Cash Management
Cash management is important for both companies and individuals, as it is
a key component of financial stability.
Financial instruments involved in cash management contain money market
funds, Treasury bills, and certificates of deposit.
Companies and individuals offer a wide range of services available across
the financial marketplace to help with all types of cash management. Banks
are typically primary financial service providers. There are also many
different cash management solutions for both companies and individuals
seeking to get the best return on cash assets or the most efficient use of
cash.
Cash is a vital part of working capital; therefore, in Paper II, of which
one of the topics is working capital management, students are expected
to demonstrate sufficient knowledge in cash management techniques
such as cash budgets and cash mathematical models in order to assist a
company to manage its cash properly.
This article starts by introducing the objectives of cash management,
followed by a discussion on what a cash budget is and how the cash
mathematical model, in particular the Miller-Orr model, can be applied
to manage cash. The article then concludes by commenting on how a
company can utilize its excess cash by investing in marketable securities.
Objectives of Cash Management
Cash plays a crucial role in a company’s operation. It is used to pay wages and salaries,
trade debts, taxes and dividends. It not only enables the company to promptly pay its
creditors and suppliers so as to foster good relations but also lets the company take
advantage of favourable business opportunities. Most importantly, it keeps the company
liquid and prevents it from insolvency or bankruptcy.
It is said in academic literature that companies hold cash for the following three motives:
• Transaction motive: As mentioned earlier, cash is used to pay bills, especially
when disbursements are greater than cash receipts from business. This is the
most important reason for keeping cash.
• Precautionary motive: Cash is used for safety reasons as a financial reserve to
meet unexpected demand, for example, an unexpected delay in collection of
accounts receivable or a sudden increase in costs of materials.
• Speculative motive: There may be unexpected profitable opportunities when
, doing businesses, like speculative interest rate movements. If a company has
excess cash on hand, it may take advantage of such opportunities.
Yet, cash on hand is considered as a non-earning asset. It earns no return for shareholders.
If a company holds excess cash on hand, it loses the profits that may be earned if the cash
had been invested elsewhere.
The objectives of cash management are therefore two-fold: (i) to have sufficient cash for
operation in order to maintain liquidity; and (ii) to invest excess cash for a return. Cash
management is not easy. Cash inflows from receipts do not perfectly coincide with the cash
outflows for disbursements. Further, some businesses are seasonable in nature so that cash
inflows and outflows fluctuate throughout the year. The company therefore needs to manage
its cash properly. One of the tools it can use to do this is to prepare a cash budget.
Cash Budget
A cash budget is a statement showing the estimated cash inflows and outflows over the
planning horizon. Companies can prepare a cash budget on a quarterly, monthly, weekly
or even daily basis. The ultimate purpose is to identify the net cash position of the
company in the future, that is, whether there is any cash surplus or deficit.
Preparation of a cash budget is an indication of good planning. If such a budget is not
prepared, the company runs the risk that if unfortunately it is in sudden need of cash, there
may be insufficient time for the company to search for alternative source of financing, forcing
it to accept funding which is more expensive.
After identifying the net cash position of the company in the future, the next question is then
how the company manages its cash surplus or deficit.
Miller-Orr Model
In order to manage its cash balance, the company can employ a mathematical model, one of
which is the Miller-Orr model. The Miller-Orr model helps the company to meet its cash
requirements at the lowest possible cost by placing upper and lower limits on cash
balances. The operation of the model is as follows:
• A company should have its desired cash level, an upper limit and lower limit on
cash balances.
• When the cash balance reaches the upper limit, the company has too much
cash. It then should use its cash to buy marketable securities in order to bring
the cash balance back to its desired cash level.
Cash management is important for both companies and individuals, as it is
a key component of financial stability.
Financial instruments involved in cash management contain money market
funds, Treasury bills, and certificates of deposit.
Companies and individuals offer a wide range of services available across
the financial marketplace to help with all types of cash management. Banks
are typically primary financial service providers. There are also many
different cash management solutions for both companies and individuals
seeking to get the best return on cash assets or the most efficient use of
cash.
Cash is a vital part of working capital; therefore, in Paper II, of which
one of the topics is working capital management, students are expected
to demonstrate sufficient knowledge in cash management techniques
such as cash budgets and cash mathematical models in order to assist a
company to manage its cash properly.
This article starts by introducing the objectives of cash management,
followed by a discussion on what a cash budget is and how the cash
mathematical model, in particular the Miller-Orr model, can be applied
to manage cash. The article then concludes by commenting on how a
company can utilize its excess cash by investing in marketable securities.
Objectives of Cash Management
Cash plays a crucial role in a company’s operation. It is used to pay wages and salaries,
trade debts, taxes and dividends. It not only enables the company to promptly pay its
creditors and suppliers so as to foster good relations but also lets the company take
advantage of favourable business opportunities. Most importantly, it keeps the company
liquid and prevents it from insolvency or bankruptcy.
It is said in academic literature that companies hold cash for the following three motives:
• Transaction motive: As mentioned earlier, cash is used to pay bills, especially
when disbursements are greater than cash receipts from business. This is the
most important reason for keeping cash.
• Precautionary motive: Cash is used for safety reasons as a financial reserve to
meet unexpected demand, for example, an unexpected delay in collection of
accounts receivable or a sudden increase in costs of materials.
• Speculative motive: There may be unexpected profitable opportunities when
, doing businesses, like speculative interest rate movements. If a company has
excess cash on hand, it may take advantage of such opportunities.
Yet, cash on hand is considered as a non-earning asset. It earns no return for shareholders.
If a company holds excess cash on hand, it loses the profits that may be earned if the cash
had been invested elsewhere.
The objectives of cash management are therefore two-fold: (i) to have sufficient cash for
operation in order to maintain liquidity; and (ii) to invest excess cash for a return. Cash
management is not easy. Cash inflows from receipts do not perfectly coincide with the cash
outflows for disbursements. Further, some businesses are seasonable in nature so that cash
inflows and outflows fluctuate throughout the year. The company therefore needs to manage
its cash properly. One of the tools it can use to do this is to prepare a cash budget.
Cash Budget
A cash budget is a statement showing the estimated cash inflows and outflows over the
planning horizon. Companies can prepare a cash budget on a quarterly, monthly, weekly
or even daily basis. The ultimate purpose is to identify the net cash position of the
company in the future, that is, whether there is any cash surplus or deficit.
Preparation of a cash budget is an indication of good planning. If such a budget is not
prepared, the company runs the risk that if unfortunately it is in sudden need of cash, there
may be insufficient time for the company to search for alternative source of financing, forcing
it to accept funding which is more expensive.
After identifying the net cash position of the company in the future, the next question is then
how the company manages its cash surplus or deficit.
Miller-Orr Model
In order to manage its cash balance, the company can employ a mathematical model, one of
which is the Miller-Orr model. The Miller-Orr model helps the company to meet its cash
requirements at the lowest possible cost by placing upper and lower limits on cash
balances. The operation of the model is as follows:
• A company should have its desired cash level, an upper limit and lower limit on
cash balances.
• When the cash balance reaches the upper limit, the company has too much
cash. It then should use its cash to buy marketable securities in order to bring
the cash balance back to its desired cash level.
