Cash ManagementBy

Debobrata Majumdar

INTRODUCTION TO CASH MANAGEMENT

Cash is the money which a firm can disburse immediately without any restriction. The term ‘cash’ includes coins, currency and cheques held by the firm, and balances in its bank accounts.Near-cash items, such as marketable securities or bank time deposits, are also included in cash.Cash is the basic input needed to keep the business running on a continuous basis; it is also the ultimate output expected to be realised by selling the service or product manufactured by the firm.

CASH MANAGEMENT

Cash management is concerned with the proper managing of cash flows into and out of the firm, cash flows within the firm and cash balances held by the firm at a point of time by financing deficit or investing surplus cash. Cash management is more important than other current assets because cash is the most significant and least productive asset that a firm holds. It is significant because it is used to pay the firm’s obligations. However cash is unproductive because unlike fixed assets or inventories it doesn’t produce goods for sale. The prime concern for cash management is to maintain adequate control over cash position to keep the firms sufficiently liquid and to use excess cash in some profitable way.

CASH MANAGEMENT CYCLE

Business operations

Information and control

Cash collections

Cash payments

Deficit

Surplus

Borrow

Invest

IMPORTANCE OF CASH MANAGEMENT

To predict cash flows accurately ,especially the inflows and there is no perfect coincidence between the inflows and outflows of cash.

Sometimes cash outflows exceeds the cash inflows because payments for taxes, dividends, or seasonal inventory build up.

But at times cash inflows will be more than cash payments because of large cash sales and debtors received.

The main aim of the firm is to manage its cash affairs in such a

way to keep cash balance at a minimum level and to invest the

surplus cash at an optimum level in profitable investment

opportunities.

FACETS OF CASH MANAGEMENT Cash planning : Cash inflows and outflows should be planned to

project cash surplus or deficit for each period of the planning period. Cash budget should be prepared for this purpose.

Managing the cash flows: the flow of cash should be properly managed. The cash inflows should be accelerated as far as possible, while the cash outflows should be decelerated.

Optimum cash level: The firm should decide about the appropriate level of cash balances. The cost of excess cash and danger of cash deficiency should be matched to determine the optimum level of cash balances.

Investing surplus cash: The surplus cash balances should be properly invested to earn profits.

MOTIVES FOR HOLDING CASHThere are three motives to hold cash by the firm:• The transaction motive: The transaction motive requires a firm to

hold cash to conduct its business in the ordinary course. The firm needs cash primarily for purchases ,wages and salaries,other operating expenses,taxes,dividends,etc. A firm also need to hold cash when there is a lack of perfect synchronisation between cash receipts cash payments.

• The precautionary motive: The precautionary motive is the need to hold cash to meet cash contingencies in the future. It provides a cushion or buffer to withstand some unexpected emergency.

• The speculative motive: The speculative motive relates to the holding of cash for investing in profit-making opportunities as and when they arise.

e.g., The firm may speculate on materials’ prices.

Cash planning: It is a technique to plan and control the use of cash. It helps to anticipate the future cash flows and needs of the firm and reduces the possibility of idle cash balances(which lowers firm’s profitability) and cash deficits(which can cause the firm’s failure).

Cash forecasting and budgeting: Cash budget is the most significant device to plan for and control cash receipts and payments. A cash budget is a summary statement of the firm’s expected cash inflows and outflows over a projected time period.

Cash forecasts are needed to prepare to cash budgets. Cash forecasting may be done on short or long-term basis. Generally forecasting covering one year or less are considered short-term; those extending beyond one year are considered long-term.

Short term cash forecasts: The important functions of short-term cash forecasts are:To determine operating cash requirementsTo anticipate short-term financingTo manage investment of surplus cash. One of the significant roles of the short-term forecast is to pinpoint when the money will be needed and when it can be repaid.These type of forecast helps a firm to :1. Select securities with appropriate maturities and reasonable risk.2. Avoid over and under-investing3. Maximise profits by investing idle money.4.

Short-term Forecasting Methods: The most commonly used methods of short-term forecasting are:

Receipts and disbursements method. The adjusted net income method

Receipts and disbursements method:The prime aim of receipts and disbursement forecasts is to summarise the cash inflows and outflows during a predetermined period.

The benefits of this method are as follows:1. It gives a complete picture of all the items of expected cash flows.2. It is a sound tool of managing daily cash operations.Limitations:3. Its reliability is reduced because of the uncertainty of cash forecasts.

For example, collections may be delayed or unanticipated demands may cause large disbursements.

4. It fails to highlight the significant movements in the working capital items.

Adjusted Net Income Method: This method of cash forecasting involves the tracing of working capital flows.It is sometimes called the sources and uses approach. Two objectives of adjusted net income approach are:

1. To project the company’s need for cash at a future date 2. To show whether the company can generate the required funds

internally, and if not,how much will have to be borrowed or raised in the capital market.

