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Cash Management

 Introduction
 Meaning and Nature
 Motives for Holding Cash
 Objectives of Cash Management
 Factors Determining Cash Needs
 Advantages of Adequate Cash
 Issues in Cash Management
 Avoiding Cash Deficit or Cash Insolvency
 Utilization of Surplus or Excess Cash
Cash Management
 Marketable Securities and its Types
 Cost of Being Short Cash
 Functions of Cash Management
 Cash Management Models
 Cash Forecasts Types and Methods
 Factors Determining Cash Budgets
 Steps and Uses of Cash Budget
 Cash Flow Statement Analysis
 Fund Flow Statement Analysis
Introduction
Cash performs vital role in the business. Cash is
termed as basic component to satisfy not only day to
day requirements of business but also making payments
to creditors. That is why maintaining adequate cash
balance is important task in cash management. This
chapter focuses on different aspects as well as
techniques for maintaining essential cash balances. The
same are as below;
Introduction
1. Meaning and nature of cash
2. Issues of cash management
3. Motives for holding cash
4. Cash planning
5. Factors determining cash needs
6. Cash Management Models
(a) Baumol Model
(b) Miller-Orr Model
7. Tools of Cash Planning
(a) Cash Budget
(b) Cash Flow from Operation
(c) Cash Inflow and Outflow Statements
(d) Statement of Working Capital Forecast
Meaning and Nature

The term cash has different meanings, in narrow


sense, it refers to currency notes, coins, bank draft etc.
In broader sense it mean near cash assets. Such assets
are marketable securities, time deposit in banks and
treasury bills etc. Both cash and near cash assets are
used in cash management. Cash is therefore describe as
the oil to lubricate the ever turning wheels of business.
Motives for holding cash
J. M. Keynes has identified following motives for
cash is held by the firm;
1] Transaction Motive: It refers to the holding of cash
to carry day to day business transactions. The
requirement of cash balance to meet routine business
needs is known as Transaction Motive.
2] Precautionary Motive: According to this motive the
concern keeps cash balance to meet some unexpected
cash needs arising may be the result of; floods, strikes,
increase in cost of raw material etc.
Motives for holding cash
3] Speculative Motive: This refers to maintaining cash
balance to take advantages of investing in profit making
opportunities which are outside the normal course of
business. This motive presents a positive and aggressive
approach of management.
4] Compensation Motive: This motive for holding
cash is to compensate banks for providing certain
services to their clients free of charge. Best e.g. of this
motive is minimum balance kept in savings bank
account or current account.
Objectives of Cash Management
The main objectives of cash management are as below;
1] Meeting Cash Disbursement: The basic objective of
cash management is to make timely payments of cash in
normal course of business. Thus, the finance manager
ensure sufficient cash balance to meet payment schedule
2] Minimizing Funds Committed to Cash Balances:
In addition to above objective, the cash management
ensure to minimize the amount blocked up as cash
balance. In this process two conflicting aspect have to
be reconciled. A high level balance and a low level cash
balance. The final aim of cash management should be to
have an optimum amount of cash balances.
Factors Determining Cash Needs
Following factors are to be considered before
determining the amount of cash requirements.
1] Position of accounts receivables
2] Operating and cash cycle
3] Control of cash disbursements
4] Nature of Product / Business
Advantages of Adequate Cash
When a firm manages to keep adequate cash balance,
following benefits obtained.
1] Higher Productivity and Liquidity
2] Firm can avail cash as well as trade discounts
3] It helps to improves credit worthiness, good will
4] It provides regular flows of cash
5] Firm can enjoy new business opportunities
6] It helps to overcome short term crises
7] It creates good confidence among the investors
8] It ensure timely procurement of raw material
Issues in Cash Management
The main aim of cash management is to match
the inflow and outflow of cash. It is very essential for a
business to maintain adequate cash balance. Many times
a concern operates profitability and yet finding it
difficult to predict cash flows accurately.
Cash management is important since it is very
difficult to correct prediction of cash flows. To gain
control on company’s cash flows, a firm or finance
manager should develop some strategies for cash
management with the help of following points.
1. Cash Planning 2. Managing Cash flows
3. Optimum Cash level 4. Investing Idle Cash
Avoiding Cash Deficit or Cash Insolvency
While managing cash flows, if company gets in
to position from where it is difficult to meet its
operating expenses, following stapes should be taken;
1. Utilise unavailed credit limits.
2. Sell marketable securities
3. Accelerates collection from debtors
4. Negotiates for short term loans from banks
5. Sell redundant assets
6. Accounts receivables may be discounted with banks
7. Put control over expenditures
8. Defer payments may be extent to the possible
Utilization of Surplus or Excess Cash
It is quite possible that firm may comes in a
position that having surplus or excess cash. At this time a
finance manager should take utmost care to put this
excess in such a way that at the time of deficit this excess
helps organisation. Cash surplus should be utilized in
following way;
1. It should be invested in temporary investment
2. Idle cash may be used for modernization etc.
3. It can be used to reduce firm’s short term loans.
4. It is to be invested in high liquid and low risk securities
Marketable Securities and its Types
As seen earlier, excess cash should be invested in
high liquid and low risk marketable securities, it is
necessary to get knowledge of marketable securities and
its different types. Thus, Marketable Securities are those
which can be converted back to cash without delays.
There are different types of such securities available in
the market. Each security offers different characteristics.
The same are depicted in the chart form on next slide.
Marketable Securities and its Types
Repurchase
Agreement
Negotiable
Certificates
Factoring
of
Deposit

