Chapter 3:

cash Management
Treasury Management
 introduction

 Cash is the most liquid asset.

 Cash is common denominator to which all other current assets can be
reduced because receivables and inventories get converted into cash.
 Cash is lifeblood of any firm needed to acquire supply resources,
equipment and other assets used in generating the products and
services.
 Marketable securities also come under near cash, serve as back pool of
liquidity which provide quick cash when needed.
 Management of cash
Although
cash is only 1-3% of total current assets but its
management is very important.
Management of cash includes the following objectives:
Determination of optimum amount of cash required in the
business.
To keep the cash balance at optimum level and investment of
surplus cash in profitable manner.
Prompt collection of cash from receivables and efficient
disbursement of cash.
 MEANING OF CASH

For the purpose of cash

management, the term cash not only
includes coins, currency notes,
cheques, bank draft, demand
deposits with banks but also the near
cash assets like marketable securities
and time deposits with bank because
they can readily be converted into
cash
 MOTIVES FOR HOLDING CASH
• In business cash is needed for the following motives:
• Transaction Motive: i.e. to purchase raw material & to pay for operating
expenses
• Precautionary Motive: To meet the future contingencies such as:
Floods, strikes and failures of important customer
Bills may be presented for settlement earlier than expected
Unexpected slow down in collection of accounts receivables.
Cancellation of some order for goods as the customer is not satisfied
 Sharp increase in cost of raw materials
• Speculative Motive: The speculative motive helps to take
advantages of:
An opportunity to purchase raw materials at a reduced price on
payment of immediate cash.
A change to speculate on interest rate movements by buying
securities when interest rates are expected to decline.
Delay purchase of raw materials on the anticipation of decline
in prices.
Make purchase at favorable prices.
• Compensating Motive: Yet another motive to hold cash balances
is to compensate banks for providing certain services and loans.
 floats

• The amount of money tied up in cheques that have been

written but yet to be collected and paid.
• Types of Floats:
 Collection Float
 Mail Float
 Processing Float
 Availability Float
Collection Float: It refers to the total time gap between the
mailing of the payment by the payer and the availability of
cash in bank.
Mail Float: It results from the time that elapse from the
mailing of cheque until it receipt.
Processing Float: It is due to the processing time before the
cheque is deposited into the bank.
Availability Float: It includes the time gap which is
consumed in the clearance of cheque.
 Management of Cash

• Cash Management involves the following 4 problems

• 1. Controlling the level of cash
• 2. Controlling the level of inflow of cash
• 3. Controlling the level of outflow of cash
• 4. Optimum investment of surplus cash
 1. Controlling the level of cash
 The Level of cash locked up in the cash balances should be only that amount
which is required.
 This is achieved by preparing what is called the “Cash Budget”
• Cash Budget
Cash budget is the cash forecast which involves the future projection of the
cash receipts as well as the cash disbursement.
It reveals the “timing” and “amount” of cash inflow and outflow over a
period studied and thus is a tool by which the finance manager is able to
plan things in a better way.
Cash budget is prepared by estimating the cash receipts from various
sources and the cash payments to different agencies
• Cash Receipts
• The cash receipts and payments are divided in to two categories:

• 1. Capital Receipts
All the money that is coming by way of capital fund raising like issue of
shares, loan raised by issuing debentures or preference shares.
Cash received when some long term asset has been sold.
• 2. Revenue Receipts
Cash received by sales of goods /services
Commissions
• Payments

• 1. Capital Payment
 The amount given to the bond holders on the maturity of the bonds
 Payment of long term loan
 Purchase of some long term fixed assets like plant or machinery etc.

• 2. Revenue Payment
Payment for raw materials purchases
Payment of wages, bills, rents
Payment of interest on long term loans
Payment of dividends on shares etc.
Preparing the cash balance (for a specific time period)
Three basic steps:
1. Opening Balance.
2.Add cash receipts and deduct the payments made.
3. Prepare the closing balance (which will be the opening
balance for the next time period).
 Example

