CASH and MARKETABLE SECURITIES MANAGEMENT

CASH MANAGEMENT – involves the maintenance of the appropriate level of

cash to meet the firm’s cash requirements and to maximize income on idle
funds.

MARKETABLE SECURITIES MANAGEMENT- involves the process of planning and

controlling investment in marketable securities to meet the firm’s cash
requirements and to maximize income on idle funds.

OBJECTIVE: To minimize the amount of cash on hand while retaining

sufficient liquidity to satisfy business requirements (e.g., take advantage of
cash discounts, maintain credit rating, meet unexpected needs.)

REASONS FOR HOLDING CASH: “Why would a firm hold cash when, being idle,
it is a non-earning asset?”
1. TRANSACTION motive (Liquidity motive)
Cash is held to facilitate normal transactions of the business.
2. PRECAUTIONARY motive (Contingent motive)
Cash is held beyond the normal operating requirement level to
provide for buffer against contingencies, such as slow-down in
accounts receivable collection, possibilities of strikes, etc.
3. SPECULATIVE motive
Cash is held to avail of business incentives (e.g., discounts) and
investment opportunities.
4. CONTRACTUAL motive- Compensating Balance Requirements
A company is required by a bank to maintain a certain compensating
balance in its demand deposit account as condition of a loan
extended to it.

OPTIMAL CASH BALANCE: BAUMUL MODEL

OCB= √(2)(Annual Cash Requirement )(Cost Per Transaction)
Opportunity Cost of Holding Cash

Total Costs of Cash Balance= Holding Costs + Transaction Costs

• Holding Costs = Average cash balance* x opportunity cost
• Transaction Costs= Number of transactions** x Cost per Transaction
*Average cash balance= OCB/2
**Number of transactions= Annual Cash Requirement/.OCB

CASH CONVERSION CYCLE

-is the average length of time a peso is tied up in current assets. It runs from the
date the company makes payment of raw materials to the date company
receives cash inflows thru collection of accounts receivable. It is also known as
the cash flow cycle.

Inventory conversion period (Inventory/CGS* per day

+ Receivable Collection period (Receivables/Sales per day)
- Payable deferral period (Payables/ Purchases per day)
CASH CONVERSION CYCLE
*Alternatively, sales per day may be also used to compute conversion period.
The intention is to use an amount in proportion to unit sales.

The firm’s goal should be to shorten its cash conversion cycle without hurting
operations. The longer the cash conversion cycle, the greater the need for
external financing (hence, the more cost of financing).

CASH MANAGEMENT STRATEGIES

1. Accelerating collections (e.g. lockbox system)
2. Slowing disbursements (e.g., playing the floats)
3. Reducing precautionary idle cash (e.g., zero-balance accounts)

THE CONCEPT OF FLOAT

FLOAT- generally defined as the difference between the cash balance per BANK
and the cash balance per BOOK as of a particular period, primarily due to
outstanding checks or other similar reasons.

Types of float:
1. POSITIVE(Disbursement) Float: Bank balance> Book Balance
Example: Outstanding checks issued by the firm that have not cleared yet

2. NEGATIVE (Collection) Float: Book Balance> Bank Balance

Examples:
a. MAIL Float- Amount of customers’ payments that have been
mailed by customers but not yet received by the seller-company.
b. PROCESSING Float- Amount of customers’ payments that have
been received by the seller but not yet deposited
c. CLEARING Float- Amount of customers’ checks that have been
deposited but have not cleared yet.
Good cash management suggests that positive float should be maximized
(negative float minimized).

MARKETABLE SECURITIES
-short-term money market instruments that can easily be converted to cash.
CERTICATES OF DEPOSITS (CD)- savings deposits at financial institutions (e.g., time
deposit)
MONEY MARKET FUNDS- shares in a fund that purchases higher-yielding bank
CDs, commercial paper, and other large-denomination, higher-yielding securities
GOVERNMENT SECURITIES
• Treasury bills- debt instruments representing obligations of the
National Government issued by the Central Bank and usually sold
at a discount through competitive bidding.
• CB Bills or Certificate of Indebtedness (CBCIs)- represent
indebtedness by the Central Bank.

FACTORS INFLUENCING THE CHOICE OF MARKETABLE SECURITIES

1. RISK
• Default Risk- refers to the chances that the issuer may not be able
to pay the interest or principal on time or at all
• Interest Rate Risk- refers to fluctuations in MS prices caused by
changes in market interest rates
• Inflation Risk- Refers to the risk that inflation will reduce the relevant
value of the investment.

2. RETURNS- The higher the MS’s risk involved the higher its required return.
While MS must consist of highly liquid short-term investments, the company
should not sacrifice safety, for higher rates of return.

3. MATURITY- Maturity dates of MS held should coincide, whenever possible,

with the date at which the firm needs cash, or when the firm will no longer
have cash to invest

4. MARKETABILITY- refers to how quickly a security can be sold before

maturity date without a significant price concession