Cash management
DR. MOHAMED KUTTY KAKKAKUNNAN
Associate Professor
P.G. Dept. of Commerce
N A M College Kallikkandy
Kannur – Kerala - India

CASH MANAGEMENT
• An important current asset
• It is the input needed to carry on the business
continuously and the output realized by selling
the goods or services
• It is the money which can be disbursed without
any restrictions and include currency, coins,
cheques and bank balance
• Least profitable but most liquid asset
• Thus, surplus cash will be invested in marketable
securities i.e near cash items

What is CASH MANAGEMENT?
managing of
(a) cash flows into and out of the firm,
(b) cash flows with in the firm, and
(c) cash balances held by the firm at a point of time
by financing deficit or investing surplus cash
Has to consider Liquidity and profitability at the same
time control over cash flows and balance

The strategy of cash management involves –
• Cash planning -
• Managing flows of cash –
• Determining and maintaining
• Investing surplus cash
Motives for holding cash
• Transaction motive (to conduct transactions)
• Precautionary motive (to meet contingencies)
• Speculative motive (to capitalize profitable
opportunities immediate cash may be required)

Cash Planning
• Forecasting inflows and outflows of cash,
determining the surplus or deficit of cash during
a given period of time
• A technique to plan and control of the use of
cash
• Can be done on daily, weekly, monthly basis and
depends upon the size of the firm
• Cash forecasting and cash budgeting
Cash budget

Determining Optimum Cash Balance
- Liquidity vs. Profitability
- Transaction motive, precautionary motive and
speculative motive
Has to determine optimum cash balance
Optimum Cash Balance Under Certainty
(Baumol’s Model)
• A model for determining optimum cash balance under certainty
• The considers cash management similar to inventory management
• According to him, management tries to minimize the various costs
related with maintaining cash balance

There are two costs with cash
• Cost of holding cash (inventory of cash) and
• The cost of converting marketable securities to
cash
Holding cost is the cost of keeping the cash balance
It is the opportunity cost – the return forgone on
marketable securities for maintaining cash
without investing
If the opportunity cost is k, the cost of maintaining
(holding) average cash balance will be
Holding cost = k(C/2) where C average cash balance

Transaction cost is the cost incurred for converting marketable
securities into cash
Depends upon total number of transactions (T), Cash Balance (C) and
cost per transaction (c), which remains constant
Transaction Cost = c(T/C)
Thus, Total Cost = k(C/2) + c(T/C)
Optimum cash balance reduces both costs to the minimum and is
found out through trade off between holding cost and transaction
costs
C=

Assumptions
• The firm is able to forecast
its cash needs with certainty
• Cash payment occur
uniformly during the period
• Opportunity cost of holding
cash is known and it is
constant
• Incur transaction costs
whenever, it converts
securities into cash

Optimum Cash Balance Under Uncertainty –
The Miller –Orr Model
Major limitation of Baumol Model is that, the model assumes
cash flow and balance to be even (do not fluctuate) and
firm is able to predict daily cash inflows and outflows. But it
is not possible. This limitation is overcome by Miller-Orr
model
According to them, net cash flows are normally distributed
with a zero value of mean and a standard deviation. The
model has two control limits – upper control limit and
lower control limit as well as a return point. If the firms
cash balance fluctuate and hit the upper limit it will
purchase securities to return to the normal position and
when the cash balance hits the lower limit, it will dispose
securities to have sufficient cash balance.

The firm sets upper and lower limits of maintaining
cash balance after considering the transaction
costs (c), interest rates (i) and the standard
deviation of (σ) net cash flows
The lower limit is set by the management after
considering the liquidity requirements
Other limits (upper limits and the control limit (Z))
(also known as distance) are set by using the
following formula
First set control limit (z)
z = (¾ X transaction cost x Cash flow variance /
interest per day)1/3

RP=
Where RP = Return point
b = Fixed cost per order for converting marketable
securities into cash
= Variance Daily Changes Expected In Cash
Balance
i= Daily interest rate earned on the securities
LL = Lower Limit
UL = 3RP – 2LL
UL = Upper limit