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Cash Management

Cash Cycle
Factors that influence the desired
level of cash
Optimal cash inventories
Short-term investment strategies

The Manager

Managing an entitys Resourc

Resource Decisions
Investment Decisions
Operati
ng
Decisio
ns
Human
Resources
Decisions

Cash Management
Inventory Management
Working Capital Management
Investment in Human Capital
Long-term Assets
Accounts Receivable

Recruitment, Selection
Training, Productivity
Performance Appraisal
Compensation
Unions & Labor Relations

Information
Decisions

Economics of Information
Database Management
Data Modeling
IS Planning & Development

Financing Decisions

Debt vs. Tax Financing

Life cycle effects,


Business cycle,
public events,
etc.

Cash Inflows

Value
Creation

Discount Rate

Cost of
Capital

Financial
Markets

Overview
ST finl planning = deals w/ short-lived assets
and liabilities (working capital management);
concerned w/ 1) size of investment in CA like
cash, A/R, Inventorya tool is cash budget
analysis and 2) how to finance ST assetsa
tool is performing credit analysis

Managing WC involves
determine:
How much to invest in CA?

- CA vs. FA
- Nature of activities/programs

In each CA?
- Cash, A/R, Inventory
- Cash Mgt
- A/R is Credit Mgt
- Inv = POM & Cash balance
models

Our objectives
Learn about the Cash Cycle
Understand the factors that influence the

desired level of cash


Learn two models that calculate the
optimal level of cash
Gain an overview of what factors/areas are
inputs to a cash budget and how they
affect the cash balance

Objectives of Public Money


Managers
Bringing the entitys cash resources within
control
Achieving optimum conservation and
utilization of the funds

Key areas of Public Cash


Management
Organization
Collection and disbursement of funds
Netting of interagency payments
Investment of excess funds
Optimal level of cash balances
Cash planning and budgeting
Bank relations

Treasury Management of
Cash Balances
Operate with smaller amount of cash
Supervision is centralized
Better service from banks
Proper allocation of funds

How much cash should a


organization keep on hand?
Enough cash to make payments when

needed. (transactions motive)

(Daily or Weekly Cash Budget helpful)

Additional cash may be held for

unexpected requirements. (precautionary


motive)

The size of the minimum


cash balance depends on:
How quickly and cheaply a organization

can raise cash when needed.

How accurately managers can predict

cash requirements.

(Cash Budget helpful)

How

much precautionary cash


managers need for emergencies.

the

The organizations maximum


cash
balance
depends
on:
Available (short-term) investment
opportunities

e.g. money market funds, CDs, commercial paper

Expected return on investment opportunities.


e.g. If expected returns are high, organizations
should be quick to invest excess cash
Transaction cost of withdrawing cash and

making an investment
Demand for Cash for daily transactions
(Cash Budget helpful)

Consider Cash an Inventory


An inventory approach to Cash
Balance decisions:
Grantsville has a daily demand for cash of $10,000.
Grantsvilles treasurer invests excess cash in the state
investment pool that earns .01% per day. In order to
transfer funds from the state pool, Grantsville must pay a
transaction cost of $20. How much cash should it transfer
when it runs out. (Grantsville can complete the cash
transfer electronically so it waits until the cash balance is
zero).

Optimal Cash Balance via Baumol


50000000 1002 504 339.3333333 258 210

Cost ($)

M
M=
=
$10,000
$10,000

rr =
= .01%
.01%
..
0001
0001

Z*=
Z* [(2M*TC)/r]
ZZ =
=
$63,246
$63,246

TC
TC =
= $20
$20

Total Costs

Holding Cos
(Z/2)*r

Order Costs:(M/Z)

Z*

Order Quantity

Problems with the Baumol Mod

Cash flows may not be very predictable, much less


constant
Treasurers may want a safety stock of cash

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

Dollars in the Cash Account

The Miller - Orr Model


Upper Limit

Buy Securities

Z
Lower Limit

Sell Securities
Days of the Month

The Miller-Orr Model


- Target Cash Balance (Z)
3

Z=

3 x TC x V
4xr

+L

where: TC = transaction cost of buying


or selling securities
V = variance of daily cash flow
r = daily return on short-term
investments
L = minimum cash requiremen

The Miller-Orr Model


- Target Cash Balance (Z)
Example: Suppose that short-term

securities yield 5% per year and it costs the


organization $50 each time it buys or sells
securities (TC). The daily variance of cash
flows is $1000 (V) and your bank requires
$1,000 minimum checking account balance
(L).*

Z=

3 x 50 x 1000
4 x .05/360

+ $1,00

= $3,000 + $1,000 = $4,00

The Miller-Orr Model


- Upper Limit
The upper limit for the cash account (H) is

determined by the equation:


H = 3Z - 2L
where:
Z = Target cash balance
L = Lower limit
In the previous example:
H = 3 ($4,000) - 2($1,000) = $10,000

Dollars in the Cash Account

The Miller - Orr Model


Upper Limit

Buy Securities

$10,00

$4000

Lower Limit

Sell Securities
Days of the Month

$10
00

Cash Pooling
Centralized cash management involves
transfer
of an agencys cash in excess of minimal
operating requirements into a centrally
managed
account also known as a cash pool.
Procedure
and
Benefits

Investment of excess
funds

The Collection & Disbursement of


Public Funds
Managing Cash
Balances
Safety
Liquidity
Maximize pool of funds
available for
investment
Concentration

Accounts
Zero-balance accounts
Highest yield

Controlling Cash
Collection &
Disbursement
Dual responsibility
Receipts maintained
in a location separate
from cash & checks
Certification of
vouchers

Collection of funds
Need for accelerating collections
How to accelerate collection of
receivables

Disbursement of funds
Importance of disbursement of funds
Review of disbursements
Payment instruments being used (checks,
drafts, wire transfers, etc.)
Bank charges and internal costs
Techniques being used
Time involved for processing of instruments

Payments Netting in Public


Cash Management
Need for payments netting
Procedure involved
Only netted amount is transferred (bilateral
netting)
Netting center (multilateral netting)

Our objectives
Learn about the Cash Cycle
Understand the factors that influence the

desired level of cash


Learn two models that calculate the
optimal level of cash
Gain an overview of what factors/areas are
inputs to a cash budget and how they
affect the cash balance

Payments netting in Public


Cash Management (contd.)

Payments Netting in Public


Cash Management (contd.)

Cash Planning and


Budgeting

Cash Planning and


Budgeting (contd.)

THANK YOU