Cash Management

Definition: Cash Management refers to the collection, handling, control

and investment of the organizational cash and cash equivalents, to ensure
optimum utilization of the firm’s liquid resources. Money is the lifeline of
the business, and therefore it is essential to maintain a sound cash flow position
in the organization.

Receivables Cash Management

Any amount which the company has earned however not yet received, i.e. its
outstanding and is expected to be received in future, is known as receivables.

An organization must manage its receivables to maintain the surplus cash inflow.
It helps the firm to fulfil its immediate cash requirements.

The cash receivables must be planned in such a way that the organization can
realise its debts quickly and should allow a short credit period to the debtors.

Payables Cash Management

The payables refer to the payment which is unpaid by the organization and is to
be paid off shortly.

The organization should plan its cash outflow in such a manner that it can
acquire an extended credit period from the creditors.

This helps the firm to retain its cash resources for a longer duration to meet the
short term requirements and sudden expenses. Even the organization can invest
this cash in a profitable opportunity for that particular credit period to generate
additional income.

Content: Cash Management

1. Objectives
2. Models
 Baumol’s EOQ Model
 Miller – Orr’ Model
3. Functions
4. Strategies
5. Techniques
6. Limitations
Objectives of Cash Management
Why do we need to manage cash flow in the organization? What is the use of cash
management in the business?

Following purposes of cash management will resolve the above queries:

 Fulfil Working Capital Requirement: The organization needs to

maintain ample liquid cash to meet its routine expenses which possible only
through effective cash management.
 Planning Capital Expenditure: It helps in planning the capital
expenditure and determining the ratio of debt and equity to acquire finance
for this purpose.
 Handling Unorganized Costs: There are times when the company
encounters unexpected circumstances like the breakdown of machinery.
These are unforeseen expenses to cope up with; cash surplus is a lifesaver in
such conditions.
 Initiates Investment: The other aim of cash management is to invest the
idle funds in the right opportunity and the correct proportion.
 Better Utilization of Funds: It ensures the optimum utilization of the
available funds by creating a proper balance between the cash in hand and
investment.
 Avoiding Insolvency: If the business does not plan for efficient cash
management, the situation of insolvency may arise. It is either due to lack of
liquid cash or not making a profit out of the money available.

Cash Management Models

Cash management requires a practical approach and a strong base to determine
the requirement of cash by the organization to meet its daily expenses. For this
purpose, some models were designed to determine the level of money on
different parameters.
The two most important models are discussed in detail below:

Let us now elaborate on each of these models:

The Baumol’s EOQ Model

Based on the Economic Order Quantity (EOQ), in the year 1952, William J.
Baumol gave the Baumol’s EOQ model, which influences the cash management of
the company.

This model emphasizes on maintaining the optimum cash balance in a year to

meet the business expenses on the one hand and grab the profitable investment
opportunities on the other side.

The following formula of the Baumol’s EOQ Model determines the level of cash
which is to be maintained by the organization:

Where,
‘C’ is the optimum cash balance;
‘F’ is the fixed transaction cost;
‘T’ is the total cash requirement for that period;
‘i’ is the rate of interest during the period

The Miller – Orr’ Model

According to Merton H. Miller and Daniel Orr, Baumol’s model only determines
the cash withdrawal; however, cash is the most uncertain element of the
business.

There may be times when the organization will have surplus cash, thus
discouraging withdrawals; instead, it may require to make investments.
Therefore, the company needs to decide the return point or the level of money to
be maintained, instead of determining the withdrawal amount.
This model emphasizes on withdrawing the cash only if the available fund is
below the return point of money whereas investing the surplus amount exceeding
this level.

Given below is the graphical representation of this model:

Where,
‘Z’ is the spread of cash;
‘UL’ is the upper limit or maximum level
‘LL’ is the lower limit or the minimum level
‘RP’ is the Return Point of cash

We can see that the above graph indicates a lower limit which is the minimum
cash a business requires to function. Adding up the spread of cash (Z) to this
lower limit gives us the return point or the average cash requirement.

However, the company should not invest the sum until it reaches the upper limit
to ensure maximum return on investment. This upper limit is derived by adding
the lower limit to the three times of spread (Z). The movement of cash is
generally seen across the lower limit and the upper limit.

Let us now discuss the formula of the Miller – Orr’ model to find out the return
point of cash and the spread across the minimum level and the maximum level:

Where,
‘Return Point’ is the point at which money is to be invested or
withdrawn;
‘Minimum Level’ is the minimum cash required for business
sustainability;
‘Z’ is the spread across the minimum level and the maximum level;
‘T’ is the transaction cost per transfer;
‘V’ is the variance of daily cash flow per annum;
‘i’ is the daily interest rate

Functions of Cash Management

Cash management is required by all kinds of organizations irrespective of their
size, type and location. Following are the multiple managerial functions related to
cash management:

 Investing Idle Cash: The company needs to look for various short term
investment alternatives to utilize surplus funds.
 Controlling Cash Flows: Restricting the cash outflow and accelerating
the cash inflow is an essential function of the business.
 Planning of Cash: Cash management is all about planning and decision
making in terms of maintaining sufficient cash in hand and making wise
investments.
 Managing Cash Flows: Maintaining the proper flow of cash in the
organization through cost-cutting and profit generation from investments is
necessary to attain a positive cash flow.
 Optimizing Cash Level: The organization should continuously function
to maintain the required level of liquidity and cash for business operations.

