Chapter 3:Cash Management

CASH• Actual cash held by the firm & deposits that can

be withdrawn on demand• Coins & notes• Current accounts & ST deposits• Bank overdrafts & ST loans• Foreign currency & deposit

• Marketable securities

WHY HOLD CASH?

Transaction MotivePrecautio

nary Motive

Speculative Motive

• Ensure bills are paid on time

• Meet day-to-day operation

• Cover unexpected business requirement

• e.g. strikes, weather disruptions

• To exploit unanticipated business / investment opportunities

• Taking advantages of bargains

CASH MANAGEMENT• Refers to the practices & techniques designed to

accelerate & control collections, ensure prompt deposit of receipts, improve control over payments methods, eliminate idle cash balance

FOCUS OF CASH MANAGEMENTPROFITABILITY• How the firm manages its cash in order to minimize

costs & maintain a return

LIQUIDITY• Has enough cash to make payments when required• Can turn other assets into cash to make payments• Can borrow money to make payments

SAFETY• Secure from theft, fraud.• High risk

MANAGING CASH BALANCE

Managing Cash Balance

Surplus Expecte

d

Invest the

Surplus

How much?

What to invest?

How long to invest?

Deficit Expecte

d

Reduce spending plans

Borrow

Loan of overdraf

t?

How much?

For how long?

MANAGING CASH• Preparation of cash budget• Managing collection & payment of cash• Management of ST cash investment• Management of overdraft & loans• Use of cash management model• Centralized or decentralized Treasury Department

PREPARATION OF CASH BUDGET

• Essential for control day-to-day cash balance & to allow efficient forward planning of the options.

• Integral part of the master budget of the business

MANAGING COLLECTION & PAYMENT OF CASH

COLLECTION

Presented the cheque on the day of receipt

Collecting cheque

from customer’s premises

Requesting payment through

Bank Giro System, standing order &

direct debit

PAYMENT

Slow down payment

MANAGEMENT OF OVERDRAFT & LOANS

Factors to be

considered

PURPOSE

SECURITY

INTEREST

DURATION

CASH MANAGEMENT MODEL

How much to hold cash?

Too much cash

Loss opportunity

to earn return

Too little cash

Risk of not making

payment timely

Attempt to minimize the total costs by determining when, & how much cash should be transferred

each time

THE BAUMOL MODEL• Is based on the idea that deciding on optimum

cash balance.

• S – the amount of cash to be used in each time period

• F – the fixed cost of obtaining new funds• i – the interest rate of holding cash• Q – the total amount to be raised

iFS

Q2

THE BAUMOL MODEL• Introduced by William Baumol• Assumption:• Able to forecast cash need with certainty• Cash payments occur uniformly over a period of time• No cash receipts during the projected period• No safety reserve• Opportunity costs of holding cash is known & fixed• Incur the same transaction costs

THE BAUMOL MODEL

Transaction cost – cost of liquidating ST investmente.g. brokerage fees, delivery costs, telephone charges

Opportunity cost – interest rate foregone on cash surplus

TREASURY MANAGEMENTIs concerned with the activities involved in managing the liquidity of a business – survival & growth of the business

REASONS FOR HAVING SEPARATE TREASURY DEPARTMENT

Large & multinational companies• Transactions will be very complex & large

scale

Companies are involved in currency, debt & security markets

Business transactions are becoming very sophisticated• Can be aided by modern communications –

treasury dept’s staff are equipped to handle

CENTRALIZED TREASURY DEPARTMENT

• Avoid duplication of skills

• Lower interest rate

• Efficient FOREX management

ADVANTAGES

• Greater autonomy

• Match local assets

DISADVANTAGES