Defined as demand deposits plus currency. Cash is often called a nonearning asset.

Sufficient cash is required

(1) to take trade discounts, (2) to maintain its credit rating, and (3) to meet unexpected cash needs.

Cash management managing of:

is

concerned

with

the

cash flows into and out of the firm, cash flows within the firm, and cash balances held by the firm at a point of time by

financing deficit or investing surplus cash

Transactions Balance A cash balance associated with payments and collections; the balance necessary for day-to-day operations.

Precautionary Balance

A cash balance held in reserve for random, unforeseen fluctuations in cash inflows and outflows. The less predictable the firms cash flows, the larger such balances should be. firms that would need large precautionary balances tend to hold highly liquid marketable securities rather than cash.

Speculative Balance A cash balance that is held to enable the firm to take advantage of any bargain purchases that might arise. Firms today are more likely to rely on reserve borrowing capacity and/or marketable securities portfolios than on cash per se for speculative purposes.

Optimum Cash Balance under Certainty: Baumols Model Optimum Cash Balance under Uncertainty: The MillerOrr Model

The firm is able to forecast its cash needs with certainty. The firms cash payments occur uniformly over a period of time. The opportunity cost of holding cash is known and it does not change over time. The firm will incur the same transaction cost whenever it converts securities to cash.

The firm incurs a holding cost for keeping the cash balance. It is an opportunity cost; that is, the return foregone on the marketable securities. If the opportunity cost is k, then the firms holding cost for maintaining an average cash balance is as follows: Holding cost = k (C / 2) The firm incurs a transaction cost whenever it converts its marketable securities to cash. Total number of transactions during the year will be total funds requirement, T, divided by the cash balance, C, i.e., T/C. The per transaction cost is assumed to be constant. If per transaction cost is c, then the total transaction cost will be:

Transaction cost = c(T / C )

The total annual cost of the demand for cash will be: Total cost = k (C / 2) c(T / C ) The optimum cash balance, C*, is obtained when the total cost is minimum. The formula for the optimum cash balance is as follows: 2cT C* k

Baumol's model for cash balance

Cost trade-off: Baumol's model

The MO model provides for two control limits the upper control limit and the lower control limit as well as a return point.
If the firms cash flows fluctuate randomly and hit the upper limit, then it buys sufficient marketable securities to come back to a normal level of cash balance (the return point).

When the firms cash flows wander and hit the lower limit, it sells sufficient marketable securities to bring the cash balance back to the normal level (the return point).

The difference between the upper limit and the lower limit depends on the following factors:
the transaction cost (c) the interest rate, (i) the standard deviation (s) of net cash flows.

The formula for determining the distance between upper and lower control limits (called Z) is as follows:

(Upper Limit Lower Limit) = (3/ 4 Transaction Cost Cash Flow Variance / Interest Rate)1/ 3

Upper Limit = Lower Limit + 3Z Return Point = Lower Limit + Z The net effect is that the firms hold the average the cash balance equal to: Average Cash Balance = Lower Limit + 4/3Z

Treasury bills Commercial papers Certificates of deposits Bank deposits Inter-corporate deposits Money market mutual funds

http://www.fimmda.org

Ready Cash Segment: Optimal balance of marketable securities held to take care of probable deficiencies in the firms cash account. Controllable Cash Segment: Marketable securities held for meeting controllable (knowable) outflows, such as taxes and dividends. Free cash segment :Free marketable securities (that is, available for as yet unassigned purposes).

Cash planning Managing the cash flows Optimum cash level Investing surplus cash

Cash planning is a technique to plan and control the use of cash. Cash Forecasting and Budgeting
Cash budget is the most significant device to plan for and control cash receipts and payments. Cash forecasts are needed to prepare cash budgets.

A table showing cash flows (receipts, disbursements, and cash balances) for a firm over a specified period.

Target Cash Balance The desired cash balance that a firm plans to maintain in order to conduct business.

You dont have to worry about predicting short-term fluctuations in cash flow, if you have solid bank commitments. Cash budget page 8

Selecting Investment Opportunities:

Safety, Maturity, and Marketability.

Realistically, the management of cash and marketable securities cannot be separated Benefits and costs associated with holding cash and marketable securities.

The benefits are twofold: (1) the firm reduces transactions costs because it wont have to issue securities or borrow as frequently to raise cash; and (2) it will have ready cash to take advantage of bargain purchases or growth opportunities.

The primary disadvantage is that the after-tax return on cash and short-term securities is very low. Thus, firms face a trade-off between benefits and costs.

Capital markets

Ready Cash Segment: Safety and ability to convert to cash is most important. Select TB for this segment. Controllable Cash Segment: Marketability less important. Possibly match time needs. May select CD, REPOS for this segment. Free cash segment : Base choice on yield subject to risk-return trade-offs. Any money market instrument may be selected for this segment.