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.
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.
