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PREETI PERIWAL NAVEEN V. NISHANT YADAV RAJIV SAH HARSHIT JAIN SUMAN D.
Cont.
The finance manager who is responsible for cash management also controls the transactions that affect the firms investment in marketable securities. In case of excess cash , marketable securities are purchased and in the case of shortage of cash , a part of the marketable securities is liquidated to procure enough cash.
Most widely used method for preparing cash budget is the receipt and disbursement method. Most suitable for companies facing uncertainty regarding their cash flows.
Lock box system: Eliminates the time gap between the collection centers and deposition of collection into companies account in a local bank. Zero balance account: Cash balance is transferred to zero balance account to purchase marketable security and maintain the accounts balance zero.
FLOAT SYSTEMS
Float is an important technique to lessen the length of the cash cycle in order to control of cash cycle in order to control of cash inflows and outflows. The float system is of two type:
a) Collection float:
The time needed by the bank to clear a cheque Cheque issued but not paid by the bank.
b) Payment float:
BAUMOLS MODEL
This model provides utility & usage for cash management problem. In this model, the carrying cost of holding cash like interest foregone on marketable securities is balanced against the fixed cost of transferring marketable securities to cash n vice-versa. This model finds a correct balance by combining holding cost & transaction cost so as to minimize the total cost of holding cash.
This model finds a correct balance by combining holding cost & transaction cost so as to minimize the total cost of holding cash. The firm incurs a holding cost for keeping the cash balance. It is an opportunity cost; that is, the return foregone on the marketable securities. If the opportunity cost is k, then the firms holding cost for maintaining an average cash balance is as follows: Holding cost= k(C/2) The firm incurs a transaction cost whenever it converts its marketable securities to cash. Total 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 c, then the total transaction cost will be: Transaction cost= c(T/C)
The optimum level of cash balance is found by the formula:C= 2BT I Where C= Optimum transaction size B= Fixed cost per transaction T= Estimated cash payment during the period I= Interest on marketable securities p.a.
EXAMPLE
A ltd. has an estimated cash payment of Rs. 8,00,000 for 1 month period & the payments are expected to be steady over the period. The fixed cost per transaction is Rs.250/- & the interest rate on marketable securities is 12% p.a. Calculate the optimal transaction size.
The optimal transaction size will be calculated by using the formula: C= 2BT I Now, for 1 period the rate of interest is 1% or 0.01 Therefore optional cash balance is.
C=
2*250*8,00,000
Average cash balance = 2,00,000 2 No. of transactions of marketable securities: = 8,00,000 2,00,000 = 4 Transactions
MILLER-0RR MODEL
Miller and Orr model have expanded the baumols model, which is not applicable if the demand for cash is not steady. This model argues that changes in cash balance over a given period are random in size as well as in direction. The cash balance of the business firm may fluctuate irregularly over a period of time.
The Miller and Orr model of cash management is one of the various cash management models in operation. It is an important cash management model as well. It helps the present day companies to manage their cash while taking into consideration the fluctuations in daily cash flow.
ASSUMPTIONS
The major assumptions with this model is that there is no underlying trend in cash balance over time. The optimal values of H and Z depend not only on the fixed and opportunity costs but also on the degree of likely fluctuations in cash balances. This model specifies the following two control limits: H = Upper control limit O = Lower control limit Z = The return point for cash balances The formula for calculation of spread between the control limits is 1/3 = 3/4 * transaction cost * variance of cash flows interest rate
EXAMPLE
Interest rate per day/annum Transaction cost per sale S.D. of cash flows per day/annum Cash balance lower limit = .03/10.95% = Rs.20 = Rs.3000 = Rs.20000
2
1/3
=Rs.7656/Hence the upper control limit is equal to the lower limit of Rs.20000 plus the spread of Rs.7656 i.e. Rs27656/-
The return point is equal to the lower limit of Rs.20000 plus the spread of Rs,7656/3 =Rs.22552
Therefore, the firms cash management policy should be based on lower and upper limits of Rs.20000 and Rs.27656 respectively and the need to initiate action to keep within those limits should not move outside this band.
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