and bank
balance, the stronger is the liquidity position.
 But the funds tied up in cash in hand and in
current accounts of banks give a yield of zero.
 The determination of optimal cash balance
assumes importance, as it affects the
profitability–liquidity position of the firm.
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4. INTRODUCTION
 Maximizing cash availability while simultaneously
minimizing idle cash is the thrust of cash
management.
 The two seemingly contradictory objectives of cash
management-maximizing the cash availability and
also the interest income-can be achieved through:
 Managing collections and disbursements
 Reliable forecasting and reporting systems
 Maximizing interest income by selecting the
optimal mix of cash (held for transaction
requirements) and marketable securities.
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5. MOTIVES FOR HOLDING
CASH
 Transactionary motive
 Precautionary-motive
 Speculative-motive
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6. CASH FLOW PROCESS AND ITS
RELEVANCE
 Cash is the lifeblood of a business.
 Lack of a perfect synchronization of inflows and
outflows make cash management important.
 In cases where the inflows precede the outflows,
the issue of productively parking the idle cash is of
importance to the firms.
 When the outflows precede the operating inflows,
the business has to have a sufficient cash buffer to
ensure that it is able to meet outflow requirements.
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7. CASH FLOW PROCESS AND ITS
RELEVANCE
 The operating cash flows are of utmost importance from
the working capital perspective.
 The cash flow surplus from operating activities
determines liquidity health and sustainability of
operations.
 This surplus also contributes towards capital servicing and
future financing needs. Hence, its management assumes
significance for the business.
 Potentially profitable companies can fail because of poor
cash management, while apparently non-profitable
companies can be kept alive by efficient cash
management techniques.
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8. PRINCIPLES OF CASH MANAGEMENT
 The two prime objectives for the firm’s cash
management system are:
 Holding enough cash balance to carry out the
operating needs of the business.
 Minimizing funds tied up in the idle cash
balance.
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9. PRINCIPLES OF CASH MANAGEMENT
 To achieve these twin objectives, the
firms need to focus on the following
three important aspects of cash
management:
 Managing collections and disbursements
 Reliable forecasting and reporting system
 Maximizing the interest income by selecting
the optimal mix of cash and marketable
securities.
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10. COLLECTIONS AND DISBURSEMENTS
MANAGEMENT
 Cash management focuses prominently on
maximizing the availability of cash through quick
collections and slow disbursements.
 Quick collection helps the firms not only in
shortening their working capital cycle but also
in reducing their collection float.
 To ensure quick collections the firm should take
the entry points closer to the customers.
 It is important to convert the collected funds
into usable funds as quickly as possible.
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11. COLLECTIONS AND DISBURSEMENTS
MANAGEMENT
 For this the firm should reduce the
internal processing float, and transfer the
collected funds into centralized pool
quickly.
 To maximize the availability of collected
funds firms should try to delay
disbursements up to the point it does not
adversely affect relationships with
suppliers.
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12. CASH FORECASTING
 A reliable system of cash forecasting helps in
identifying the amounts of cash surpluses and
deficits along with the periods in which they fall.
 This facilitates proper resource planning.
 An accurate forecasting system forms the
bedrock of effective cash management, as cash
forecasting involves projections of all possible
cash flows expected during the forecast periods.
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13. CASH FORECASTING
 Cash forecasting is an integrated exercise that
requires information from different sources/
departments.
 The starting point of cash forecasting is the
sales projections.
 In the light of these projected sales, the other
departments like production, marketing, and
personnel prepare their respective budgets,
which are eventually integrated into the
overall cash forecast for the firm.
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14. CASH FORECASTING
 The time horizon for forecasting may range from
one day to one year, depending upon the
requirements.
 Both short-duration and long-duration forecasts
should correspond with each other.
 The process of moving from forecasts of shorter
duration to those of longer duration is known as
scheduling, while the process of moving from
long-duration forecasts to short-duration
forecasts is known as distribution.
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15. CASH VS MARKETABLE SECURITIES
 Determining the optimal cash balance
assumes significance as cash is the most
liquid but least productive current asset.
 The key issue is to determine the mix of
cash held as working balance and cash
invested in marketable securities.
 A high level of working balance reduces
the transaction costs but increases the
opportunity cost.
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16. CASH VS MARKETABLE SECURITIES
 The issue of optimal level of working balance is
resolved in the light of tradeoff of opportunity
costs and transaction costs.
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17. CASH VS MARKETABLE
SECURITIES - MODELS
 The models to determine the optimal
working balance of a firm can be classified
into two categories—certainty-based
models and uncertainty-based models.
 Certainty-based models follow the EOQ
approach of inventory management while
uncertainty-based models follow the
stochastic modeling.
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18. BAUMOL MODEL
 Baumol Model uses the EOQ method of inventory
control to determine the optimal level of working
balance under conditions of uncertainty.
 Like the EOQ model, the objective function of the
Baumol model is of cost minimization.
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19. BAUMOL MODEL
 The objective function is to minimize
the total cost. This will be done at the
point where the opportunity cost is
equal to the transaction cost.
 As per the model the optimal working
balance (C) can be calculated as:
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K
bT
2
C 
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20. MILLER-ORR MODEL
 The Miller–Orr model adopts the stochastic approach
to decisions regarding the optimal working balance.
 Following the control limits approach, the Miller–Orr
model provides two control limits
 the upper control limit,
 the lower control limit, and
 a return point.
 The firm’s cash balance is allowed to fluctuate
between the upper control limit and the lower control
limit.
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21. MILLER-ORR MODEL
 No transaction is needed, as per the model, till
the cash balance fluctuates between the upper
control limit and the lower control limit.
 Purchase or sale of marketable securities takes
place only when one of these limits is reached.
 The Return Point (R) is calculated as follows:
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3
2
K
4
bs
3
L
Point)
(Return
R 

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22. MILLER-ORR MODEL
 The Lower Control Limit (L) is set by the
management based on the past cash flow
pattern and expected future requirements.
 The upper control limit (H) is defined as follows:
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L
R
3
)
Limit
Control
Upper
(
H 

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23. MILLER-ORR MODEL
GRAPHICAL VIEW
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24. MILLER-ORR MODEL
 As can be seen in the previous figure, when the
firm’s cash flow touches the lower limit on day t2,
disinvestment of marketable securities takes place
to the tune of (R-L).
 Such a transaction brings the cash balance of the
firm back to the normal level, i.e., the Return Point
(R).
 Similarly, when the firm’s cash balance touches the
upper limit on day t5, the firm undertakes
investment transactions and buys marketable
securities to the tune of (H-R).
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25. MILLER-ORR MODEL
 Such investment transactions bring the firm
back to a normal level of cash balance, i.e.,
the Return Point (R).
 For the rest of the days no investment or
disinvestment transaction gets triggered, as
the firm’s working balance is within the upper
and the lower control limits.
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