WHAT IS CASH MANAGEMENT??????

MANAGEMENT OF CASH
Determination of optimum amount of cash required in the business Keep the cash balance at optimum level and investment of surplus cash in profitable manner. Prompt collection of cash from receivables and efficient disbursement of cash.

MOTIVES OF HOLDING CASH

Transaction Motive Precautionary Motive Speculative Motive Compensating Motive

FACTORS DETERMINING CASH NEEDS

Timing of Cash Flows Cash Shortage Costs Cash Excess Costs Cash Management Costs Uncertainty Firms Capacity to Borrow in Emergent Situations Attitude of Management Efficiency of Management

METHODS OF CASH MANAGEMENT Cash Budget Cash Flow Statements Cash Management models

CASH BUDGET
A cash budget is a summary of movement of cash during a particular period.It is also known as short term cash forecasting.

Benefits:
In estimating the extent of short fall if any and to arrange it from some reliable and cheap sources.

In preparing a detailed purchase and payment schedule in respect to acquiring some capital goods(fixed

COMPONENTS.
The three main components necessary for preparing a cash budget : Time period. Desired cash position. Estimated sales and expenses.

FOUR MAJOR SECTIONS OF CASH BUDGET

Receipts Section-It consists of listing of all of the cash inflows, except for financing. Disbursements Section-It consists of all cash payment planned for the budgeted period. These payments will includeraw materialpurchases,direct labour payments. The Financing Section-It deals the borrowings and repayments

ADVANTAGES
It provides a comprehensive picture of cash inflows and cash outflows as also the resultant surplus and deficit. It may also duly alert the management of any possible deficit so that a little more vigorous control on cost and cash outflows can be exercised.

DISADVANTAGES
The system may not prove to be reliabe incase of delay in receipts of dues(cash inflow) or sudden payment(cash outflow) due to some unexpected and urgent needs. The system does not reveal and reflect the changes in the movement of working capital components,mainly in regard to inventories andsundry debtors.(bills receivable or accounts receivable).

BAUMOL MODEL

Baumol Model of Cash Management The Baumol model of cash management is one of many by which cash is managed by companies. It is extensively used and highly useful for the purpose ofcashmanagement. Use of Baumol Model The Baumol model enables companies to find out theirdesirable level of cash balance under certainty. Relevance At present many companies make an effort to reduce the costs incurred by owning cash. They also strive to spend less money on changing marketable securities to cash. The

timal Cash Balance via Baumol Mode

50000000 1002 504 339.3333333 258 210

Cost ($)

Z*= Z* [(2M*TC)/r]

Total Costs
Holding Costs: (Z/2)*r

Order Costs:(M/Z)*TC

Z*

Order Quantity (Z)

Q. A Firm estimates that it is required to make cash disbursements of Rs 567 lakh in a year which is spread over uniformly at Rs 47.25 lakh per month. The firm invests only in treasury bills for cash management purposes. The present yield is 8 percent p.a .It costs the firm Rs

SOLUTION

[(2*900*56,700,00)/0.08 = = 1,129,491 OR Rs 11.30 Lakh.

C= [(2M*TC)/r]

Assumptions
There are certain assumptions or ideas that are critical with respect to the Baumol model of cash management. The particular company should be able to change the securities that they own into cash, keeping thecost oftransaction the same. Under normal circumstances, all such deals have variable costs and fixed costs. The company is capable of predicting its cash necessities They should be able to do this with a level of certainty The company should also get a fixed amount of money. They should be getting this money at

Problems with the Baumol Model

Cash flows may not be very predictable, much less constant Treasurers may want a safety stock of cash

CONT.
The company is aware of the opportunity cost required for holding cash. It should stay the same for a considerable length of time. The company should be making its cash payments at a consistent rate over a certain period of time. In other words, the rate of cash outflow should be regular.

The Miller - Orr Model

The Miller-Orr Model provides a formula for determining the optimum cash balance (Z), the point at which to sell securities to raise cash (lower limit L) and when to invest excess cash by buying securities and lowering cash holdings (upper limit H). Depends on:
transaction costs of buying or selling securities variability of daily cash (incorporates uncertainty) return on short-term investments

The Miller - Orr Model

Dollars in the Cash Account

Upper Limit

Buy Securities

Z
Lower Limit Sell Securities

Days of the Month

CONT.
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. 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.

CONT
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. It is normally assumed in such cases that the average value of the distribution of net cash flows is zero. It is also understood that the distribution of net cash flows has a standard deviation. The Miller and Orr model of cash management also assumes that distribution of cash flow is normal

Application of Miller and Orr Model of Cash Management The Miller and Orr model of cash management is widely
used by most business entities. However, in order for it applied properly the financial manages 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 ofinterest Calculating the SD (Standard Deviation) of regular

The Miller-Orr Model - Target Cash Balance (Z)

3

Z=

3 x TC x V +L 4xr

where: TC = transaction cost of buying or selling securities V = variance of daily cash flows r = daily return on short-term investments L = minimum cash requirement

Q: A company projects the daily net cash flows for the next seven days as follows: 1 Day 2 3 4 5 6 7
Cash flow +24 +13-12 Forecast -16 +36 +4 +28

The policy of the company is to maintain a minimum cash balance of Rs 10,000 at all times. Fixed cost for every security transaction is Rs 1600 and return on marketable securities is 10% p.a. The company desires to know the target cash

Calculation of the Variance of cash Flows Forecast (Xi) 24 13 -16 -12 36 4 -28 TOTAL= (X) (Xi-X) (Xi-X)2 V 441 100 361 225 1089 1 961 3178 (XIX)2/n =3178/ 7 =Rs 454 Xi/n=2 21 1/7 =RS 3 10 -19 -15 33 1 -31 0

Findings
These two findings signify that the finance manager will allow the daily cash balance to fluctuate till it reaches the upper limit of Rs 185,104. When the balance becomes greater than this figure he will purchase sufficient worth of securities to reduce the cash balance to Z of Rs 68,368

 On the lower side when the cash balance drops to the minimum balance of Rs 10,000 he will sell adequate amount of securities to raise the cash balance to Rs 68,368

Z-Score 1968 model Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + .999X5 where: X1 is working capital total assets X2 is retained earnings (profit) total assets X3 is EBIT total assets X4 is market value of equity book value of debt X5 is sales total assets Zones of Discrimination:
Z > 2.99 -Safe Zone

Z-Score cont

A more recent estimate by Altman (in 2000) is significantly different: Z = 0.72X1 + 0.85X2 + 3.1X3 + 0.42X4 + X5 Once again, this has been rounded to two significant figures. Altman's 2000 paper revisits the z-score and his proprietary ze . Other single number measures of financial strength exist, including