HANDOUTS ON FUNDAMENTALS OF
FINANCIAL MANAGEMENT 1 (For Classroom
Discussion)
(Ms. Carmelita U. de Guzman, CPA, MGM)
Chapter 9: Cash and Marketable
Securities Management
(Reference: Van Horne and John M.
Wachowicz, Fundamentals of Financial
Management, 13th edition)
(refer to the powerpoint presentation of Ms. Agripa)
Chapter 18: Cash and Marketable
Securities Management
(Reference: Cabrera, Ma. Elenita
Balatbat, Financial Management
(Principles and Applications, vol. 1) 2015
edition)
CASH MANAGEMENT
1. Minimizing cash balances as well as
having accurate knowledge of when cash
moves into and out of the company can
improve overall corporate responsibility.
2. Objective of Cash Management: To
keep the investment in cash as low as
possible while still keeping the firm
operating efficiently and effectively.
3. Strategies in Monitoring Cash
Balances:
a) accelerate cash inflows by optimizing
mechanisms for collecting cash
b) monitor the cash disbursement needs
or payments schedule
c) minimize the amount of idle cash or
funds committed to transactions and
precautionary balances; and
c) avoid misappropriation and handling
losses in the normal course of business
4. Reasons for Holding Cash Balances:
a) transaction facilitation involves the
use of cash to pay for planned business
expenditures such as supplies, payroll,
taxes suppliers bills, interest on debts,
cash dividends and acquisition of long-
term fixed assets.
b) precautionary motive keep enough
cash for emergency purposes since the
cash inflows and outflows are not usually
perfectly synchronized. This is more
likely important in seasonal or cyclical
industries where cash inflows are more
uncertain. Firms with precautionary
needs usually rely on unused lines of
bank credit.
c) compliance with creditors covenant
be able to comply with the requirement
of lending institutions and other creditors
of keeping a certain percentage of
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borrowed funds in the firms bank
accounts
d) investment opportunities allow the
firm to take advantage of investment
opportunities that would otherwise be
impossible to transact. Example: when a
block of raw materials is offered at
discounted prices if purchased on cash
basis.
To determine how much cash to keep on
hand, firms must know the trade-off
between the opportunity cost associated
with holding too much cash against the
shortage costs of not having enough
cash.
5. Approaches in Determining the Target
Cash Balance:
a) Cash Budget the tool used to
present the expected cash inflows and
cash outflows
b) Cash Break-even Chart shows the
relationship between the companys cash
needs and cash sources. It indicates the
minimum amount of cash that should be
maintained to enable the company to
meet its obligations.
c) Optimal Cash Balance using the
c.1) Baumol model - balances the
opportunity cost of holding cash against
the transactions costs associated with
replenishing the cash account by selling
off marketable securities or by borrowing.
c.2) Miller-Orr model assumes that
the distribution of daily net cash flows is
normally distributed and allows for both
cash inflows and outflows
6. Other factors influencing the target
cash balance:
a) Option to incur short-term borrowing
to meet unexpected demands for cash.
If the probability of an unexpected
demand for cash causing the firm to
borrow in the short-term is low enough,
or if the amount of interest to be earned
by investing in longer-term securities is
higher than that to be earned on
marketable securities, then it might be
worth it for the firm to risk occasionally
paying a relatively high interest rate on
short-term borrowing.
b) Transaction costs and time element:
Transaction costs as well as time
associated with trading securities have
fallen so dramatically low that many
business firms decide to sell marketable
securities as needed in order to meet any
unforeseen demand for cash during the
day.
c) Many firms must keep certain average
minimum balances in their deposit
accounts as part of borrowing
agreements with their bank. Some firms
occasionally meet unforeseen demand
for cash that causes their deposit
account to temporarily fall below the
minimum compensating balance. To
offset this, they keep a corresponding
amount of excess cash in the account in
a later period. Thus enabling them to
cover up the earlier deficiency and
meeting the required average minimum
balance.
7. Effective cash management generally
encompasses proper management of
cash flows which entails among others
the following:
a) improving forecasts of cash flows
By improving the forecasts of cash
receipts and disbursements and
arranging things so that cash receipts
coincide or occur at an earlier time than
the timing of required cash outflows,
firms can reduce their cash balance to
meet transactional requirements to a
minimum. It the firm is able to reduce its
cash balance, bank loans will be reduced
together with the corresponding interest
expense, thus boosting profits.
b) using floats Float is defined as the
difference between the balance shown in
a firms books and the balance on the
banks record. It arises from the delays
in mailing, processing and clearing
checks through the banking system.
c) synchronizing cash inflows and
outflows
Synchronized cash flows is a situation in
which inflows coincide with outflows
thereby permitting a firm to hold low
transactions balances. A thorough review
of the cash flow analysis, cash
conversion cycle and cash budget would
be most helpful.
d) accelerating cash collections Once
credit sales have been effected, there
should be a built-in mechanism for timely
recovery from the debtors such as:
d.1) prompt billing and periodic
statements prepared to show the
outstanding bills
d.2) incentives such as trade and cash
discounts offered to the customers for
early/prompt payments should be well
communicated to them.
