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CASH MANAGEMENT
Cash management is concerned with (a)
management of cash flows into and out of the firm,
(b) cash management within the firm and (c)
management of cash balances held by the firm
deficit financing or investing surplus cash.
Strategies to manage cash:
1. Cash planning
2. Managing cash flows
3. Optimum cash level
4. Investing surplus cash
Motives of Holding Cash:
1. Transaction motive This refers to a firm
holding cash to meet its routine expenses which
are incurred in the ordinary course of business.
2. Precautionary motive This refers to the need
to hold cash to meet some exigencies which
cannot be foreseen.

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3. Speculative motive This relates to holding

cash to take advantage of unexpected changes
in business scenario which are not normal in the
usual course of firms dealings.
4. Compensating motive This is yet another
motive to hold cash to compensate banks for
providing certain services and loans.
Objectives of Cash Management:
There are two major objectives for cash
management in a firm (a) meeting payments
schedule and (b) minimizing funds held in the form
of cash balances.
The efficiency of cash management can be
augmented by controlling a few important factors:
(a) Prompt billing and mailing and (b) Collection of
cheques and remittances of cash.
Models for Determining Optimal Cash
Two important models:
(a) BAUMOL Model
(b) MILLER-ORR Model.

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Baumol Model
The Baumol model helps in determining the
minimum cost amount of cash that a manager can
obtain by converting securities into cash. It is an
approach to establish a firms optimum cash
balance under certainty. The total cost associated
with cash management has two elements (a) cost
of conversion of marketable securities into cash and
(b) the opportunity cost.
Optimum cash balance = (( 2 x F x T ) / k )
F = Fixed cost per transaction
T = Estimated annual requirement of cash
K = The opportunity cost of holding cash balance.
Example:
A firms annual cost requirement is Rs.
2,00,00,000. The opportunity cost of capital is
15% per annum. Rs. 150 is the per transaction
cost for the firm when it converts is short term
securities to cash. Find out the optimum cash
balance.
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Answer: Optimum Cash Balance =

( ( 2 x 150 x 20,000,000 ) / 0.15 ) = Rs. 200,000

Miller-Orr Model
Miller-Orr came out with another model due to the
limitation of the Baumol model. The Miller-Orr
model assumes that cash balances randomly
fluctuate between an upper control limit ( time to
buy marketable securities ) and a lower control limit
( time to convert securities into cash ).
The spread between the upper and lower cash
balance limits (called Z) can be computed using
Miller-Orr model as below:
Z = 3 ( ( ) x ( TC x VCF ) / IR )^1/3
TC= Transaction Cost
VCF = Variance of Cash Flows
IR = Interest Rate
And
Return Point = Lower Limit + Spread(Z) / 3
Example:
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A company has a policy of maintaining a minimum

cash balance of Rs. 100,000. The standard deviation
in daily cash balances is Rs. 10,000. The interest rate
on a daily basis is 0.01%. The transaction cost for
each sale or purchase of securities is Rs.50.
Compute the upper control limit and the return
point as per the Miller-Orr model.
Answer:
Z = 3( ( ) x ( 50 x 10,000^2 ) / 0.0001 )^1/3
= Rs.100,415
The upper control limit of cash balance is
Rs.(100,000 + 100,415) = Rs.200,415
The return point is
Rs.100,000 + Rs.(100,415 / 3) = Rs.133,472
Cash planning is a technique to plan and control the
use of cash.
Cash budget is a device to plan for and control cash
receipts and payments.
Cash budgets are prepared under three methods:

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1. Receipts and Payments method

2. Income and Expenditure method
3. Balance Sheet method.
Investment of Surplus Funds
Some of the examples where surplus funds can be
invested:
1. Treasury Bills
2. Negotiable Certificates of Deposit
3. Unit 1964 Scheme
4. Ready Forwards
5. Badla Financing
6. Inter-Corporate Deposits
7. Bill Discounting
8. Investment in Marketable Securities
9. Money Market Mutual Funds (MMMF)

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