Types
of
Securities Global
Treasury
Depository
Securities
Receipt

Banker’s Commercial
Acceptance Paper
Cost of Being Short Cash
The term short cost refers to, cost associated with a
shortage of cash in the firm’s cash requirements. Such
cost may be incurred in any of the following form ;

1. Loss of Discount: Due to shortage of cash, firm can’t


avail the facility of discount.
2. Transaction Cost: Brokerage, related to sale of assets
3. Borrowing Cost: High rate of interest, penalty charges
Functions of Cash Management
Following are the basic functions of Cash Management;
1. Controlling inflow of cash or sources of cash
(a) Accelerating Collection
(b) Concentration Banking
(c) Lock-box System
(d) Efficient Inventory Production Management
2. Control Over Cash Outflow or Application of Cash
(a) Efficient System of Cash Disbursement
(b) Billing Float
(c) Mail Float
(d) Check Processing Float
(e) Bank Processing Float
3. Optimum Investment of Surplus Cash
4. Controlling Level of Cash
(a) Preparing Cash of Cash
(b) Providing unpredictable discrepancies
(c) Consideration of Short Cost
(d) Exploring other sources of finance.
Cash Management models
It may be necessary for a cash management to
know what should be the optimum cash balance must be
maintain. There are number of cash management models
developed to determine the optimum level of cash
balances. Below mentioned are two important cash
models;
1] William J. Baumol Model
2] Merton Miller and Daniel Orr Model
We shall look each one of them in brief.
Cash Management models
1] William J. Baumol Model: This model is based on
combination of inventory theory with monetary theory. To
determine optimum level of cash balance for company,
Economic Order Quantity Model is used in the standard
inventory situations. According to this model, the optimum
cash level is that level, where the carrying cost and transaction
cost are the minimum. Symbolically this method can be
presented as below;
2 UP
C= S
Where,
C = Optimum Cash Balance
U = Annual (monthly) Cash disbursement
P = Fixed Cost Per Transaction
S = Opportunity Cost of one Re. p.a.
Cash Management models
2] Merton Miller and Daniel Orr Model: The main
objective of this model is to maximize earning by
investing in securities. Symbolically it is presented as
below; 3 b 2
Z= 4i
Where,
Fixed Cost Associated with
b=
Security Transactions
 = Variance of Daily net Cash Flows
i = Interest Rate per day on Securities
Cash Forecasts Types and Methods
Cash forecasts is nothing but a summary of
expected cash inflow and outflow over a period of time. It
is mainly concerned with an assessment of probable
future events. On the basis of objective cash forecasts can
be grouped as under;
1] Short-Term Cash Forecasts: It is normally cover period
of 12 months. It is also called Cash budgeting.
2] Long-Term Cash Forecasts: All the forecasts beyond
one year comes under this head.
Cash Forecasts Types and Methods
Methods of cash forecasts can be illustrated as below;
I. For Short-Term Cash Forecasts:
(a) Receipt and Payment Method
or
Cash Budget Method
(b) Adjusted Net Income Method
or
Cash Flow Statement Method

