Chapter 12 Cash Management

Fundamentals of Financial Management
Chapter 12: Cash Management
Concept of Cash and Cash Management
In finance, cash refers to the cash at hand, at bank or near cash items. Near cash items are those non-cash assets
which can be easily converted into cash in relatively short period of time. For example marketable securities are near
cash items. So, cash are those assets which are highly liquid and easily available for payment. It includes currency,
coins, negotiable money order, checks, bank balance and near cash assets.
There are two aspect of cash management namely cash disbursement and cash collection. Cash disbursement
includes the payment of bills to suppliers and contractors, salary and wages. Likewise, cash collection includes the
collection of account receivables and checks from its customers. The timing of cash collection and cash disbursement
are different in most of the cases. It causes surplus of cash while deficit of cash some other time. However, the firm
should proper cash management system that calls for investment of surplus cash in marketable securities as idle cash
does not earn. In other hand, the firm should hold optimal cash with it in order to meet the short term financial
obligations. Cash management refers to efficient process of managing the cash collection and disbursement, investing
excess cash in marketable securities, financing the cash deficit and determination of optimal cash balance.
Significance or Importance of Cash Management

a. Management of cash flows: Above all, cash management helps in balancing the cash collection and cash
disbursement that helps to run normal course of business smoothly. It speeds up cash collection that can be
promptly used to meet the obligations.
b. Meet the obligatory cash flows: The effective cash management ensures the timely payment of the short
term and long term financial obligations.
c. Capital expenditure projects: Decision on investment in capital projects depends upon the cash flows that are
expected to receive from the projects. Initially, the cash outflows have to be made. So, the firm needs to have
effective cash management system in order to determine the effect of cash outflow and cash inflows in
deciding whether or not to invest in capital projects.
d. Favorable external financing: Firms with proper cash management have goodwill due to their ability in
meeting the liabilities on time. Thus, the firm with goodwill can have easy access to capital markets and
favorable terms and conditions in external financing.
e. Discount, special purchase and business opportunities: Availability of cash allows the firm to take advantage
of discount and special purchase. Moreover, the available business opportunities can be easily used due to
cash management practices.
f. Investment of surplus cash: Surplus can be invested in marketable securities that earn interest and maintain
the liquidity of the firm.
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Motives of Holding Cash
a. Transaction Motive: It refers to the motive of carrying out day to day business operation smoothly. It
satisfies the normal course of cash disbursement and cash collection. Firm disburse cash for its purchase of
raw materials from its suppliers, wages and salaries to its employees, interest, commission, brokerage, rents
etc. In other hand, the firm receives cash from sales, interest on investment etc. So, the firm needs to hold
cash for transaction motives.
b. Precautionary Motive: Firms need to maintain the cash as safety margin for unpredictable events and
uncertainties like strikes, lock-ups, and increase in cost of raw materials, fall in market demand.
Precautionary motive ensure the firm to meet all the cash needs during such emergencies.
c. Speculative Motive: The firm holds cash in order to meet the business opportunities available in the market.
For example, decrease in price of raw materials, decrease in cost of funds and huge discounts. The firm
purchases the larger quantity of inventory than required at the time when price actually falls and sells them at
higher price in future. The firm can make super normal profit is such conditions.
Advantage of Holding Adequate Cash

Cash should not be hold more or less than requirement and it must be just adequate. The holding of cash in adequate
amount offers the following advantages:
a. Advantage Of Cash Discount: Most business purchases are made in credit basis. The duration of credit period
generally ranges from 15 days to 90 days. Suppliers of trade credit must be paid within the due date. But
sometimes the suppliers may offer cash discount for the early payment. Therefore, adequate cash balance needs to
be held to take the benefit of cash discount offered by suppliers. Whether to take or forgo the cash discount
depends on the comparative cost benefit analysis of cash discount foregone. Generally, forgoing the cash discount
involves higher opportunity cost than the cost of short-term bank loan.
b. Favorable Credit Rating: Holding adequate cash also enables a firm to maintain favorable credit rating. Short-
term credit standing of a firm is determined mostly on the basis of current and quick ratio position. Suppliers of
short-term funds evaluate the firm's short-term solvency position in terms of its ability to meet the standard line of
business. Holding of adequate cash maintains the current and quick ratio at favorable position so that the firm will
be able to meet the standard of credit analysis of the supplier of short-term funds.
c. Favorable Business Opportunities: Holding of adequate cash helps the firms to take the advantage of reduced
price offer at immediate cash payment, and also maintain precaution against some emergencies such as strikes and
lock-up, flood, fire, malpractices of competitors etc.
Functions of Cash Management

