Cash Management

Cash Cycle

Factors that influence the desired level of cash

Optimal cash inventories

Short-term investment strategies

The Manager

Resource Decisions

Information Decisions

Financing Decisions

Investment Decisions

Human ResourcesDecisions

Managing an entity’s Resources

Cash ManagementInventory ManagementWorking Capital ManagementInvestment in Human CapitalLong-term AssetsAccounts Receivable

Economics of InformationDatabase ManagementData ModelingIS Planning & Development

Debt vs. Tax FinancingCost ofCapital

Discount Rate

Value Creation

FinancialMarkets

Cash Inflows

OperatingDecisions

Recruitment, SelectionTraining, ProductivityPerformance AppraisalCompensationUnions & Labor Relations

Life cycle effects,Business cycle, public events,etc.

Overview

ST fin’l planning = deals w/ short-lived assets and liabilities (working capital management);

concerned w/ 1) size of investment in CA like cash, A/R, Inventory…a tool is cash budget analysis and 2) how to finance ST assets…a tool is performing credit analysis

Managing WC involves determing:

• 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 entity’s cash resources within controlAchieving optimum conservation and utilization of the funds

Key areas of Public Cash Management

OrganizationCollection and disbursement of fundsNetting of interagency paymentsInvestment of excess fundsOptimal level of cash balancesCash planning and budgetingBank relations

Treasury Management of Cash Balances

Operate with smaller amount of cashSupervision is centralizedBetter service from banksProper 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 the managers need for emergencies.

The organization’s 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’

Grantsville has a daily demand for cash of $10,000.Grantsville’s 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).

An inventory approach to CashBalance decisions:

the trade-offs: - hold little cash = invest remainder in M/S to earn interest

the trade-offs: - hold little cash = invest remainder in M/S to earn interest

- if hold too little cash = incur transactions costs to meet cash needs

- if hold too little cash = incur transactions costs to meet cash needs

- hold lots of cash = forgo investing in M/S and earning interest

- hold lots of cash = forgo investing in M/S and earning interest

50000000 1002 504 339.3333333 258 210

Order Quantity (Z)

Cost ($)

Z*

Total Costs

Holding Costs: (Z/2)*r

Order Costs:(M//Z)*TC

Optimal Cash Balance via Baumol Model

Z*Z*= [(2M*TC)/r]

M = $10,000M = $10,000 r = .01% .0001r = .01% .0001TC = $20TC = $20

Z = $63,246Z = $63,246

Problems with the Baumol Model

• 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

Days of the Month

Do

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ash

Acc

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nt The Miller - Orr Model

Lower Limit

Upper Limit

Z

Sell Securities

Buy SecuritiesH

L

The Miller-Orr Model- Target Cash Balance (Z)

3 x TC x V 4 x r

Z = + L3

where: TC = transaction cost of buying or selling securities

V = variance of daily cash flows r = daily return on short-term

investments L = minimum cash requirement

• 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).*

The Miller-Orr Model- Target Cash Balance (Z)

3 x 50 x 1000 4 x .05/360

Z = + $1,000

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

3

The Miller-Orr Model- Upper Limit

• The upper limit for the cash account (H) is determined by the equation:

H = 3Z - 2Lwhere:Z = Target cash balanceL = Lower limit

• In the previous example:H = 3 ($4,000) - 2($1,000) = $10,000

Days of the Month

Do

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th

e C

ash

Acc

ou

nt The Miller - Orr Model

Lower Limit

Upper Limit

$4000

Sell Securities

Buy Securities$10,000

$1000

Cash Pooling

Centralized cash management involves transfer

of an agency’s cash in excess of minimaloperating requirements into a centrally

managedaccount also known as a cash pool.

Procedureand

Benefits

Investment of excess funds

The Collection & Disbursement of Public Funds

Controlling Cash Collection & Disbursement

• Dual responsibility• Receipts maintained in a

location separate from cash & checks

• Certification of vouchers

Managing Cash Balances• Safety • Liquidity• Maximize pool of funds

available for investment– Concentration Accounts

– Zero-balance accounts

• Highest yield

Collection of funds

Need for accelerating collectionsHow to accelerate collection of receivables

Disbursement of fundsImportance of disbursement of fundsReview of disbursements

Payment instruments being used (checks, drafts, wire transfers, etc.)Bank charges and internal costsTechniques being usedTime involved for processing of instruments

Payments Netting in Public Cash

ManagementNeed for payments nettingProcedure 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

Stop Here

Payments netting in Public Cash Management

(contd.)

Payments Netting in Public Cash Management

(contd.)

Cash Planning and Budgeting

Cash Planning and Budgeting (contd.)