II. For Long-Term Cash Forecasts:


(a) Fund Flow Statement Analysis
or
Balance Sheet Forecast Method
Factors Determining Cash Budget
While preparing cash budget following factors has to
be consider very carefully.
1. Operating Decisions
2. Capital Expenditure Plans
3. Customers Credit Decisions
4. Tax on Profit
5. Financial Obligations
6. Profit Plan
7. Degree of Liquidity
8. Overhead Expenses to be incurred
9. Debt Repayment and Dividend Plans
Steps and Uses of Cash Budget
Following steps are taken while preparing cash budget.
1. Estimating the timing and amount of cash
2. Estimating the expenditure involving cash
3. Controlling cash receipts with expenditures
4. Forecasting the requirements of additional financing

The uses of Cash Budget can be summarised as below,


1. It is used as a tool to cash planning and control
2. It gives information to management for decision making
3. It helps to take advantage of cash discount
4. It reveals the surplus amount
5. It act as a tool to measure effective utilization of cash
Illustration:
From the following data, forecast the cash position at the end of April, May
and June 2003.
Month Sales Purchase Wages Miscellaneous
(Rs.) (Rs.) (Rs.) (Rs.)
February 6,00,000 4,20,000 50,000 35,000
March 6,50,000 5,00,000 60,000 40,000
April 4,00,000 5,20,000 40,000 30,000
May 5,80,000 5,30,000 50,000 60,000
June 4,40,000 4,00,000 40,000 30,000

Additional Information:
1] Sales : 10% realized in the month of sales; balance realized equally in two subsequent months.
2] Purchases : There are paid in the month following the month of supply.
3] Wages : 10% paid in arrears following month.
4] Rent : Rs.5,000 per month paid Quarterly in advance due in April.
5] Miscellaneous expenses : Paid a month in arrears.
6] Income Tax : First installment of advance tax Rs.1,50,000 due on or before 15th June.
7] Income from Investment : Rs.30,000 received quarterly in April, July etc.
8] Cash in hand : Rs.30,000 on 1st April.
Solution: Cash Budget for the month of April, May and June
Particulars April Rs. May Rs. June Rs.
Opening Balance of Cash 30,000 75,500 7,000
Add: Cash Receipts :
Cash Sales 40,000 58,000 44,000
Receipts from Debtors (Credit Sales):
Collection in 1st month 2,92,500 1,80,000 1,98,000
Collection in 2nd month 2,70,000 2,92,500 1,80,000
Income From Investment 30,000 - -
Total Cash Receipts : [1] 6,62,500 6,06,000 4,29,000
Less : Cash Payments :
Creditors for Purchases 5,00,000 5,20,000 5,30,000
Wages : Current (90%) 36,000 45,000 36,000
Arrears (10%) 6,000 4,000 5,000
Rent 5,000 - -
Miscellaneous Expenses 40,000 30,000 60,000
Income Tax - - 15,000
Total Payments : [2] 5,87,000 5,99,000 7,81,000
Closing Balance of Cash 75,500 7,000 (-) 3,52,000
Working Notes:
1] Out of total Sales, 10% are cash sales. Balance 90% are credit sales. In any
given month 50% of credit sale of the previous two months are collected.
2] In any given month, 90% of the wages of the same month and 10% of
previous months wages are paid.
Particulars Feb. March April May June
Rs. Rs. Rs. Rs. Rs.
Total Sales 6,00,000 6,50,000 4,00,000 5,80,000 4,40,000
Less: Cash (10%) 60,000 65,000 40,000 58,000 44,000
5,40,000 5,85,000 3,60,000 5,22,000 3,96,000
Collection in 1st
Month after Credit --------- 2,70,000 2,92,500 1,80,000 1,98,000
Sales
Collection in 2nd
Month after Credit ---------- ----------- 2,70,000 2,92,500 1,80,000
Sales
Total Credit 5,62,000 4,72,500 3,78,000
Cash Flow Statement Analysis
The word fund is used in a narrow sense refers to
cash. When cash is used as ‘fund’ the analysis relates to
movement of cash. Cash flows refers to actual movement
of cash into and out of an enterprises. When cash flows
into organisation, it called ‘inflow of cash’, similarly when
cash goes out of business its called ‘outflow of cash’. The
cash flow statement depicting movement of cash position
from one period to another.
Uses and Limitations of Cash Flow Statement
The uses of Cash Flow Statement are as below;
(a) It is useful to management to prepare dividend policies
(b) It guides management to evaluate the changes in cash
(c) It helps to know, how movement of cash took place
(d) It shows the details about sources and application of
cash

