Cash Management

Cash is the most liquid asset of all and is vital for existence of any business firm. Its efficient

management is crucial to the solvency of the business because as we all know cash is the focal

point of the funds flows in a business.

It can be understood in two senses, one is actual cash held by firm and deposits withdraw able on

demand, and in another sense it includes marketable securities, which can be convertible into cash

immediately. The goal of cash management is to reduce the amount of cash that is being used

within the firm so as to increase profitability, but without reducing business activities or exposing

the firm to undue risk in its financial obligations.

Cash flows in connection with credit serve to introduce the concept of FLOAT which is the time

lag or delay between the moment of disbursement of funds on the part of the customer and the

moment of receipt of funds on the part of the seller (i.e., mail time, processing time, and clearing

time with the banking system).

What factors must be considered when deciding on the appropriate amount of cash to hold?

Cash in checking accounts must be held so that bills are paid on time (transactions balance), for

emergencies such as strikes, weather disruptions, etc. (Precautionary balance), bank requirements

for loans or other services provided (Compensating balance), and for taking advantage of

bargains (speculative balance).

Motives for holding cash

1. The transaction motive: Firms are in existence to create products or provide services. The

providing of services and creating of products results in the need for cash inflows and outflows.

Firms hold cash in order to satisfy the cash inflow and cash outflow needs that they have.

2. The precautionary motive: Holding cash as a precaution serves as an emergency fund for a

firm. If expected cash inflows are not received as expected cash held on a precautionary basis

could be used to satisfy short-term obligations that the cash inflow may have been bench marked


3. Compensating motive: Banks provide a variety of services to business firms, such as

clearance of cheque, supply of credit…etc., for which a minimum balance is required to be kept

with the bank, this balance is to compensate banks for services rendered.

4. The speculative motive: Economist Keynes described this reason for holding cash as

creating the ability for a firm to take advantage of special opportunities that if acted upon quickly

will favor the firm. An example of this would be purchasing extra inventory at a discount that is

greater than the carrying costs of holding the inventory.

Cash management is concerned with the managing of:

1. Cash flows into & out of the firm,

2. Cash flows within the firm

3. Cash balances held by the firm at a point of time by financing deficit or investing surplus


Factors that affect the cash needs:-

Cash Cycle:

Cash Outflow Cash Inflow

Cost of Cash Balance

Other Considerations


While a company's demand for cash has already been discussed above, it does not always keep

the entire amount in the form of cash balance in the current account for the simple reason that the

opportunity cost of idle cash is considerably high. That is why, companies try to maintain, besides

cash, other liquid assets which provide some return but at the with relatively low risk. Let us first

consider the forms of liquidity and then the choice of liquidity mix.

Forms of Liquidity

Cash Balance in the Current Account: This is the highest form of liquid asset a company can

conceive of, but the return provided by it is nil. However, companies maintain approximately four

to five per cent of their total assets, on the average, in this form despite no returns for reasons

already explained.

Keeping Reserve Drawing Power Under Cash Credit/ Overdraft Arrangement: This form of

liquidity appears to be quite attractive as it can have access to bank borrowing. However,

constraints imposed by to be. Close scrutiny of the quarterly budgets of the company by banks

and imposition of penal interest of two per cent over and above the normal rate of interest on

under- or over – utilization make this form more tedious and time consuming. However, a built-in

cushion may possibly be included while preparing the quarterly budgets and during some periods

the full amount may be drawn. The tax benefit on the interest makes effective after – tax – rate to

be much less costly, even if part of it is held in the form of idle cash. This not only helps as a

liquid source but also helps in obtaining equal or higher limits during the forthcoming year.

Marketable Securities: These are short – term securities of government such as treasury bills

and other gilt edged securities whose default risk is nil and, for that very reason, the return is low.

It is preferable to ensure the maturity structure of these short-term securities with the likely

periods of excessive cash drain on the part of the company. Then, the transaction costs can be

considerably minimized as early liquidation prior to maturity may result in low return from these


Investment in Inter-Corporate Deposits: A company can invest money with other companies

in the form of short – term deposits ranging from two or three months to five or six months at

remunerative rates. However, these deposits being unsecured in nature, are subject to

considerable risk, unless the companies accepting such deposits have excellent antecedents as to

their paying habits.

From among the different forms of liquidity available to a company a deliberate choice has to be

made in selecting an appropriate mix that suits the liquidity requirements of the company and

disposition of its management towards risk.


The choice of selecting the portfolio of cash and near cash assets also known as the choice of

liquidity mix is governed by a variety of factors which are briefly explained below:

Uncertainty Surrounding Cash Flow Projections: It is generally said that the only certain

factor in the corporate environment is its uncertainty. Even if cash flow projections have been

made with the utmost care the general uncertainty can at times make the projections go awry.

