Management of Cash and Marketable Securities

CashCash is the ready currency to which all liquid assets can be reduced.

Near CashNear cash implies marketable securities viewed the same way as cash because of their high liquidity.

Marketable SecuritiesMarketable securities are short-term interest earning money market instruments used by firms to obtain a return on temporarily idle funds.

Motives For Holding Cash

Cash management is one of the key areas of working capital management. There are four motives for holding cash:

Transaction motive, Precautionary motive,Speculative motive, and Compensating motive.

Objectives of Cash Management

The basic objectives of cash management are two-fold:(a) to meet the cash disbursement needs (payment schedule)(b) to minimise funds committed to cash balances.

Factors Determining Cash Needs

The factors that determine the required cash balances are:

(1) Synchronization of cash flows(2) Short Costs

(1) Transaction costs(2) Borrowing costs(3) Loss of cash-discount, (4) Cost associated with deterioration of the credit rating.(5) Penalty rates

Excess Cash Balance CostsProcurement and ManagementUncertainty and Cash Management

Determining Cash Need

There are two approaches to derive an optimal cash balance, namely, minimising cost cash models and cash budget.

Cash Management/Conversion Models

Baumol Model, Miller-Orr Model and Orgler’s Model.

Baumol Model

Baumol Model is a model that provides for cost efficient transactional balances and assumes that the demand for cash can be predicted with certainly and determines the optimal conversion size/lot.

Miller-Orr ModelMiller-Orr Model is a model that provides for

cost-efficient transactional balances and assumes uncertain cash flows and determines an upper limit and return point for cash balances.

Orgler’s ModelAccording to this model, an optimal cash management strategy can be determined through the use of a multiple linear programming model. The construction of the model comprises three sections:

selection of the appropriate planning horizon, selection of the appropriate decision variables

and formulation of the cash management strategy

itself.

Cash Budget: Management Tool

Cash budget is a statement of the inflows and outflows of cash that is used to estimate its short-tern requirements.

The various purposes of cash budgets are:1)to coordinate the timings of cash needs. 2)it pinpoints the period(s) when there is likely to be excess

cash; 3)it enables a firm which has sufficient cash to take advantage

of cash discounts on its accounts payable, to pay obligations when due, to formulate dividend policy, to plan financing of capital expansion and to help unify the production schedule during the year so that the firm can smooth out costly seasonal fluctuations; finally,

4)it helps to arrange needed funds on the most favourable terms and prevents the accumulation of excess funds.

Operating Cash FlowsThe main operating factors/items which

generate cash outflows and inflows over the time span of a cash budget are tabulated

Operating Cash Flows

The main operating factors/items which generate cash outflows and inflows over the time span of a cash budget are tabulated in Exhibit 1.

EXHIBIT 1  Operating Cash Flow Items

Inflows/Cash Receipts Outflows/Disbursements

1.

Cash sales 1.

Accounts payable/Payable payments

2.

Collection of accounts receivable

2.

Purchase of raw materials

3.

Disposal of fixed assets 3.

Wages and salary (payroll)

4.

Factory expenses

5.

Administrative and selling expenses

6.

Maintenance expenses

7.

Purchase of fixed assets

EXHIBIT 2  Financial Cash Flow Items

Cash Inflows/Receipts Cash Outflows/Payments

1. Loans/Borrowings 1. Income-tax/Tax payments

2. Sales of securities 2. Redemption of loan

3. Interest received 3. Repurchase of shares

4. Dividend received 4. Interest paid

5. Rent received 5. Dividends paid

6. Refund of tax

7. Issue of new shares and securities

The cash budget, as a cash management tool, would throw light on the net cash position of a firm. After knowing the cash position, the management should work out the basic strategies to be employed to manage its cash. The present section attempts to outline the basic strategies of cash management.

Cash cycleCash turnover

Cash Management: Basic Strategies

Minimum Operating Cash

Minimum operating cash is the level of opening cash balance at which a firm would meet all obligations and is computed by dividing total annual outlays by the cash turnover.

The basic strategies that can be employed to do the needful are as follows:

a) Stretching Accounts Payable,

b) Efficient Inventory-Production Management,

c) Speedy Collection of Accounts Receivable, and

d) Combined Cash Management Strategies.

Cash Management Techniques/Processes

The cash management strategies are intended to minimise the operating cash balance requirement. The basic strategies that can be employed are

Speedy Cash CollectionsPrompt Payment by CustomersEarly Conversion of Payments into CashConcentration Banking   Lockbox System

Slowing Disbursements

Apart from speedy collection of accounts receivable, the operating cash requirement can be reduced by slow disbursements of accounts payable.

Avoidance of Early Payments Centralised Disbursements  Float

Marketable Securities

Marketable securities are an outlet for surplus cash as liquid security/assets. To be liquid a security must have two basic characteristics, that is, a ready market and safety of principal.

Selection Criterion

1)financial risk,

2)interest rate risk,

3)taxability,

4)liquidity, and

5)yield among different financial assets.

Marketable Security Alternatives

Treasury BillsNegotiable Certificates of Deposit (CDs)  Commercial Paper Bankers’ Acceptances Repurchase (Repo) Agreements  Units Intercorporate Deposits Bills Discounting Money Market Mutual Funds/Liquid Funds

CASH MANAGEMENT PRACTICES IN INDIA

Cash management in India presents a daunting task in light of the huge number of clearing houses (1,056) and bank branches (more than 75,000). The main features of cash management practices in India are:

1) Collection methods, 2) Payment mechanisms, and 3) Electronic banking.

COLLECTION METHODS

Bulk CollectionPost-dated Cheque (PDC) ManagementElectronic Clearing Service—Debit SchemeCheque Truncation

PAYMENT MECHANISM

 ChequeCheque payable at parCustomer’s or pay orderDemand draftReal-time gross settlement (RTGS)Electronic Funds Transfer (EFT)Special Electronic Funds Transfer (SEFT)Electronic Clearing Service (ECS) – CreditInterest/Dividend warrants