The limitations of Cash Flows are;


(a) It does not reveal the overall financial position of firm
(b) It can’t provide a comprehensive picture, as non-cash
expenses and income are excluded.
(c) The balances disclosed by Cash Flow statement may not
treated the actual liquid position.
Preparation of Cash Flow Statement
While preparing cash flow statement, it starts with
opening balance of cash in hand and cash at bank, all the
sources of cash are added to an opening balance and all
application of cash are deducted. The balance represents
cash and bank balance at the end of accounting period.
While applying this method following general principals
may be taken for measuring cash from operations.
Increase in Current Assets Decrease in Cash
Decrease in Current Assets Increase in Cash
Increase in Current Liability Increase in Cash
Decrease in Current Liability Decrease in Cash
Fund Flow Statement Analysis
This is a statement summarizing the significant
financial changes in items of financial position which have
occurred between the two different balance sheet dates.
This statement is prepared on the basis of “Working
Capital” concept of funds. It is also termed as “ Statement
of Sources and Application of Fund”, “Where Got and
Where Gone Out Statement”, “Inflow and Outflow of Fund
Statement”.
Uses and Limitations of Fund Flow Statement
The uses of Fund Flow Statement are as below;
(a) It highlights the uses of funds between two a/c periods
(b) It brings into light financial strength and weakness
(c) It gives detailed explanation of movement of funds
(d) It is an instrument used by the investors for effective
decisions at the time of their investment proposals.

The limitations of Fund Flows are;


(a) It ignores to project future operations
(b) It is also ignores when transactions involves between
current accounts or non-current accounts.
(c) This statement does not focus on transactions involves in
non-fund items.
Preparation of Fund Flow Statement
Fund Flow analysis involves the following
important three statements such as,
1. Funds From Operations
2. Statement of Changes in Working Capital
3. Fund Flow Statement
While preparing Working Capital Statement
following rules may be kept in mind.
Increase in Current Assets Increases in Working Capital
Decrease in Current Assets Decreases in Working Capital
Increase in Current Liability Decreases in Working Capital
Decrease in Current Liability Increases in Working Capital
Illustration
Sales 2003 Nov. 3,20,000
X Y Z Ltd. has given the forecasts sales for Jan
Dec. 2,80,000
2000 to July 2004 and actual sale for November
2004 Jan. 3,20,000
and December 2004 as under with other
particulars given, prepare a cash budget for the Feb. 4,00,000
five months i.e. From January to May 2004. Mar. 3,20,000
1] Sales 20% Cash and 80% Credit payable in Apr. 4,00,000
the third month (Jan. Sales in March) May 3,60,000
2] Variable Expenses 5% on credit Sales time June 4,80,000
lag half month. July 4,00,000
3] Commission 5% on credit Sales payable in the third month
4] Purchases 60% of sales of the third month, Payment made in the third month of purchases
5] Rent and other expenses Rs. 12,000/- per month
6] Fixed Assets purchases – March Rs. 2,00,000/- , Taxes – April Rs. 80,000
7] Opening Cash Balance Rs. 1,00,000
Solution:
Working Notes: 1]Realization From Sales:
Nov. Dec. Jan. Feb. March April May
Rs. Rs. Rs. Rs. Rs. Rs. Rs.
Sales 3,20,000 2,80,000 3,20,000 4,00,000 3,20,000 4,00,000 3,60,000
Cash Sales 64,000 80,000 64,000 80,000 72,000
20% (JAN) (FEB) (MAR) (APR) (MAY)
Credit Sales 2,56,000 2,24,000 2,56,000 3,20,000 2,56,000
80% (NOV) (DEC) (JAN) (FEB) (MAR)
Total 3,20,000 3,04,000 3,20,000 4,00,000 3,28,000

2]Creditors for Goods:


Nov. Dec. Jan. Feb. March April May
Rs. Rs. Rs. Rs. Rs. Rs. Rs.
Purchases 60% 1,92,000 2,40,000 1,92,000 2,40,000 2,16,000 2,88,000 2,40,000
Of Sales of (JAN) (FEB) (MAR) (APR) (MAY) (JUNE) (JULY)
Payment to 1,92,000 2,40,000 1,92,000 2,40,000 2,16,000
Creditors (NOV) (DEC) (JAN) (FEB) (MAR)