The benefits of this method are as follows:3. It highlights the movements in the working capital items, and

thus helps to keep a control on a firm’s working capital.4. It helps in anticipating a firm’s financial requirements.Limitations It fails to trace cash flows, and therefore its utility in controlling

daily cash operations is limited.

Sensitivity Analysis

One useful method of getting insight about the variability of cash flows is sensitivity analysis. optimistic most probable pessimisticCash budget can be prepared under three sales condition.

long-term cash forecasting

Long term cash forecasts are prepared to give an idea of the company’s financial requirements in the distant future. They are not as detailed as the short term forecasts are.

It can be used to evaluate the impact of, say,new product developments or plant acquisitions on the firm’s financial condition three ,five or more years in the future.

Major uses:

It indicates as company’s future financial needs,especially for it’s working capital requirements.

It helps to evaluate proposed capital projects.it pinpoints the cash required to finance these projects as well as the cash to be generated by the company to support them.

It helps to improve corporate planning.Long-term cash forecasts compel each division to plan for future and to formulate project carefully.

• MANAGING CASH COLLECTION AND DISBURSEMENTS:

This is done after the cash budget is prepared and appropiate cash flow is established.

It is to ensure that there does not exist a significant deviation between projected cash flows and actual cash flows.

so, to achieve this proper control over cash collection and disbursement has to be there.

Accelerating cash collections:

Cash collections can be accelerated by reducing the lag or gap between the time a customer pays a bill and the time the cheque is collected and the funds become available for the firm’s use.

The amount of cheques sent by customer which are not yet collected is called collection or deposit float.

within this time gap the delay is caused by the mailing time i.e. the time taken by cheque in transit and the processing time. The greater the firm’s deposit float,the longer the time taken in

converting cheues into usable funds.

Decentralised collections

An efficient Financial manager will attempt to reduce the firm’s deposit float by speeding up the mailing , processing and collection times.

Firm can use Decentralised collection system to speed up the cash collection and reduce deposit Float.

A Decentralized collection procedure, called concentration banking in Usa, is a system of operating through a number of centres, instead of a single collection centre centralised at the firm’s head office.

The basic purpose of the decentralized collections is to minimize the lag between the mailing time from customers to the firm and the time when the firm can make use of funds.

The firm will have a large number of bank accounts operated in the areas where the firms has its branches. all branches may not have collection centre.

the selection of the collection centre depend Upon the volume of billing.

The collection centre will be required to collect cheques from customers and deposit in their local bank account.

The collection centre then transfer funds to the concentration bank account.

Funds can be transferred through wire transfer,fax or through email also.

Decentralised collection system saves maililng and processing time and thus reduces the deposit float and consequently,the financial requirements.

LOCK BOX SYSTEMAnother technique to speeding up the mailing, processing and

collection time which is quite popular in USA,is the lock box system.

In case of the concentration banking ,cheques received by a collection centre and after processing,are deposited in the bank.

lock box system helps the firm to eliminate the time between the receipt of cheques and their deposit in the bank.

In lock box system a firm establishes a number of collection centres,considering customer locations and volume.

At each centre the firm hires a post office box and instructs its customers to mail their bill to the box.The bank picks up the mail several times a day and deposits the cheque in the firms account.

lock-box-system involves cost also.for the services provided under a lock-box management banks charges a fee or minimum balance has to be there.

Clearing:Before the amount is credited or debited to any account,it has to pass

through clearing system.the clearing process refers to the exchange of instruments by banks drawns on them through a clearing house.

Instruments like cheques,demand drafts,interest and dividend warrant can go through clearing.

Electronic data is used for clearing. India have started using MICR to automate the clearing process.They maintain an account with the reserve bank of INDIA(RBI)Which is debited for inward clearing(items drawn on plus outward

returns) and credited for outward clearing(items drawn on other banks plus inward returns).

The clearing house covers banks located in a defined geographical area. thus,when we say a cheque is payable in local clearing in BomBay then it must be Drawn on a bank located within the geographical area covered by the Bombay clearing house. it is based on a time limits.

cheques must be returned within a tight deadline ,so quick processing is essential. Returned cheques can be divided into two categories(a)Inward returns( cheque presented by other banks and returned)(b)outward retuns( cheque returned by other banks).

Controlling disbursements:The effective control of disbursement can also help

the firm in conserving cash and reducing the financial requirements. Disbursements arise due to trade credit, which is a source of funds. The firm should make payments using credit terms to the fullest extent. There is no advantage of paying early.By delaying payments as much as possible, The firm makes maximum use of trade credit as a source of funds-a source which is interest free.

• Payment Float:

some firms use the technique of playing the float to maximise the availibility of funds.

when the firm’s actual bank balance is greater than the balance shown in the firm’s books, the difference is called disbursement or payment Float.

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