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  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 CASH MANAGEMENT 2 CHAPTER 24
  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. CASH MANAGEMENT 3 CHAPTER 24
  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. CASH MANAGEMENT 4 CHAPTER 24
  5. MOTIVES FOR HOLDING CASH  Transactionary motive  Precautionary-motive  Speculative-motive CASH MANAGEMENT 5 CHAPTER 24
  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. CASH MANAGEMENT 6 CHAPTER 24
  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. CASH MANAGEMENT 7 CHAPTER 24
  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. CASH MANAGEMENT 8 CHAPTER 24
  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. CASH MANAGEMENT 9 CHAPTER 24
  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. CASH MANAGEMENT 10 CHAPTER 24
  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. CASH MANAGEMENT 11 CHAPTER 24
  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. CASH MANAGEMENT 12 CHAPTER 24
  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. CASH MANAGEMENT 13 CHAPTER 24
  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. CASH MANAGEMENT 14 CHAPTER 24
  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. CASH MANAGEMENT 15 CHAPTER 24
  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. CASH MANAGEMENT 16 CHAPTER 24
  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. CASH MANAGEMENT 17 CHAPTER 24
  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. CASH MANAGEMENT 18 CHAPTER 24
  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: CASH MANAGEMENT 19 K bT 2 C  CHAPTER 24
  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. CASH MANAGEMENT 20 CHAPTER 24
  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: CASH MANAGEMENT 21 3 2 K 4 bs 3 L Point) (Return R   CHAPTER 24
  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: CASH MANAGEMENT 22 L R 3 ) Limit Control Upper ( H   CHAPTER 24
  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). CASH MANAGEMENT 24 CHAPTER 24
  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. CASH MANAGEMENT 25 CHAPTER 24