•
example
•
2. Controlling the level of inflow of cash
 After preparing the cash budget the finance manager should ensure that
there is no deviation in the inflow of the cash.
 Any deviation from the expected cash inflow can lead to upsetting of the
whole budget activity.
 The Finance manager needs to devise appropriate techniques so that the
cash coming to the firm should not get diverted to anywhere else.
 The cash should also come on time.
 There are multiple types of collection systems to control the level of inflow
of cash.
 Types of collection systems
1. Over the counter collection
It is the system where the payment is received in face to face
meeting the customers.
Mostly retail or customer business receive full or at least some part of
their payments on the over the counter basis.
Since payments are not mailed, an over the counter system does not
contain mail float.
Basic Components It includes the field unit at which the payment is
received, a local deposit bank that serve as the entry point for the firms
banking system and an input into the firms central information system.
2. MAILED PAYMENT COLLECTION SYSTEM
 Many companies receive payments through cheques mailed by
customers in response to an invoice.
 A mailed payment system contains all three components of collection
float i.e. mail float, processing float, float & availability float.
 Itconsists of collection centers, deposit banks and an information
system.
 Payments are mailed by customers to a designated collection centre
operated by company or by an outside agent.
 Payments are processed at collection centre; cheques are encoded; the
deposit is prepared and made and the data are transmitted to the
companies information system.
• Cash flow timeline over The Mailed Collection system
• 3. Pre authorized payments:
• Pre authorized cheques, drafts etc. are sometimes used
when the payment amount and payment dates are
specified in advance.
• On the agreed date the payee initiates the value transfer
from the payer through the banking system.
• This collection system eliminates the mail float, reduce
processing and availability and improve both parties
forecasting ability.
• 4. Cash Concentration
 Decentralized system of account receivables, for the firms having their operations
spread over a large geographical area.
 The firm establishes a large number of collection centers in different geographical
areas.
 The collection centers deposit the cheques from the debtors to the local branch of
the concentration bank.
 The local bank transfers a certain amount of money on daily basis to the Bank at
Head office.
 This results in the faster collection of the funds.
• Advantages Of Concentration
• 1. The collection process results in a larger pool of funds that makes
any temporary interest earning investment more economical.
• 2. With all the cash in the central location, control over the cash is
simplified.
• 3. It simplifies short-term financing and investment decisions.
• Concentration Banking
• 5. A Lock Box System
 A lock-box is a post office box number to which some or all the firm’s
customers are instructed to send their cheques.
 The firm grants permission to its bank to take these cheques and
immediately send them in the clearing process.
 In lock-box location analysis the following areas should be taken into
mind:
Determining customer zone.
Obtaining bank cost data.
The cost of floats
 3. Controlling the level of outflow of cash
 Known as disbursement system. This relates to the cash payment to be
given to the creditors.
 Here the aim is totally opposite to what one has in controlling the cash
inflow. Delay the payment as much as possible and thus want to
slowdown the process.
 The combination of the faster collection and slow disbursement leads to
maximum availability of funds.
 It includes the banks, delivery mechanism and procedures the firms used
to facilitate the movement of cash from the firm’s centralized cash pool
to disbursement banks and then suppliers.
Disbursement banks are bank upon which disbursement
cheques are drawn. It may be more complex than
collection system. It generally falls under more direct
control of head Quarters.
The concentration bank serve as value between firm’s
collection system, liquidity portfolio and disbursement
bank.
• Disbursement Banking
 Types of disbursement systems
• 1. Zero Balance System:
 It is the common strategy for funding disbursement as the cheques are presented.
 Under this system the participatory bank does not keep any permanent stock of
cash in this account.
 Instead it agrees that when the morning disbursement for firm presented to it,
bank will advise to the firm of the amount of cash required to these
disbursements. The money will then be wire transferred into the zero balance
account and the cheques will be honoured.
 In this way the disbursing firm’s cheques are honoured as they are presented, but
the firm does not tie up cash while the cheques are in mail and while they are
clearing.
• 2. Controlled disbursement
 If the zero balance system is not feasible, another system is the use of
controlled disbursement which is often used when the firm’s
disbursement bank receives cheques for clearance throughout the
day.
 In this system, the firm projects the amount of cheques to arrive each
day at the disbursement bank and transfers the amount of expected
cheques to the account on that day or just before.
 Of course, the firm does not know what outstanding cheques will be
presented on any particular day; to hedge the uncertainty the firm
keeps a safety stock of cash in this account.
4. Optimum investment of surplus
cash
• Investment in Marketable Securities
 The management of investment in marketable securities is an
important financial management responsibility because of the
close relationship in between cash and marketable securities.
 Once the optimum level of cash is determined the residual of its
liquid assets is invested in marketable securities.
There are 2 problems that the firm face while taking the decision to invest
the surplus cash
 1. Where to invest
1. Which type of security
2. For how much time
3. Liquidity etc
 2. Determine the amount of surplus cash in hand.
 The cash in excess of what is considered the “normal cash requirement” of
the firm is called the excess cash.
 So FM needs to know what is the “ normal cash requirement”.
 This “ normal cash requirement” is also called the safety level of cash.
 How to determine this “safety/optimum level of cash”
• How to determine the safety level of cash?
Normal Period Safety level Cash
Safety Level of cash = Desired days of cash X Avg daily cash outflow
Example: A FM feels that I should have sufficient funds to meet the cash
requirement for 7 days and the average daily cash outflow for those 7
days is Rs 6000/day
Safety Level of cash = 7 X 6000 = Rs 42,000
Peak Period safety Level of cash
Safety Level of cash = Desired days of cash X Avg daily cash outflow of
peak period
Example : Avg daily cash outflow for the peak days was Rs 4000 and a FM
wants to have sufficient cash for the 5 peak days
Safety Level of cash = 5X 4000 = Rs 20,000
Models to determine the optimum level of cash
Baumol Model
This model is based on minimization of 2 costs.
Carrying cost – When the firm holds cash and it is not in circulation the
firm is loosing the opportunity to invest it somewhere. This is also
called opportunity cost and in this model it is called the carrying cost.
Transaction Cost – When a firm has kept its cash in securities that can
be converted in to cash , it has to pay certain costs like commissions,
admin costs etc.
As per this model that amount of cash( both in hand and in securities) is
the optimum where total of the 2 costs in minimum.
• Miller-Orr Model
Baumol model is suitable where the cash outflow is steady and
can be predicted with accuracy in advance.
Where the cash flows are random Miller-Orr model is used.
This model consists of setting an upper limit, lower limit and
return point for the cash.
Upper limit is represented = h
Lower limit = O
Return Point = z
A company has a policy of maintaining a minimum cash
balance of RM 100,000. The standard deviation in daily cash
balances is RM 10,000. The interest rate on a daily basis is
0.01%. The transaction cost for each sale or purchase of
securities is RM 50. Compute the return point as per the
Miller-Orr model.

Z RM33,471.65 + RM100,000 = RM133,471.65