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Cash Management Models

The function of Cash management

Sure that firm has adequate cash at all times There are time when firm faced cash surplus rather than cash deficit Cash mgmt. includes management of cash surpluses in app. Manner

Issues in front of the finance manager

Whether to hold cash surplus in the form of cash in anticipation of future needs or invest it in interest earning short-term securities If the surplus is to be held partly as cash and partly as securities, what should be the proportion How frequently and in what amount should the securities

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Baumol Model
(William J. Baumol)

All the cash surplus in initially parked in short-term securities

A part of these securities are liquidated at regular intervals to meet cash req. When part of the securities are liquidated the proceeds are held as cash in hand till it is completely utilized Onces that happens the next batch of securities are liquidated

Assumptions

Two costs are involved: Holding Costs and transaution costs Holding cost: Interest foregone on Cash Balance held Transaution Cost: incurred in Converting securities into cash

The cash requirement for the particular period is known in advance 3/26/12

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The total cost

TC=I(C/2)+b(T/C) TC= Total Costs(total conversion cots+total holding costs) I=Interest rate on marketable securities per planning period C= amount of securities liquidated per batch T=Estimated cash requirement over the planning period

The cost where the TC are minimum

C=SQRT(2bT/I)

Refer Illustration 6:

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Miller & Orr Model

Assumption

Two cost: Holding and conversion costs Conversion costs are fixed irrespective of the size of the conversion Cash inflows & outflows over a period are random both in size & direction

The Model does not fix either the amount of conversion of securities or the timing

Instead it specifies the levels at which securities need to be converted into cash And the levels to which the cash balance is required to be brought at the time of such conversion

The Model specifies an Upper control Limit(UL), Return Point(RP) and 3/26/12 a Lower Control Limit (LL)

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When cash balance reaches the Lower control limit

Securities are required to be liquidated to bring the cash balance to the Return Point

When cash balance reaches the Upper control limit

Cash is required to be parked in marketable securities to bring cash balance down to the return point

RP=Cuberoot(3b2/4I+LL) UL= 3 RP -2LL

Where, LL= Lower control limit RP= Return Point

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