CASH MANAGEMENT

Cash Management
- involves the control over the receipts and payments of cash to minimize
nonearning cash balances.

Objective of Cash Management

- the basic objective of cash management is to keep the investment in cash as low
as possible while keeping the firm operating efficiently and effectively.
- To invest cash for a return while retaining some for liquidity and to satisfy future
needs.
- Money = Future needs, Excess cash  to be invested to earn investment income

Motives of Holding Cash

1) Transaction Motive
- pertains to your operational motive.
- refers to the cash required by a firm to meet the day to day needs of its business
operations.
Ex. cash to make the payments in the form of salaries, wages, interests,
dividends, goods
purchased, etc.
2) Precautionary Motive
- refers to the tendency of a firm to hold cash, to meet the contingencies or unforeseen
circumstances arising during business.
Ex. increase in the price of raw materials, labor strike, lockouts, change in the
demand, etc
3) Contractual Motive (Compliance to Creditor’s Covenant)
- refers to the money that is required to be maintained (compensating balances) to
satisfy a contractual agreement.
4) Speculative Motive (Investment Opportunities)
- a firm holds cash to exploit the possible opportunities that are out of the normal
course of business.
- maintain cash to avail future business opportunity.
a) bargain purchases
b) low-interest rate
Cash Management Techniques
1. Synchronizing Cash Flows

o Synchronize cash flows is a situation in which inflows coincide with outflows

thereby permitting a firm to hold low transactions balances. A thorough review of
the cash flow analysis, cash conversion cycle and cash budget would be most
helpful.
o By improving the forecasts of cash receipts and disbursements and arranging
things so that cash receipts coincide or occur at an earlier time than the timing of
required cash outflows, firm can reduce their cash balance to meet transactional
requirements to a minimum.

2. Using Floats Book balance, not equal, to bank balance = Float

o Floats is defined as the difference between the balance shown in a firm’s books
and the balance on the banks record.
o It arises from the delays in mailing, processing and clearing checks through
banking system.
TYPES OF FLOATS
a. Disbursement Float (Positive Float)
- represents the value of the checks the firm has written but which are
still being processed and thus have not been deducted on the firm’s
account balance by the bank. (Outstanding Checks)
For example, suppose a firm writes on the average, checks
amounting to P50,000 each day, and it takes 5 days for these checks to
clear and to be deducted from the firm’s bank account. This will cause
the firm’s own checkbook to show a balance of P250,000 smaller than
the balance on the bank’s records.
b. Collection float (Negative Float)

- represents the amount of checks that have been received but which
have not yet been credited to the firm’s account by the bank. (Deposit
in Transit)

Suppose that the firm also receives checks in the amount of

P50,000 but it loses four days while they are being deposited and
cleared. This will result in P200,000 of collections float.

o What is the goal in using floats? - “Good cash management suggests that
positive float (disbursement) be maximized while negative float (collection) be
minimized.”

o Maximize Positive Float  Increasing Days AP  Slow Down Disbursement

o Minimize Negative Float  Decreasing Days AR Accelerate Collection
3. Accelerating Cash Collections

o The finance manager should take steps for speedy recovery from debtors and
for this purpose, proper internal control should be installed in the firm.

a. Prompt billing and periodic statements – timely billing

b. Incentives such as trade and cash discounts – offer discount
c. Prompt deposit – depositing received money immediately to the bank
d. Direct deposit to firm’s bank account
e. Electronic depository transfer or payment by wire – online banking
f. Maintenance of regional collection office – lockbox system
LOCKBOX SYSTEM
- a lockbox is a bank-operated mailing address to which a company directs its
customers to send their payments.
- The bank opens the incoming mail, deposit all received funds in the company’s
bank account and scans the payments and any remittance information.
- The scanned images are posted to a secure website, the company’s accounting
staff can access the images to apply payments to an outstanding account
receivable.

Illustration:
 It usually takes Charmander Inc. 10 calendar days to receive and deposit
customer remittances. The system is expected to reduce mailing time by 1.5 days,
reduce processing time by 1.0 day, and reduce check clearing time by 0.5 day.
The average daily receipts are P200,000.
The expected rate of return is 5%.
Required:
If the lockbox system could be arranged at an annual cost of 22,000, what would
be the annual net gain from instituting the system?
Solution:
4. Control or Slow Down Disbursements

o Any action on the part of the finance officer which slows the disbursement
of funds lessens the use for cash balance. This can be done by:

a. Centralized processing of payables – fixing due dates

b. Delaying payment - stretching payables
c. Play the float – take advantage of time in takes to clear the check
d. Less frequent payroll – semimonthly rather than weekly payroll
e. Zero balance accounts (ZBA) – concentration banking

5. Reducing the Need for Precautionary Balance

o Since the transaction and precautionary motives are the important

determinants of the cash requirement, factors influencing their combined
level in the firm must be analyzed.
There are techniques that are available for reducing the need for precautionary
balances. These include:

a. More accurate cash budgeting

b. Lines of credit - pre-arranged loan withdrawable anytime
c. Temporary investments – highly liquid investments
d.

Cash Flow Management

- Determining the target cash balance.
- target cash balance may be derived or cash flow can be managed by:
a. Preparing cash budget
b. Preparing cash break-even chart
c. Determine optimal cash balance using Baumol Model

Cash Budget
- the cash budget is the tool used to
present the expected cash inflows
(receipts) and cash outflows
(disbursements).
Cash Break-even Chart
- this chart shows the relationship between the company’s cash needs and cash
sources.
- It indicates the minimum amount of cash that should be maintained to enable the
company to meet its obligations.

Illustration:
 XYZ Company manufactures plastic which it sells to other industrial users. The
monthly production capacity of the company is 1,200,000 kilos. Selling price is P2
per kilo.
Its cash requirements have been determined as follows:
a) Fixed monthly payments amounting to P250,000
b) Variable cash payments are 50% of sales
Required:
1) Determine the cash breakeven point
2) Prepare a cash breakeven chart
Solution:
Optimal Cash Balance
The Baumol Model – used when;
1. Needs cash
2. Converting securities or investments

When you are converting securities or invesments you incur;

a) Transaction costs – cost of converting securities or investments
b) Opportunity costs - benefits foregone by converting securities or
investments.
***Note: The two costs are inversely related to each other.

Illustration:
 Bulbasaur Inc. projects that cash outlays of P45 million will occur uniformly
throughout the year. Bulbasaur plans to meet its cash requirements by periodically
selling marketable securities from its portfolio. The firm’s marketable securities are
invested to earn 12 percent, and cost per transaction of converting securities to
cash P30.
Required:
1) Determine the total costs if the transaction size is;
a) 200,000
b) 100,000

***The two costs are inversely related to each other.

 The Goal of Baumol Model
- To determine the OPTIMAL CASH BALANCE or OPTIMAL TRANSACTION
SIZE, because this is the point where TOTAL COSTS is the MINIMUM.
- Only at OPTIMAL TRANSACTION SIZE, Transaction Costs = Opportunity
Costs

Illustration:
 Bulbasaur Inc. projects that cash outlays of P45 million will occur uniformly
throughout the year. Bulbasaur plans to meet its cash requirements by periodically
selling marketable securities from its portfolio. The firm’s marketable securities are
invested to earn 12 percent, and cost per transaction of converting securities to
cash P30.
Required:
a. Compute for the Optimal Cash Balance
b. Total costs using the Optimal Cash Balance

Solution: Comparison:
CASH MANAGEMENT EXERCISES