Cash Management

CASH MANAGEMENT

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Presented by Ashish Jaiswal Pankaj Aggarwal Shailendra Kumar

What is cash management

• Cash management is a term that covers a number of functions that help individuals and businesses process receipts and payments in an organized and efficient manner. Administering cash assets today often makes use of a number of automated support services offered by banks and other financial institutions.

• When it comes to cash collections, there are a few popular options today that can make the process of receiving payments from customers much easier. Automated clearing houses make it possible to transact a business to business cash transfer that deducts the payment from the customer account and deposits the funds in the vendor account. Generally, this service is available for a fee at local banks.

Key areas of Public Cash Management

OrganizationCollection and disbursement of fundsNetting of interagency paymentsInvestment of excess fundsOptimal level of cash balancesCash planning and budgetingBank relations

Treasury Management of Cash Balances

Operate with smaller amount of cashSupervision is centralizedBetter service from banksProper allocation of funds

How much cash should a organization keep on hand?

• Enough cash to make payments when needed. (transactions motive)• (Daily or Weekly Cash Budget helpful)

• Additional cash may be held for unexpected requirements. (precautionary motive)

The size of the minimum cash balance depends on:

• How quickly and cheaply a organization can raise cash when needed.

• How accurately managers can predict cash requirements.• (Cash Budget helpful)

• How much precautionary cash the managers need for emergencies.

The organization’s maximum cash balance depends on:

• Available (short-term) investment opportunities• e.g. money market funds, CDs, commercial paper

• Expected return on investment opportunities.• e.g. If expected returns are high, organizations

should be quick to invest excess cash• Transaction cost of withdrawing cash and

making an investment • Demand for Cash for daily transactions

• (Cash Budget helpful)

Consider Cash an ‘Inventory’

Grantsville has a daily demand for cash of $10,000.Grantsville’s treasurer invests excess cash in the state investment pool that earns .01% per day. In order to transfer funds from the state pool, Grantsville must pay a transaction cost of $20. How much cash should it transfer when it runs out. (Grantsville can complete the cash transfer electronically so it waits until the cash balance is zero).

An inventory approach to CashBalance decisions:

the trade-offs: - hold little cash = invest remainder in M/S to earn interest

the trade-offs: - hold little cash = invest remainder in M/S to earn interest

- if hold too little cash = incur transactions costs to meet cash needs

- if hold too little cash = incur transactions costs to meet cash needs

- hold lots of cash = forgo investing in M/S and earning interest

- hold lots of cash = forgo investing in M/S and earning interest

50000000 1002 504 339.3333333 258 210

Order Quantity (Z)

Cost ($)

Z*

Total Costs

Holding Costs: (Z/2)*r

Order Costs:(M/Z)*TC

Optimal Cash Balance via Baumol Model

Z*Z*= [(2M*TC)/r]

M = $10,000M = $10,000 r = .01% .0001r = .01% .0001TC = $20TC = $20

Z = $63,246Z = $63,246

Problems with the Baumol Model

• Cash flows may not be very predictable, much less constant

• Treasurers may want a ‘safety stock’ of cash

The Miller - Orr Model

• The Miller-Orr Model provides a formula for determining the optimum cash balance (Z), the point at which to sell securities to raise cash (lower limit L) and when to invest excess cash by buying securities and lowering cash holdings (upper limit H).

• Depends on: • transaction costs of buying or selling securities• variability of daily cash (incorporates uncertainty)• return on short-term investments

Days of the Month

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The Miller - Orr Model

Lower Limit

Upper Limit

Z

Sell Securities

Buy Securities

H

L

The Miller-Orr Model- Target Cash Balance (Z)

3 x TC x V 4 x r

Z = + L3

where: TC = transaction cost of buying or selling securities

V = variance of daily cash flows r = daily return on short-term

investments L = minimum cash requirement

• Example: Suppose that short-term securities yield 5% per year and it costs the organization $50 each time it buys or sells securities (TC). The daily variance of cash flows is $1000 (V) and your bank requires $1,000 minimum checking account balance (L).*

The Miller-Orr Model- Target Cash Balance (Z)

3 x 50 x 1000 4 x .05/360Z = + $1,000

= $3,000 + $1,000 = $4,000

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The Miller-Orr Model- Upper Limit

• The upper limit for the cash account (H) is determined by the equation:

H = 3Z - 2Lwhere:Z = Target cash balanceL = Lower limit

• In the previous example:H = 3 ($4,000) - 2($1,000) =

$10,000

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The Miller - Orr Model

Lower Limit

Upper Limit

$4000

Sell Securities

Buy Securities

$10,000

$1000

Investment of excess funds

Cash Planning and Budgeting

Cash Planning and Budgeting (contd.)

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