Cash & Liquidity Management

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Prabhat Mittal 1
 Session Outline
Cash & Cash Management

Motives of holding cash

Cash Budget

Methods of Budgeting

Cash Management Models

Money Market Investment Options

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 Cash & Cash Management
Cash Planning
Cash Forecasting:
Cash Management
o Receipt & Disbursement Method
Cash means Liquid
o Adjusted Net Income Method
Assets that a Business
Owns. It includes
Cheques, Money Orders To meet Cash Disbursement as per
& Bank Drafts Payment Schedule
Objectives of Cash To meet Cash Collection as per
Cash Management Management Repayment Schedule
means efficient To minimize funds locked up as Cash
Collection & Balance by maintaining optimum cash
Disbursement of cash balance
and any Temporary
Investment of Cash
Transaction Motive
Motives of
Holding Cash
Speculative Motive
Precautionary Motive

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 Motives of holding cash
Need for cash

Cash facilitates the meeting of the day-to-day expenses

Transaction Need and other debt payments.

Cash may be held in order to take advantage of

Speculative Needs profitable opportunities

Cash may be held to act as for providing safety against

Precautionary
Needs
unexpected events.

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 Cash Budget
Helpful in Planning
Controlling Cash Expenditure
Functions Testing the Influence of Proposed
/Importance of Expansion
Cash Budget
Cash Budget means Basis of Long Term Planning & Co-
estimation of Cash ordination
Receipt and Cash
Disbursement during a
future period of Time Methods of Receipts & Payment Method
Preparing Cash Adjusted Profit & Loss Account Method
Budget
Cash Budget is a forecast
of future Cash Receipts
and Cash Disbursement
over various intervals of Treasury Bills
Time Investment of Inter-Corporate Deposits
Surplus Cash Investment in Market Securities
Short term FDs

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 Methods of Budgeting
Receipts and Payments Method: In this method all the expected receipts
and payments for budget period are considered. All the cash inflow and
outflow of all functional budgets including capital expenditure budgets are
considered
(used for short term forecasting)

Adjusted Income Method: In this method the annual cash flows are
calculated by adjusting the sales revenues and cost figures for delays in
receipts and payments (change in debtors and creditors) and eliminating
non-cash items such as depreciation
(used for long term forecasting)

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 Illustration
You are given below the Profit & Loss Accounts for two years
for a company, Sales are expected to be `
12,00,00,000 in year 3.
As a result, other expenses will increase by
`50,00,000 besides other charges. Only raw materials are in
stock.
Assume sales and purchases are in cash terms and the
closing stock is expected to go up by the same amount as
between year 1 and 2. You may assume that no dividend is
being paid.
The Company can use 75% of the cash generated to service a
loan. How much cash from operations will be available in
year 3 for the purpose?

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 Illustration

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 Illustration project profit and loss
account

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 IllustrationCash Flow

Available for servicing the loan: 75% of ` 2,54,00,000 or ` 1,90,50,000

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 Controlling of Cash Flows
Accelerate Cash Flows Decelerating Cash Flows

Cash Flows means Paying on Last Date

Prompt Payment by Customers
Cash Inflows and Cash Payable through Draft
Outflows Adjusting Payroll Funds
Quick conversion of payment
into Cash Centralization of Payments
If Cash Inflows are Making use of Float
Decentralized Collection
more than Cash
Outflows, it is Positive
Cash Flow and vice-
versa

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 Float
The term float is used to refer to the periods that affect cash as it moves through the different
stages of the collection process. Four kinds of float with reference to management of cash are:

Billing Float Mail Float

The time between the sale and the mailing This is the time when a cheque is being
of the invoice is the billing float. processed by post office, messenger
service or other means of delivery.

Cheque Processing Float Banking Processing Float

This is the time required for the seller to This is the time from the deposit of the
sort, record and deposit the cheque after it cheque to the crediting of funds in the
has been received by the company. sellers account.

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 Cash Management Models
The purpose of cash management models is to ensure that cash does
not remain idle unnecessarily and at the same time the firm is not
confronted with a situation of cash shortage.
All these models can be put in two categories:-
Inventory type models; and
Stochastic models.

Inventory type models (economic order quantity ) applies equally to

cash management problems under conditions of certainty or where
the cash flows are predictable.

However, where cash flows are not predictable, Stochastic models are
used.

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 Baumols EOQ Model
According to this model, optimum cash level is that level of cash where the
carrying costs and transactions costs are the minimum.

The formula for determining optimum cash balance is:

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 EOQ Model

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 Illustration
A firm maintains a separate account for cash disbursement. Total
disbursement are ` 1,05,000 per month or ` 12,60,000 per year.
Administrative and transaction cost of transferring cash to disbursement
account is ` 20 per transfer. Marketable securities yield is 8% per annum.
Determine the optimum cash balance according to William J. Baumol model.

The optimum cash balance C =

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 Miller-Orr Cash Model
This model is designed to determine the time and size of transfers
between an investment account and cash account. In this model
control limits are set for cash balances. These limits may consist of h
as upper limit, z as the return point; and zero as the lower limit.

When the cash balance reaches the upper limit, the transfer of cash
equal to h z is invested in marketable securities account.

When it touches the lower limit, a transfer from marketable

securities account to cash account is made.

During the period when cash balance stays between (h, z) and (z, 0)
i.e. high and low limits no transactions between cash and
marketable securities account is made.

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 Miller-Orr Cash Model
According to this model the net cash flow is completely stochastic.

33 2
+
UL =43RP 2LL
where: RP = return point
b = fixed cost per order for converting marketable
securities into cash.
I = daily interest rate earned on marketable securities
2 = variance of daily changes in the expected cash balance
LL = the lower control limit
UL = the upper control limit

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 Money Market Investment Options for
Surplus Funds
Investment Description Maturity Liquidity

91 days, 182 days

Treasury Bills Issued by GOI, sold at discount Very liquid and marketable
And 364 days

Offers interest higher then the Liquid, penal interest charged

Fixed Deposits 15 days to 5 years
Treasury bills on premature cancellation

Large value, issued by banks at

Certificate of Deposits (CD) 7 to 365 days Fairly Liquid
discount

Unsecured debt issued by

Commercial Paper (CP) 7 to 365 days Secondry market is not liquid
companies

Inter Corporate Deposits mad by one firm with

90 to 180 days Illiquid
Deposits (ICD) another.

Mutual funds investing in liquid, No minimum

Money Market Mutual Funds Liquid
Short-term securities period

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