1. CASH MANAGEMENT

2. NATURE OF CASH
In cash management the term cash has been used in two senses:-
Narrow Sense: Under this cash covers currency and generally accepted equivalents of cash, viz., cheques, demand drafts and banks demand deposits.
Broad Sense: Here, cash includes not only the above stated but also near cash assets. There are Bank’s time deposits and marketable securities.

3. MOTIVES FOR HOLDING CASH
J M Keynes identified three possible motives for holding cash :
Transaction motive
Precautionary motive
Speculative motive

4. Objectives of Cash Management
To meet Cash Payments
To quote Bollen,”Cash is an oil to lubricate the
ever turning wheels of business: without it , the
process grinds to a stop”.
To maintain Minimum Cash Balance (Reserve)

5. Features of Cash Management
Cash Planning (estimate Cash Surplus/ Deficit through Cash Budget)
Cash Flows Management (Cash Inflows & Cash Outflows)
Determination of Optimum Cash Balance (cost of excess cash and danger of cash deficiency will match)
Investment of Surplus Cash (properly invested in marketable securities, to earn profits)

6. CASH MANAGEMENT MODELS
Several cash management models have addressed this issue of split between marketable securities and cash holdings. Two such models are :
Baumol model
Miller and Orr model

7. BAUMOL MODEL Provides for Cost efficient transactional balances
Assumes that the demand for cash can be predicted with certainty
determines the optimal conversion size/lot
focus of the model is to minimise the total cost
associated with cash management
comprising total conversion costs (that is, costs incurred each time marketable securities are converted into cash)
and
the opportunity cost of keeping idle cash balances which otherwise could have been invested in marketable securities

8. Costs of Holding Cash Costs in dollars of holding cash
Trading costs increase when the firm must sell securities to meet cash needs.
Trading costs
Total cost of holding cash
Opportunity Costs
The investment income foregone when holding cash. C*
Size of cash balance

9. BAUMOL MODEL
2CF
ECL= O
where: ECL = Economic Conversion lot or Optimum Cash Balance
C = Cost per conversion
F = Projected cash requirements during the planning period
O= interest rate per planning period on investment in marketable securities

10. BAUMOL MODEL-Example
V ltd.’s estimated cash need for the year are Rs Lakhs. Cost of transaction is Rs.2000/lot & the opportunity cost is 20%. Calculate Economic Conversion Lot?
Here, C= Rs.2000, F= Rs.20 Lakhs & O= 20% or 0.20
2 x 2000 x 20 lakhs = Rs. 2 Lakhs
EOL=

11. MILLER & ORR MODEL Provides for cost-efficient transactional balances
assumes uncertain cash flows
determines an upper limit and return point for cash balances.
Objective of Model is to determine the optimum cash balance level which minimises the cost of cash management

12. Implications of the Miller-Orr Model
To use the Miller-Orr model, the manager must do four things:
Set the lower control limit for the cash balance.
Estimate the standard deviation of daily cash flows.
Determine the interest rate.
Estimate the trading costs of buying and selling securities.

13. The Miller-Orr Model
The firm allows its cash balance to wander randomly between upper and lower control limits. $
When the cash balance reaches the upper control limit U, cash is invested elsewhere to get us to the target cash balance Z. U
When the cash balance reaches the lower control limit, L, investments are sold to raise cash to get us up to the target cash balance. Z L
Time

14. MILLER AND ORR MODEL 3b 2 RP = 3 + LL 4I UL = 3RP – 2LL
where: RP = return point
b = fixed cost per order for converting marketable securities into cash.
I = daily interest rate earned on marketable securities
 2 = variance of daily changes in the expected cash balance
LL = the lower control limit
UL = the upper control limit

15. MILLER AND ORR MODEL- Example
X Ltd. has a policy of maintaining a minimum cash balance of Rs. 500,000. The standard deviation of the company’s daily cash flows is Rs.200,000 & the annual interest rate is 14%. The transaction cost of buying or selling securities is Rs. 150 per transaction. Calculate X Ltd.’s return point & upper control limit?
Return point = x 150 x 200,000 x 200, ,000
4 x 0.14
365
= Rs. 727,227
Upper Control Limit = 3 RP – 2LL= 3 x727,227 – 2 x 500,000
= Rs. 16,81,681

16. FLOAT
The cash balance shown by a firm on its books is called
the book, or ledger, balance whereas the balance shown
in its bank account is called the available, or collected,
balance. The difference between the available balance
and the ledger balance is referred to as float.
There are two kinds of float :-
disbursement float - cheque issued but not debited in the customer’s A/c
payment float- cheque deposited but not credited in the customer’s A/c

17. Accelerating Collections
Customer mails payment
Company receives payment
Company deposits payment
Cash received
time
Mail delay
Processing delay
Clearing delay
Mail float
Processing float
Clearing float
Collection float

18. MONEY MARKET INSTRUMENTS OR MARKETABLE SECURITIES
Mutual fund scheme
(Money market schemes)
Treasury bills
Commercial paper
Certificates of deposit
Inter-corporate deposits
(Call deposits, 3 months and 6 months deposits)
Bill discounting