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Chapter 27
CASH AND LIQUIDITY
MANAGEMENT
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OUTLINE
Motives for Holding Cash
Cash Budgeting
Long-term Cash Forecasting
Reports for Control
Cash Collection and Disbursement
Optimal Cash Balance Investment of Surplus Funds
Cash Management Models
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MOTIVES FOR HOLDING CASH
Keynes identified three possible motives for holding cash :
Transaction motive
Precautionary motive
Speculative motive
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CASH BUDGET
The principal method of cash budgeting is the receipts and disbursements method.
Under this method, the cash forecast shows the timing and magnitude of cash
receipts and disbursements over the forecast period.Illustration
The following information about Beta Company is given:
The estimated sales for the period January 20X1 through June 20X1 are as
follows: Rs.100,000 a month from January through March and Rs.120,000 amonth from April through June.
The sales for November and December of the previous year have been
Rs.100,000 each.
Cash and credit sales are expected to be 20 percent and 80 percent respectively. The receivables from credit sales are expected to be collected as follows: 50
percent after one month and the balance 50 percent after two months.
Other anticipated receipts are: Rs.5,000 from the sale of a machine in March and
Rs.2000 interest on securities in June.
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CASH BUDGETING
January February March April May June
1. Sales 100,000 100,000 100,000 120,000 120,000 120,000
2. Credit sales 80,000 80,000 80,000 96,000 96,000 96,000
3. Collection of
accounts
receivables 80,000 80,000 80,000 80,000 88,000 96,0004. Cash sales 20,000 20,000 20,000 24,000 24,000 24,000
5. Receipt from
machine sale 5,000
6. Interest 2,000Total cash
receipts 100,000 100,000 105,000 104,000 112,000 122,000
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CASH BUDGETING
Relevant information for cash payments
Beta Company plans to purchase materials worth Rs.40,000 in January and
February and materials worth Rs.48,000 each month from March through
June. Payments will be made a month after the purchase
A payment of Rs.40000 will be made in January for purchases in the previous
December
Miscellaneous cash purchases of Rs.2000 per month are planned from Januarythrough June
Wage payments will be Rs.15000 per month, January through June
Payments for manufacturing expenses will be Rs.20,000 per month and for
general administrative expenses will be Rs.10,000 per month, January throughJune
Dividend payment of Rs.20,000 and a tax payment of Rs.20,000 are planned for
June
A machine will be bought in cash for Rs. 50,000 in March
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CASH BUDGETING
January February March April May June
1. Material
purchases 40,000 40,000 48,000 48,000 48,000 48,0002. Credit material
purchases 40,000 40,000 48,000 48,000 48,000 48,000
3. Payment of 40,000 40,000 40,000 48,000 48,000 48,000accountspayable
4. Miscellaneous 2,000 2,000 2,000 2,000 2,000 2,000cash purchases
5. Wages 15,000 15,000 15,000 15,000 15,000 15,000
6. Manufacturingexp. 20,000 20,000 20,000 20,000 20,000 20,000
7. General admn.
expense 10,000 10,000 10,000 10,000 10,000 10,0008. Dividend - - - - - 20,000
9. Tax - - - - - 20,000
10. Capital - - 50,000 - - -expenditureTotal payments 87,000 87,000 137,000 95,000 95,000 135,000(3+4+5+6+7+8+9+10)
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CASH BUDGETING
Assuming that the cash balance on 1st January is Rs.22,000 and the minimum cash balance
required by the firm is Rs.20,000, the summary cash forecast is given below.
January February March April May June1. Opening cash
balance Rs.22,000
2. Receipts 100,000 100,000 105,000 104,000 112,000 122,000
3. Payments 87,000 87,000 137,000 95,000 95,000 135,000
4. Net cash flow (2 3) 13,000 13,000 (32,000) 9,000 17,000 (13,000)
5. Cumulative net
cash flow 13,000 26,000 (6,000) 3,000 20,000 7,000
6. Opening cash
balance +Cumulative net flow (1 + 5) 35,000 48,000 16,000 25,000 42,000 29,000
7. Minimum cash balance
required 20,000 20,000 20,000 20,000 20,000 20,000
8. Surplus or deficit in 15,000 28,000 (4,000) 5,000 22,000 9,000
relation to the minimumcash balance required(6 7)
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LONG-TERM CASH FORECASTING
Adjusted net income method is generally used for long-term cash
forecasting.
20 X 0 20 X 1 20 X 2 20 X 3 20 X 4
Source
Net income after taxes
Non-cash charges
(Depreciation, amortisation,
etc.)Increase in borrowings
Sale of equity shares
Miscellaneous
Uses
Capital expenditures
Increase in current assetsRepayment of borrowings
Dividend payment
Miscellaneous
Surplus/ Deficit
Opening cash balance
Closing cash balance
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REPORTS FOR CONTROL
Daily Cash Report
Daily Treasury Report
Monthly Cash Report
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CASH COLLECTION AND DISBURSEMENT
Float
Speeding up Collections
Delaying Payments
EDI : Will the Float Disappear
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FLOAT
The cash balance shown by a firm on its books is called
the book, or ledger, balance whereas the balance shown
in its bank account is called the available, or collected,
balance. The difference between the available balanceand the ledger balance is referred to as float.
There are two kinds of float viz., disbursement float andpayment float
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OPTIMAL CASH BALANCE
C*
Costs
Total costs
Opportunity cost
Transaction cost
Cash balance
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INVESTMENT OF SURPLUS FUNDS
It may be useful to divide a firms short-term investment
portfolio into three segments:
Ready cash segment
Controllable cash segment
Free cash segment
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CRITERIA FOR EVALUATING
INVESTMENT OPTIONS
Safety
Liquidity
Yield
Maturity
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INVESTMENT OPTIONS
Fixed deposits with banks
Treasury bills
Mutual fund schemes
Money market schemes
Commercial paper
Certificates of deposit
Inter-corporate deposits Ready forwards
Bill discounting
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CASH MANAGEMENT MODELS
Several cash management models have addressed this issueof split between marketable securities and cash holdings.
Two such models are :
Baumol model
Miller and Orr model
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BAUMOL MODEL
2bT
C=
I
where: C= amount of marketable securities converted into cash
per order
I= interest rate per planning period on investment in
marketable securities.
T= Projected cash requirements during the planning
period
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MILLER AND ORR MODEL
3b2RP = 3 +LL
4I
UL = 3RP2LL
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 balanceLL = the lower control limit
UL = the upper control limit
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SUMMING UP
There are three possible motives for holding cash, viz., transaction
motive, precautionary motive, and speculative motive.
The principal method of short-term cash forecasting is the receiptsand payment method.
The method generally used for long-term forecasting is the adjusted
income method.
To enhance the efficiency of cash management collections and
disbursements must be properly monitored.
A variety of options are there for investing surplus funds available
for short periods.
William Baumol has proposed a model which applies the EOQ
concept to determine the cash conversion size.
Expanding on the Baumol model, Miller and Orr consider a
stochastic generating process for periodic changes in cash balance.
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