Cash Management Strategies

Cash management involves decision making at every step. It is not an immediate
solution but a strategical approach to financial problems. Following are the
strategies of cash management:
Business Line of Credit: The organization should opt for a business line of credit
at an initial stage to meet the urgent cash requirements and unexpected
expenses.

Money Market Fund: While carrying on a business, the surplus fund should be
invested in the money market funds. These are readily convertible into cash
whenever required and yield a considerable profit over the period.

Lockbox Account: This facility provided by the banks enable the companies to
get their payments mailed to its post office box. This lockbox is managed by the
banks to avoid manual deposit of cash regularly.

Sweep Account: The organizations should avail the facility of sweep accounts
which is a mix of savings and fixed deposit account. Thus, the minimum balance
of the savings account is automatically maintained, and the excess sum is
transferred to the fixed deposit account.

Cash Deposits (CDs): If the company has a sound financial position and can
predict the expenses well along with availing of a lengthy period, it can invest the
surplus cash in the cash deposits. These CDs yield good interest, but early
withdrawals are liable to penalties.

Cash Flow Management Techniques

Managing cash flow is a contemplative process and requires a lot of analytical
thinking. The various techniques or tools used by the managers to practice cash
flow management are as follows:
  Accelerating Collection of Accounts Receivable: One of the best ways
to improve cash inflow and increase liquid cash by collecting the debts and
dues from the debtors readily.
 Stretching of Accounts Payable: On the other hand, the company
should try to extend the payment of dues by acquiring an extended credit
period from the creditors.
 Cost Cutting: The company must look for the ways of reducing its
operating cost to main a good cash flow in the business and improve
profitability.
 Regular Cash Flow Monitoring: Keeping an eye on the cash inflow and
outflow, prioritizing the expenses and reducing the debts to be recovered,
makes the organization’s financial position sound.
 Wisely Using Banking Services: The services such as a business line of
credit, cash deposits, lockbox account and sweep account should be used
efficiently and intelligently.
 Upgrading with Technology: Digitalization makes it convenient for the
organizations to maintain the financial database and spreadsheets to be
assessed from anywhere anytime.

Limitations of Cash Management

Cash management is an inevitable part of business organizations. However, it has

a few shortcomings which make it unsuitable for small organizations; these are as
follows:
Cash management is a very time consuming and skilful activity which is
required to be performed regularly.

As it requires financial expertise, the company may need to hire consultants or

other experts to perform the task by paying administrative and consultation
charges.

Small business entities which are managed solely, face problems such as
lack of skills, knowledge, time and risk-taking ability to practice cash
management.

Motives for Holding Cash

Definition: The Motives for Holding Cash is simple, the cash inflows and outflows are
not well synchronized, i.e. sometimes the cash inflows are more than the cash outflows
while at other times the cash outflows could be more. Hence, the cash is held by the
firms to meet the certain as well as uncertain situations.

Motives for Holding Cash

Majorly there are three motives for which the firm holds cash.
1. Transaction Motive: The transaction motive refers to the cash required by a firm to
meet the day to day needs of its business operations. In an ordinary course of business,
the firm requires cash to make the payments in the form of salaries, wages, interests,
dividends, goods purchased, etc.

Likewise, it also receives cash from its sales, debtors, investments. Often the firm’s
cash inflows and outflows do not match, and hence, the cash is held up to meet its
routine commitments.

2. Precautionary Motive: The precautionary motive refers to the tendency of a firm to

hold cash, to meet the contingencies or unforeseen circumstances arising in the course
of business.

Since the future is uncertain, a firm may have to face contingencies such as an increase
in the price of raw materials, labor strike, lockouts, change in the demand, etc. Thus, in
order to meet with these uncertainties, the cash is held by the firms to have an
uninterrupted business operations.

3. Speculative Motive: The firms hold cash for the speculative purposes to avail the
benefit of bargain purchases that may arise in the future. For example, if the firm feels
the prices of raw material are likely to fall in the future, it will hold cash and wait till the
prices actually fall.

Thus, a firm holds cash to exploit the possible opportunities that are out of the normal
course of business. These opportunities could be in the form of the low-interest rate
charged on the borrowed funds, expected fall in the raw material prices or favorable
change in the government policies.

Thus, the cash is the most significant and liquid asset that the firm holds. It is significant
as it is used to pay off the firm’s obligations and helps in the expansion of business
operations.