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CASH MANAGEMENT

PREETI PERIWAL NAVEEN V. NISHANT YADAV RAJIV SAH HARSHIT JAIN SUMAN D.

CONCEPT OF CASH MANAGEMENT


Cash management helps to maintain the balance between the twin objectives of liquidity and cost. The term CASH with reference to cash management is used in two different ways. i. Narrower sense ii. Broader sense The modern finance manager is required to manage the cash flow arising out of the operations of the business firm.

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.

MOTIVES OF HOLDING CASH


Transaction Motive Precautionary Motive Speculative Motive Compensation Motive

OBJECTIVES OF CASH MANAGEMENT


The cash management strategies are focusing around two goals. The risk-return trade off of any firm can be reduced to two prime objectives for the firms cash management system , which are as under: I. Meeting the cash outflows. II. Minimizing the cash balance.

PROFITABILITY vs. LIQUIDITY


Profitability of business concept signifies the operational efficiency of the business organization by value addition through the utilization of resources. The liquidity refers to the ability of the organization to realise value in money , and its ability to pay in cash the obligations that one due for payment.

FACTORS AFFECTING CASH NEED & MANAGEMENT


CASH CYCLE: The term cash cycle refers to the length of the time between the payment for purchase of raw materials and the receipt of sales revenue. CASH INFLOWS & OUTFLOWS: Every business firm has to maintain cash balance its expected inflows & outflows are not always synchronized. COST OF CASH BALANCE: One of the factors to be considered while determining the minimum cash balance is the cost of maintaining cash or of meeting shortages of cash.

PLANNING CASH MANAGEMENT


In order to maintain an optimum cash balance, business has to prepare CASH BUDGET which can be done by:Receipts & Payments method. Adjusted Income method. Adjusted balance sheet method.

COMPONENTS OF CASH BUDGET


FORECASTING THE RECEIPTS: Sales based receipts. Other receipts. FORECASTING THE PAYEMENTS : Payments for materials etc., Payments for operating expenses. Other cash disbursements.

CASH CONVERSION CYCLE


The cash flow cycle could be modelled on the basis of its elements & it is identified as : Inventory conversion period = Time taken to convert raw material to finished goods & dispatch them to fulfill customer orders. Receivable conversion period = Time taken to convert sales into cash received. Payable deferral period = Average time taken from purchase/ usage of raw material labour & expenses to payment. CASH COVERSION CYCLE= The period of 123 to give the actual working capital cycle

SIGNIFICANCE AND IMPORTACE OF CASH BUDGET


Cash budget helps in following ways :
I. Identification of the period of cash shortage. II. Identification of cash surplus and duration III. Better coordination of timing.

Most widely used method for preparing cash budget is the receipt and disbursement method. Most suitable for companies facing uncertainty regarding their cash flows.

CASH MANAGEMENT CONTROL


To avoid deviations from projected cash inflows and outflows. Also helps in speeding up cash collection.
Concentration banking: Decentralization of collections of accounts receivable.

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.

COMPUTERISED CASH MANAGEMENT


Instant updating of account:

The transfer of funds will take place very fast:

Information about foreign exchange rates:

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:

MANAGEMENT OF SURPLUS CASH


Short term deposits in bank and financial institution. Arrange funds for cash shortage: Devise ways to arrange additional funds.

OPTIMUM CASH MANAGEMENT


The cash budget for a business firm indicates the period when it is expected to have a shortage or surplus of funds. In case of shortage, the finance manager has to find a way for source and in the case of surplus, he has to invest the same for the profitability of business. Hence, the finance manager must determine and assess the optimum cash balance for the business. The problem of determining optimum cash balance for the firm implies a trade off between risk and return of maintaining of cash balance. To achieve this, there are several cash management models:

Baumols model Miller and Orr model

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

0.01 = 2,00,000 Therefore, Optimal transaction size is 2,00,000

Average cash balance = 2,00,000 2 No. of transactions of marketable securities: = 8,00,000 2,00,000 = 4 Transactions

LIMITATIONS OF THIS MODEL


This model can be applied only when the payments position can be reasonably assessed. This model merely suggests only the optimal balance under a set of assumptions but in actual situation it may not hold good. The firm is able to forecast its cash needs with certainty

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.

Overview of Miller and Orr Model

DESCRIPTION OF MILLER-ORR MODEL


As per the Miller and Orr model of cash management the companies let their cash balance move within two limits the upper limit and the lower limit. The companies buy or sell the marketable securities only if the cash balance is equal to any one of these. When the cash balances of a company touches the upper limit it purchases a certain number of salable securities that helps them to come back to the desired level. If the cash balance of the company reaches the lower level then the company trades its salable securities and gathers enough cash to fix the problem.

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

Spread (between control limits) = {[3/4*(20*3000 )]/0.0003}

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.

APPLICATION OF MILLER-ORR MODEL


The Miller and Orr model of cash management is widely used by most business entities. However, in order for it applied properly the financial managers need to make sure that the following procedures are followed: Finding out the approximate prices at which the salable securities could be sold or bought Deciding the minimum possible levels of desired cash balance Checking the rate of interest Calculating the SD (Standard Deviation) of regular cash flows

THANK YOU

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