Commission 5% 38,000 11,200 38,000 1,600 38,000


On Credit Sales (NOV) (DEC) (JAN) (FEB) (MAR)
Cash Budget (January to May 2004)
Particulars Jan Feb. March April May
Rs. Rs. Rs. Rs. Rs.
Cash Receipts:
Opening Balance 1,00,000 1,88,200 3,11,000 1,96,200 2,30,200
Realization from Sales 3,20,000 3,04,000 3,20,000 4,00,000 3,28,000
Total Cash Receipts 4,20,000 5,92,200 6,31,000 5,96,200 5,58,200
Cash Payments :
Paymt. for Goods Pur. 1,92,000 2,40,000 1,92,000 2,40,000 2,16,000
Variable Expenses 15,000 18,000 18,000 18,000 19,000
Commission 12,800 11,200 12,800 16,000 12,800
Rent and Other Exp. 12,000 12,000 12,000 12,000 12,000
Addition Fixed Assets --------- --------- 2,00,000 --------- ---------
Taxes --------- --------- --------- 80,000 ---------
Total Cash Payment 2,31,800 2,81,200 4,34,800 3,66,000 2,59,800
Closing Bal. of Cash 1,88,200 3,11,000 1,96,200 2,30,200 2,98,400
Illustration:
From the following Balance Sheet of ABC Ltd. you are required to calculate cash from
operations. 2002 2003
Particulars
Rs. Rs.
Capital and Liabilities:
Share Capital 2,00,000 2,00,000
Profit made during the year 1,41,000 1,73,000
Provision for Depreciation 10,000 14,000
Long Term Loans 20,000 30,000
Trade Creditors 64,500 53,000
Outstanding Expenses 8,500 1,500
4,44,400 4,71,500
Assets :
Plant and Machinery 2,85,000 3,00,000
Stocks 98,000 1,13,000
Trade Debtors 39,500 28,500
Cash Balances 21,500 30,000
4,44,400 4,71,500
Solution:
Calculation of cash from operations.
2002 2003
Particulars
Rs. Rs.
Profit made During the Year
(Closing Balance of P & L A/c) 1,73,000
Add:
Provision for Depreciation 4,000
Decrease in Debtors 11,000 15,000
1,88,000
Less:
Decrease in Creditors 11,500
Decrease in Outstanding Expenses 7,000
Increase in Stock 15,000
Net Profit (Opening Balance of P & L A/c) 1,41,000 1,74,500
Cash from Operation : 13,500
Illustration:
From the following Balance Sheets of ABC Ltd. you are required to prepare Cash Flow
Statement.

Liabilities 2003 2004 Assets 2003 2004


Share Capital 2,00,000 3,00,000 Fixed Assets 2,00,000 3,00,000
Profit & Loss A/c 1,00,000 1,60,000 Good Will 1,00,000 80,000
General Reserve 60,000 80,000 Stock 1,00,000 1,60,000
Debenture 1,00,000 1,20,000 Trade Debtors 1,00,000 1,60,000
Trade Creditors 60,000 80,000 Bills Receivables 20,000 40,000
Outstanding Exp. 20,000 30,000 Bank Balance 20,000 30,000
5,40,000 7,70,000 5,40,000 7,70,000
Solution: Calculation of cash from operations.
2002 2003
Particulars
Rs. Rs.
Profit made During the Year
(Closing Balance of P & L A/c) 1,60,000
Add:
General Reserve (60,000 – 80,000) 20,000
Good will Written off 20,000
Increase in Outstanding Expenses 10,000
Increase in Trade Creditors 20,000 70,000
2,30,000
Less:
Increase in Stock (1,00,000 – 1,60,000) 60,000
Increase in Debtors (1,00,000 – 1,60,000) 60,000
Increase in Bills Receivables 20,000
Net Profit (Opening Balance of P & L A/c) 1,00,000 2,40,000
Cash from Operation : (-10,000)
Cash Flow Statement

Source of Cash Rs. Application of Cash Rs.


Opening Balances: Purchases of Fixed Assets 1,00,000
Cash at Bank 20,000 Cash lost in Operation 10,000
Add : Closing Balance :
Issue of Shares 1,00,000 Cash at Bank 30,000
Issue of Debentures 20,000
1,40,000 1,40,000

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