However the degree of uncertainty is more in certain types of industries than in others. For

example general engineering industry is more recession prone than others. Consequently, the

onset of recession which was not anticipated may call for a thorough revision of cash flows and

policy changes in respect of products plans, dividend payments etc. Similarly tea plantations can

get adversely affected with an untimely hailstorm. Even within the same company which is stable

and growing certain types of cash flows, especially collections and payables tend to be more

uncertain than others. When the degree of uncertainty is high as evidenced by the sensitivity of

cash forecasts to adverse changes in some of the underlying assumptions, the company will do

well to have the liquidity mix tilted largely towards cash balance and in so far as possible reserve

drawing powe3r under the cash credit / overdraft arrangement and to a less extent gilt – edged

securities. On the other hand certain types of industries such as synthetic fabrics, electrical

appliances enjoy stable and growing demand. Once a company has established its image the

degree of uncertainty surrounding cash flow projections will be comparatively less. Consequently

the liquidity mix of such companies will be tilted more towards marketable securities and intercorporate


Attitude of the Management towards Risk: When the management of the company attaches

greater importance to a given percentage increase in return than to the same percentage increase

in liquidity, the portfolio of liquidity mix chosen tends to have a higher proportion of cash

balance and marketable securities and cash balances.

When the attitude of the management towards risk is quite conservative the liquidity mix chosen

tends to have a higher proportion of cash balance and marketable securities and a lower

proportion of intercorporate deposits.

Ability to Raise Non – bank funds and / or Control its Cash Flows: When a company is

favourably placed in a position have ready access to non – bank funds it can afford to have less

proportion of cash and more of intercorporate deposits and marketable securities. This ind of a

situation arises mostly in the case of group companies. For example, when a manufacturing

company promoted by a group faces cash shortage, a

Finance and Investment Company promoted by the same group can come to its rescue by

providing funds. Such a company need not maintain a large portion of its liquid assets in the form

of cash. Similarly, companies, which can control its cash flows effectively, need not hold a large

proportion of idle cash in their liquidity mix. This kind of situation can arise in the cash of

companies that have horizontal or vertical integration. For example a manufacturing company,

which has got substantial interest and / or has promoted another company for the supply of raw

materials the company can exercise greater control on payables. On the other hand, companies

which do not enjoy ready access to non – bank sources of funds and / or not in a position to

control cash flows may have to have greater proportion of cash and reserve drawing power in

their liquidity mix.

Cash Planning

Cash planning is a technique to plan and control the use of cash. Cash Forecasting and Budgeting

– Cash budget is the most significant device to plan for and control cash receipts

and payments.

– Cash forecasts are needed to prepare cash budgets.

Short-term Cash Forecasts The important functions of short-term cash forecasts

To determine operating cash requirements

To anticipate short-term financing

To manage investment of surplus cash.

Short-term Forecasting Methods

» The receipt and disbursements method

» The adjusted net income method.

Receipt and Disbursements Method

The virtues of the receipt and payment methods are:

It gives a complete picture of all the items of expected cash flows.

It is a sound tool of managing daily cash operations.

This method, however, suffers from the following limitations:

Its reliability is reduced because of the uncertainty of cash forecasts. For

example, collections may be delayed, or unanticipated demands may cause large disbursements.

It fails to highlight the significant movements in the working capital


Adjusted Net Income Method

The benefits of the adjusted net income method are:

It highlights the movements in the working capital items, and thus helps

to keep a control on a firm's working capital.

It helps in anticipating a firm's financial requirements.

The major limitation of this method is:

It fails to trace cash flows, and therefore, its utility in controlling daily

cash operations is limited.

Long-term Cash Forecasting

The major uses of the long-term cash forecasts are:

It indicates as company's future financial needs, especially for its

working capital requirements.

It helps to evaluate proposed capital projects. It pinpoints the cash

required to finance these projects as well as the cash to be generated by the company to support


It helps to improve corporate planning. Long-term cash forecasts compel

each division to plan for future and to formulate projects carefully.

Managing Cash Collections and Disbursements

Accelerating Cash Collections

– Decentralised Collections

Controlling Disbursements

– Lock-box System

– Disbursement or Payment Float

Features of Instruments of Collection in India

How to accelerate cash collections?

Decentralized collections

Lock-box system

Prompt payment by Customers

Early conversion of payment into cash

Objective of Cash Management

i) Meeting the cash outflows

ii) Minimizing the Cash Balance

Instrument Pros Cons

1.Cheques No charge

Payable through clearing

Can be discounted after receipt

Low discounting charge

Requires customer limits which are interchangeable

with overdraft limits

Can bounce

Collection times can be long

Collection charge

2.Drafts Payable in local clearing

Chances of bouncing are less

Cost of collection

Buyers account debited on day one

3.Documentary bills Low discounting charge

Theoretically, goods are not released till

payments are made or the bill is accepted

Not payable through clearing.

High collection cost

Long delays


4.Trade bills No charge except stamp duty

Can be discounted.

Discipline of payment on due date.

Procedure is relatively cumbersome

Buyers are reluctant to accept the due date


5.Letters of credit Good credit control as goods are released

on payment or acceptance of bill.

Seller forced to meet delivery schedule

because of expiry date.

Opening charges

Transit period interest

Negotiation charges

Need bank lines to open LC.

Stamp duty on usance bills

Ways to Improve Collection of Cash

A. Changing customer paying habits

1.Letters, telephone calls, or personal visits

2.Economic incentive for paying bills faster; offer discounts

B. Improve the Delivery system (reduce the negative float)

1.Regional banking (customers pay bills to banks since they can transfer funds more quickly than

mail order delivery).

2.Lockbox collection system (firm rents a post office box in a particular city and the bank

monitors the lockbox periodically).

3.Electronic communications (i.e., data-phone wire systems).

C. Bypass the problem (Factoring of receivables).


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