Module 9

Cash and Marketable

Securities Management
M. MANAYAO, CPA, MBA
Learning Objectives
Understand Understand the concept of cash management.

Learn Learn the objectives of cash management.

Identify Identify the reasons for holding cash balances.

Know Know how to determine the target cash balance.

Understand Understand the objective of marketable securities.

Realize Realize the reason for holding marketable securities.

Learn Learn the types of marketable securities.

Introduction

Managing cash is becoming even more sophisticated in the global and

electronic age of the 21st century as finance managers try to squeeze the last
peso of profit out of their cash management strategies. Despite whatever
lifelong teachings about the virtues of having cash, the corporate financial
manager actively seeks to keep this nonearning asset to a minimum.
Minimizing cash balances as well as having accurate knowledge of when
cash moves into and out of the company can improve overall corporate
profitability. However, a business firm would not want to get caught
without cash when it is needed. Cash management involves control over the
receipts and payments of cash so as to minimize nonearning cash balances.
Objective of Cash Management

01 02 03 04
Accelerate cash Monitor the cash Minimize the Avoid
inflows by disbursement needs amount of idle cash misappropriation
optimizing or payments or funds committed and handling losses
mechanisms for schedule. to transactions and in the normal
collecting cash. precautionary course of business.
balances; and
Reasons for Holding Cash

1. Transaction Facilitation. This involves the use of cash to pay for planned business expenditures such
as supplies, payrolls, taxes, suppliers’ bills, interest on debts, cash dividends and acquisitions of long-
term fixed assets.
2. Precautionary Motive. Although the firm expects cash to come in from day-to-day operations and
other financing activities, the inflows and outflows are not usually perfectly synchronized. It will need
to keep enough cash for emergency purposes. Precautionary cash balances are more likely to be
important in seasonal or cyclical industries where cash inflows are more uncertain. Firms with
precautionary needs usually rely on unused lines of bank credit.
3. Compliance with Creditor’s Covenant. Another major reason for holding cash is to be able to comply
the requirement of lending institutions and other creditors of keeping a certain percentage of borrowed
funds in their bank accounts (e.g., compensating balance).
4. Investment Opportunities. Having excess cash may allow the firm to take advantage of investment
opportunities that would otherwise be impossible to transact. Example is when a block of raw materials
is offered at discounted prices if purchased on cash basis.
Determining the Target Cash
Balance

The target cash balance may be derived

with the use of the following approaches,
namely:
• Cash Budget
• Cash Break-even Chart
• Optimal Cash Balance using the
• Baumol Model
• Miller-Orr Model
The Baumol Model

In most medium or large-sized corporations liquidity management has assumed a greater role over
the past decade. Since cash is needed for both transactions and precautionary needs in all companies,
it must be available in some form, (cash, marketable securities, borrowing capacity) all of the time.
The liquidity managers must utilize some formal models or techniques to maintain the optimal
amount at each moment in time because too much liquidity brings down the rate of return on total
assets employed and too little liquidity jeopardizes the very existence of the firm itself. In managing
the level of cash (currency plus demand deposits) for transaction purposes versus cash (marketable
securities), the following costs must be considered:
1. Fixed and variable brokerage fees, and
2. Opportunity costs such as interest foregone by holding cash instead of near cash.
The Baumol Model

 Where:

 T = transaction costs which is a fixed

amount per transaction. It includes the
cost of securities transactions or cost of
obtaining a loan.

 K = opportunity cost of holding cash.

Interest rate on marketable securities or
the cost of borrowing cash.

 F = total demand for cash over a period of

time.
The Miller-Orr Model

The Miller-Orr Model takes a different

approach to calculating the optimal cash
management strategy. It assumes that the
distribution of daily net cash flows is
normally distributed and allows for both
cash inflows and outflows.
 Cash Management
Techniques
Effective cash management encompasses the
proper management of cash inflows and outflows,
which involve:
1. Synchronizing cash flows
2. Using floats
3. Accelerating cash collections
4. Getting available funds to where they are
needed
5. Controlling disbursements

M. Manayao, CPA, MBA

Using Floats
Float is defined as the difference between the
balance shown in a firm’s books and the balance
on the bank records. It arises from the delays in
mailing, processing and clearing checks through
the banking system.

Disbursement float represents the value of the

checks the firm has written but which are still
being processed and thus have not been deducted
from the firm’s account balance by the bank.
Collections 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.
 Accelerating Cash Collections

Incentives such as trade and cash Prompt deposit. Once the checks/drafts are
Prompt billing and periodic statements discounts offered to the customers for received from customers, no delay should
prepared to show the outstanding bills. early/prompt payments. These should be occur in depositing these receipts with the
well communicated to them. banks.

Electronic depository transfer or payment by

wire. With the developments taking place in
Direct deposit to firm’s bank account. the computer technology, the present booking
Customer may also be advised to deposit system is also being switched over the
computer network of banks to offer efficient
their checks or cash directly into the bank banking services and cash management Maintenance of regional collection office.
account of the firm and furnish details to services to their customers. The network will
the firm. be linked to the different branches, banks and
the transfer of funds will take place very fast
that will result to substantial reduction of float.