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d.3) once the checks/drafts are received
from customers, no delay should occur in
depositing these receipts with the bank.
d.4) customers may also be advised to
deposit their checks or cash directly into
the bank account of the firm and furnish
details to the firm.
d.5) electronic depository transfer or
payment by wire
d.6) maintenance of regional collection
office
e) controlling disbursements actions
slowing the disbursement of funds
lessens the use for cash balance, which
can be done by:
e.1) centralized processing of payables
permits the finance manager to evaluate
the payments coming due for the entire
firm and to schedule the availability of
funds to meet these needs on a
company-wide basis, resulting to more
efficient monitoring of payables and float
balances.
e.2) zero balance accounts (ZBA)
special disbursement accounts having a
zero peso balance on which checks are
written. As checks are presented to a
ZBA for payment, funds are
automatically transferred from the
master account.
e.3) delaying payment paying on the
last day of the credit period if one is not
going to take advantage of any offered
trade discount for early payment.
e.4) play the float involves taking
advantage of the time it takes for the
companys check to clear the banking
system.
e.5) less frequent payroll paying semi-
monthly instead of paying the workers
weekly
f) obtaining additional funds when and
where they are needed Since the
transaction and precautionary motives
are the important determinants of the
cash requirement, factors influencing
their combined level in the firm must be
analyzed. Some of the techniques
available for reducing the need for
precautionary balances are:
f.1) more accurate cash budgeting- the
closer the fit between cash inflows and
outflows, the more certain the forecasts,
the less need for precautionary balances.
f.2) lines of credit a pre-arranged loan
where the company can withdraw
anytime within the period agreed upon.
f.3) temporary investments are high-grade securities characterized
Investments in highly liquid securities by a high-degree of safety of principal
may be maintained instead of holding the and maturity of one year or less. The
idle precautionary cash balances. two major types of money market
instruments are:
MARKETABLE SECURITIES MANAGEMENT (a.1) Discount paper sells for less than
its par or face value. The difference
1. Objective of Marketable Securities
between the securitys purchase price
Management
and par value represents the investors
a) Marketable securities usually consist
income. At maturity, the investor
of treasury bills, commercial paper,
receives the face value or par value of
certification of time deposits from
the instrument.
commercial banks, and money market
(a.2) Interest-bearing securities
notes.
instruments which pay interest based on
b) Excess funds in anticipation of a cash
the par value or face value of the
outlay other than immediate
security and the period of investment.
transactions, should be converted from
b) Treasury bills short-term
cash to interest-earning marketable
government securities with a maturity of
securities, in order to maximize earnings.
one year or less, issued at a discount
2. Reasons for Holding Marketable
from face value often called risk-free
Securities
security. These are tax exempt with high
a) serves as a substitute for cash
degree of marketability.
balances
c) Other short-term commercial papers
b) held as a temporary investment.
issued by finance companies, banks and
c) built up to meet known financial
other corporations typically unsecured
requirements such as tax payments,
and maturities range from a few days to
maturing bond issue, etc.
270 days.
3. Factors Influencing the Choice of
d) Negotiable certificates of deposit
Marketable Securities
short-term loans to commercial banks
a) Risks
with maturities ranging from a few weeks
(a.1) Default risk the risk that the
to several years. These contain some
issuer of the security cannot pay the
default and interest rate risks but can
principal or interest at due dates.
easily be sold prior to maturity.
(a.2) Interest rate risk the risk of
e) Repurchase agreements (REPOS)
declines in market values of the security
sale of government securities (e.g.
due to rising interest rates.
treasury bills) or other securities by a
bank or securities dealer with an
(a.3) Inflation risk the risk that inflation
agreement to repurchase. These usually
will reduce the real value of the
involve a very short-term overnight to a
investment.
few days. These are attractive to
(a.4) Marketability (liquidity) risk refers
corporations because of the flexibility of
to the risk that securities cannot be sold
maturities. These agreements have little
at close to the quoted market price and
risk because of their short maturity and
is closely associated with liquidity risk.
the commitment of the borrower to
(a.5) Event risk the probability that
repurchase the securities at a fixed or
some event such as merger,
higher specified price.
recapitalization or a leverage buyout will
f) Bankers Acceptance time draft
occur and suddenly will increase a firms
drawn on, and accepted by a bank
default risk.
usually used as a source of financing in
b) Maturity Marketable securities held
international trade. These are sold as
should mature or can be sold at the same
discount paper with maturities ranging
time cash is required.
from a few weeks to 9 months. The
c) Yield or returns on securities
yields on acceptance are competitive
Generally, the higher a securitys risk,
because of low default risk owing to as
the higher its required return.
many as three parties who may be liable
4. Types of Marketable Securities
for payment at maturity.
a) Money market instruments the most
g) Money market mutual fund an open-
suitable investment for idle funds. These
ended mutual fund that invests in

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money-market instruments. These sell
shares to investors and then accumulate
the funds to acquire money market
instruments. These allow small investors
to participate directly in high-yielding
securities that are often denominated in
large amounts. These shares are highly
liquid because they can be sold back to
the fund at any time. Returns or yields
depend on the money market
instruments held in the portfolio of the
fund.