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Liquidity management
Cash Management
Liquidity management
- is an aspect of current asset management
that relates to the management of the optimal
quantity of liquid assets (cash, marketable
securities,
and receivables) a firm should
have on hand.
Cash Management
- an aspect of liquidity management that
relates to optimizing mechanisms for
collecting and disbursing cash.
Cash Management
- an aspect of liquidity management that
relates to optimizing mechanisms for
collecting and disbursing cash.
Case Background:
On January 1, 2015, Golden Buckets Corporation has a
beginning cash balance of P1.8 Million. Each week, its cash
outflows exceed its cash inflows by an average of P900,000.
As a result, the cash balance drops to zero at the end of the
2nd week. Every end of the second week, Golden Buckets
replenishes its cash by depositing P1.8 Million.
The interest rate that can be earned if cash is invested in
Marketable Securities is 5% p.a. and the net cash outflows is
the same everyday and is known with certainty.
The cost per trading is P1,200.
Problem:
How can Golden Buckets
minimize the cost of maintaining
its cash and how much should be
the optimum cash balance that
Golden Buckets must maintain in
order to minimize its carrying
costs and opportunity costs?
CASE SOLUTION:
Using the BAT (Baumol-Allais-Tobin)
Model, a classic model for analyzing cash
management problems, we can determine
the factors affecting cash management and
solve Golden Bucket's poor cash
management problem.
FORMULA:
C* = (2TxF)/R
BAT MODEL:
Total Cost = opportunity costs + trading costs
Opportunity costs = (C/2) x R
Trading costs = (T/C) x F
where:
F = trading costs or fixed cost of making a
securities trade to replenish cash
T = total amount of new cash needed for
transaction purposes over the relevant planning
period, say one year.
R = interest rate of the marketable securities
C = cash balance
SOLUTION:
Step 1. By using different alternatives,
determine the peso value of the opportunity
cost of holding cash to determine how much
interest is forgone.
Formula: Opportunity Cost = (C/2) x R
SOLUTION:
Step 2. Determine the total trading costs for the
year by first determining how many times Golden
Buckets will trade within the year.
Formulae: T = C/2 x 52 weeks
Total Trading Costs = (T/C) x F
SOLUTION:
Step 3. Determine the cash balance with the
lowest total costs for the year by adding the
opportunity cost and trading costs.
Formula: Total Costs = (C/2) x R + (T/C) x F
( 2TF ) / R
C* = (2 x P42,800,000 x P1,200)/ 5%
= P1,498,800
SOLUTION:
Step 5. Check whether the cash balance that
should be maintained results to equal values in
opportunity costs and trading costs.
CONCLUSION:
1. Applying the BAT Model, we can determine the optimal cash balance
that must be maintained by the firm where the total cost of maintaining
cash is at its lowest value where the opportunity cost is equal to trading
cost.
2. The amount of cash balance that should be maintained will vary
depending on the interest rate of the Marketable Securities, the cost per
trading and the average cash balance per period.
3. In the case of Golden Buckets Corporation, the optimal cash balance
that they should maintain should be P1,498,800 where the opportunity
cost of P37,470 is equal to the trading cost of P37,470 or a total cost of
P74,940.
4. It is not enough for Golden Buckets to find a solution for determining its
optimal cash balance, but it must seek for ways where it can
prevent its cash flows to exceed its cash inflows by looking
into the effects of the other current assets to its cash flows.
Thank You
Kingsoft Office
published by www.Kingsoftstore.com
@Kingsoft_Office
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