Cash management is concerned with the management of cash inflows, outflows and cash flows within the firm. It
also includes the matters relating to financing of deficit and investment of surplus cash so as to maintain optimum
cash balance. The functions of cash management start when a customer writes checks to pay the firm on its account
receivable. The function ends when a supplier, an employee or the government realizes funds from the firm on an
account payable or accruals. The basic issue of cash management is to enable a firm to maintain sufficient liquidity
and also at the same time improve its profitability.
If cash flows were accurately predicted, the firm would not have to give much attention on management of cash.
Cash outflows to some extent are certain but cash inflows cannot be predicted accurately. There is no perfect
synchronization between cash inflows and cash outflows. Sometimes, cash outflows exceeds cash inflows due to
unusual payment of obligation and non-seasonal build up in inventories and receivables. And sometimes cash inflows
will be more due to excessive sales than expectation and rapid conversion of receivables into cash.
To overcome the uncertainty about cash flow prediction and to maintain coincidence in cash inflow and outflow, the
firm's cash management function should consist of following strategies:
o Turn over inventory as quickly as possible, avoiding stock-out that may result in a loss of sales.
o Pay accounts payable as late as possible without deteriorating the firm's credibility, but take advantage of
any favorable cash discount.
o Collect account receivables as quickly as possible without loosing future sales due to high-pressure
collection techniques. Cash discounts, if any are economically justifiable, may be used to accomplish this
objectives.
o Involve in cash planning to determine deficit or surplus cash in each period.
o Surplus cash must be invested into marketable securities.
Cash Management Techniques

Cash management has been essential role of financial manager since the improper amount of cash are not desirable in
the firm. For instance, excess cash holding has opportunity cost while less cash may deteriorate the liquidity position
and goodwill of the firms. Financial managers can use various tools and techniques of cash management. Some of the
techniques are discussed below:
a. Managing Collections: The firm can manage the collection by speeding up the receivables. It makes the fund
available earlier which have the opportunity cost associated with it. The basic idea under this technique is to
collect the cash as soon as possible and disburse the cash as late as possible. It makes the pool of funds available
for the firm that can be invested to generate extra income. For this the firm can reduce the collection delay.
Several ways of managing the cash collection are:
i. Lock- Box System: The firm establishes the collection center or lock-box in different geographical location
where the checks are dropped by the customers. Such checks are collected by the local bank and directly

deposited to the firm’s account. It reduces the collection delay and speeds up the collections. However, the
bank charges the cost of providing lock-box system and requires the compensating balance.
ii. Concentration Banking: It is decentralized collection system in which the collection centers are opened in
different locations. Each collection center collects the checks and deposits then in the local bank. This
reduces the time lag between the mailing of the checks between the customer and the firm and between the
firm and the local bank. The checks deposited in local bank are sent to concentration bank each day where
the firm has its disbursement account. Concentration banking is expected to reduce the collection delay. It
also involves the cost and compensating balance requirements.
b. Control of Disbursement: Another method of cash management is controlling the disbursement or delaying the
disbursement.
i. Payables centralization: The payables of the firm should only be made from the headquarters of the firm
that eventually slows down the disbursement process.
ii. Payment by draft: The firm may pay through draft which takes time to get cleared in the bank. The
suppliers have to present the draft for acceptance of the issuer which delays the cash disbursement.
iii. Zero-Balance account: Opening the zero-balance account enables the firm to transfer the funds from master
account only when the disbursement is actually required. So, there is reduction in idle cash.
iv. Controlled disbursement accounts (CDA): Under this technique, the firm deposits the funds only when the
checks are presented for the payment
c. Using the Float: When the firm writes the check, it takes time to clear that checks. It causes the difference in the
balance of the bank’s record and the firm’s record. The firm immediately reduces its balance while the bank
reduces only when the checks are cleared. It is called disbursement float (positive float). Likewise when the firm
receives the check, the firm immediately increases the balance on its record while the bank records only when
the checks are cleared. It causes the firm’s record to show more balance than the banks. It is called collection
float (negative float). So, the float is the difference between the balance shown by firm’s record and bank’s
record. If the net float (disbursement float – collection float) is positive figure, the firm is able to use the excess
cash that has the opportunity cost.

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Chapter 12 Cash Management

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Fundamentals of Financial Management

Chapter 12: Cash Management

Concept of Cash and Cash Management

Significance or Importance of Cash Management

Copyright©Bibek Khadgi Page 1

Advantage of Holding Adequate Cash

Functions of Cash Management

Copyright©Bibek Khadgi Page 2

Cash Management Techniques

Copyright©Bibek Khadgi Page 3

Copyright©Bibek Khadgi Page 4

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