M. Manayao, CPA, MBA

Slowing Disbursements
1 2 3 4 5

Centralized Zero balance Delaying “Play the float”. Less frequent

processing of accounts (ZBA).
payables. This
payment. If one This involves payroll. Instead
These are special
permits the finance disbursement is not going to taking advantage of paying the
manager to evaluate accounts having a take advantage of of the time it workers weekly,
the payments coming zero peso balance on any offered trade takes for the they may just be
due for the entire firm
and to schedule the
which checks are discount for company’s check paid semi-
availability of funds to written. As checks early payment, to clear the monthly.
are presented to a
meet these needs on a
ZBA for payment, pay on the last banking system.
company-wide basis.
It also results to more funds are day of the credit
efficient monitoring of automatically period.
payables and float transferred from the
balances. master account.

M. Manayao, CPA, MBA

Reducing the Needs for Precautionary Balance

More accurate cash

budgeting. Most critical is the Temporary investments.
Lines of credit. This is a pre-
accuracy of the cash budget or Investments in highly liquid
arranged loan where the
forecast. The closer the fit securities may be
company can withdraw
between cash inflows and maintained instead of
outflows, the more certain the anytime within the period
holding idle precautionary
forecasts the less need for agreed upon.
cash balances.
precautionary balances.

M. Manayao, CPA, MBA

Marketable
Securities
Objective

Realistically, management of cash and marketable securities cannot be

separated. Management of one implies management of the other.

The firm may hold excess funds in anticipation of a cash outlay. When funds
are being held for other than immediate transaction purposes, they should be
converted from cash into interest-earning marketable securities. Marketable
securities which should be of highest investment grade usually consist of
treasury bills, commercial paper, certification of time deposits from
commercial banks, and money market notes.
Reasons for Holding Marketable Securities

1. They serve as a substitute for cash balances. Many firms prefer to hold
marketable securities as a substitute for transaction balances,
precautionary balances, for speculative balances or for all three. In most
cases, however, the securities are held primarily for precautionary purposes
or as a guard against a possible shortage of bank credit.
2. They are held as a temporary investment where a return is earned while
funds are temporary idle.
3. They are built up to meet known financial requirements such as tax
payments, maturing bond issue and so on.
Factors Influencing the Choice of Marketable Securities
1. Risks
2. Maturity
3. Yield or return on securities
Risks
➢ Default risk. The risk that the issuer of the security can not pay the principal or interest at
due dates. The funds invested in short-term marketable instruments should be safe and
secure as regards repayment of principal and interest as and when it matures since the
return on short-term investments is offered less than long-term investments, the
acceptable risk level is required to be lesser commensurate with lower return. Some of the
investments like commercial paper are offered with credit ratings. The government
treasury bills, banker’s acceptance and certificate of deposits carry minimum default risk.
➢ Interest rate risk. The risk of declines in market values of the security due to rising
interest rates.
➢ Inflation risk. The risk that inflation will reduce the “real” value of the investment. In
periods of rising prices, inflation risk is lower on investments (e.g., common stock, real
estate) whose returns tend to rise with inflation than on investment whose returns are
fixed.
Risks
➢ Marketability (liquidity) risk. This refers to the risk that securities cannot be sold
at close to the quoted market price and is closely associated with liquidity risk.
The liquidity is the basic objective of investment in these instruments. It should
offer the facility of quick sale in the market as and when need arises for cash, with
low transaction cost, without loss of time and no erosion on amounts invested
with fall in price of investments.

➢ Event risk. The probability that some event (such as merger, recapitalization or a
leverage buyout) will occur and suddenly will increase a firm’s default risk. Bonds
issued by regulated companies as banks or electric utilities generally have lesser
event risk than bonds issued by industrial and service companies. Treasury
securities usually do not carry any risk, barring national disaster. Also, long-term
securities are affected more by unfavorable events than are short-term securities.
 Money Market Instrument

Treasury Bills

Other short-term Commercial Papers Issued by Finance

Types of Companies, Banks and Other Corporations
Marketable Negotiable Certificates of Deposit

Securities Repurchase Agreements (REPOS)

Banker’s Acceptance

Money Market Mutual Fund

M. Manayao, CPA, MBA

Problem 1 (page 299)

Initial amount 10,000

Add: Deposits 70,000
Less: Checks (25,000)
Bank Balance 55,000

Float (55,000 – 40,000) 15,000

Problem 2 (page 300)
Requirement a
Outstanding Checks = 620 + 400 + 320 + 700 + 440 = 2,480

Requirement b
Checks #423 and 424 – (620 + 400) x 75% 765
Checks #425 to 427 – (320 + 700 + 440) x 40% 584
Total expected value of payments 1,349

Requirement c
Disbursement float = 2,480 – 1,349 = 1,131
Problem 4 (page 300)
Requirement a
Optimal cash balance = 2 x 3M x 125 /8% = 96,825
Average cash balance = 96,825 / 2 = 48,412

Requirement b
Optimal cash balance = 2 x 3M x 75 /12% = 61,237
Average cash balance = 61,237 / 2 = 30,619
➢QUESTIONS????
➢REACTIONS!!!!!
END