Cash Forecasting

And
Models for the Management of Cash
Lecture 2
• Cash: Cash is the ready currency to
which all liquid assets can be reduced.
• Near Cash: It implies marketable
securities viewed the same way as
cash because of their high liquidity.
• Marketable Securities: Short-term
interest earning money market
instruments used by firms to obtain a
return on temporarily idle funds
 Motives For Holding Cash
Cash management is one of the key areas of
working capital management. There are four
motives for holding cash:

1) Transaction motive,
2) Precautionary motive,
3) Speculative motive, and
4) Compensating motive.
 1. Transaction motive
The transaction motive refers to the holding of cash to meet
anticipated obligations whose time is not perfectly synchronized with
cash receipts.

2. Precautionary motive
Precautionary motive is a motive for holding cash/near-cash as a
cushion t meet unexpected contingencies/demand for cash. The
unexpected cash needs at short notice may be the result of:

❖Floods, strikes and failure of important customers;

❖Bills may be presented for settlement earlier than expected;
❖Unexpected slow down in collection of accounts receivable;
❖Cancellation of some order for goods as the customer is not
satisfied;
and
❖Sharp increase in cost of raw materials.
3. Speculative motive
Speculative motive is a motive for holding
cash/near-cash to quickly take advantage of
opportunities typically outside the normal
course of business.
4. Compensating motive
Compensating motive is a motive for holding
cash/near-cash to compensate banks for
providing certain services or loans.
The basic objectives of cash management are
two-fold:

(a) to meet the cash disbursement needs

(payment schedule)
(b) to minimize funds committed to cash
balances.
Meeting Payments Schedule
A basic objective of cash management is to meet the
payment schedule, that is, to have sufficient cash to meet the
cash disbursement needs of a firm.
The importance of sufficient cash to meet the payment
schedule can hardly be over emphasized. The advantages of
adequate cash are:
1) it prevents insolvency or bankruptcy arising out of the
inability of a firm to meet its obligations;
2) the relationship with the bank is not strained;
3) it helps in fostering good relations with trade creditors
and suppliers of raw materials
4) a cash discount can be availed of if payment is made
within the due date.
5. it leads to a strong credit rating which enables
the firm to purchase goods on favorable terms
and to maintain its line of credit with banks and
other sources of credit;
6. to take advantage of favorable business
opportunities that may be available
periodically; and finally,
7. the firm can meet unanticipated cash
expenditure with a minimum of strain during
emergencies, such as strikes, fires or a new
marketing campaign by competitors.
• For example, a firm is entitled to a 2 per cent
discount for a payment made within 10 days
when the entire payment is to be made
within 30 days. Since the net amount is due
in 30 days, failure to take the discount
means paying an extra 2 per cent for using
the money for an additional 20 days. If a firm
were to pay 2 per cent for every 20-day
period over a year, there would be 18 such
periods (360 days ÷ 20 days). This represents
an annual interest rate of 36 per cent;
Minimizing Funds Committed to Cash Balances

The second objective of cash management is to minimize

cash balances. In minimizing the cash balances, two
conflicting aspects have to be reconciled. A high level of
cash balances will, as shown above, ensure prompt
payment together with all the advantages. But it also
implies that large funds will remain idle, as cash is a
non-earning asset and the firm will have to forego
profits. A low level of cash balances, on the other hand,
may mean failure to meet the payment schedule. The
aim of cash management, therefore, should be to have
an optimal amount of cash balances.
Another general factor to be considered in determining cash needs is the
cost associated with a shortfall in the cash needs. Included in the short costs
are the following:
(1) Transaction costs associated with raising cash to tide over the shortage.
This is usually the brokerage incurred in relation to the sale of some
short-term near-cash assets such as marketable securities.
(2) Borrowing costs associated with borrowing to cover the shortage. These
include items such as interest on loan, commitment charges and other
expenses relating to the loan.
(3) Loss of cash-discount, that is, a substantial loss because of a temporary
shortage of cash.
(4) Cost associated with deterioration of the credit rating which is reflected in
higher bank charges on loans, stoppage of supplies, demands for cash
payment, refusal to sell, loss of image and the attendant decline in sales and
profits.

(5) Penalty rates by banks to meet a shortfall in compensating balances.

Inflow and Outflow Management
 Cash and Marketable
Securities Management

• Motives for Holding Cash

• Speeding Up Cash Receipts
• S-l-o-w-i-n-g D-o-w-n Cash
Payouts
• Electronic Commerce
Collection Float

Mail Processing Availability

Float Float Float

Deposit Float

Collection Float: Total time between the mailing

of the check by the customer and the availability
of cash to the receiving firm.
Mail Float

Customer Firm
mails check receives check

Mail Float: Time the check is in the mail.

Processing Float

Firm Firm
receives check deposits check

Processing Float: Time it takes a company

to process the check internally.
Availability Float

Firm Firm’s bank

deposits check account credited

Availability Float: Time consumed in clearing

the check through the banking system.
Deposit Float

Processing Float Availability Float

Deposit Float: Time during which the check

received by the firm remains uncollected funds.
 Earlier Billing
Accelerate preparation and mailing of
invoices
• computerized billing
• invoices included with shipment
• invoices are faxed
• advance payment requests
• preauthorized debits
 Preauthorized Payments
Preauthorized debit
The transfer of funds from a payor’s bank
account on a specified date to the payee’s bank
account; the transfer is initiated by the payee
with the payor’s advance authorization.
 Lockbox Systems
Traditional Lockbox
A post office box maintained by a firm’s bank that is
used as a receiving point for customer remittances.
Electronic Lockbox
A collection service provided by a firm’s bank that
receives electronic payments and accompanying
remittance data and communicates this information to
the company in a specified format.
 Lockbox Process*
• Customers are instructed to mail their remittances to
the lockbox location.
• Bank picks up remittances several times daily from
the lockbox.
• Bank deposits remittances in the customers account
and provides a deposit slip with a list of payments.
• Company receives the list and any additional mailed
items.

* Based on the traditional lockbox system

 Concentration Banking
Cash Concentration
The movement of cash from lockbox or
field banks into the firm’s central cash pool
residing in a concentration bank.
Compensating Balance
Demand deposits maintained by a firm to
compensate a bank for services provided, credit
lines, or loans.
 Concentration Banking
Moving cash balances to
a central location:
• Improves control over inflows and outflows
of corporate cash.
• Reduces idle cash balances to a minimum.
• Allows for more effective investments by
pooling excess cash balances.
 Methods of Managing
Disbursements
Payable Through Draft (PTD):
A check-like instrument that is drawn against the
payor and not against a bank as is a check. After a
PTD is presented to a bank, the payor gets to decide
whether to honor or refuse payment.
• Delays the time to have funds on deposit to cover
the draft.
• Some suppliers prefer checks.
• Banks will impose a higher service charge due to
the additional handling involved.
 Methods of Managing
Disbursements
Zero Balance Account (ZBA):
A corporate checking account in which a zero
balance is maintained. The account requires a
master (parent) account from which funds are drawn
to cover negative balances or to which excess
balances are sent.
• Eliminates the need to accurately estimate
each disbursement account.
• Only need to forecast overall cash needs.