Cash Management in Business
Introduction :: April May June Total Receipts (A) Total Payment (B)
Cash management is concerned with the management of cash which is an important component of working capital representing a perfectly liquid asset possessed by an organization. The need of optimal cash in every business cannot be overemphasized on the one hand, too little cash at its disposal may seriously damage its smooth operations and on other hand, too much of cash balance may come in the way of maximum profits. Therefore, it is obvious that any balance more than the maximum cash balance is unproductive and it should always be kept to the minimum. Effective management of cash available for day-to-day operations is essential, if cash needs of a business are to be met effectively. Thus, it may be rightly regarded as an appendage of financial function or financial management. Cash management is as old as ‘use of money’ itself in business.
Modern system of cash management also includes controllership. It is concerned with making use of cash resources in such a way that maximize a firm’s profit without endangering its liquidity position or credit standing in the market. Cash management refers to the functions of a financial executive concerning in a business enterprise. Cash management is as old as the use of money in business but its nature and scope has changed considerably with the passage of time. Traditional cash management was relatively simple. It was more concerned with treasure ship, it regarded a holding of a large cash balance as assign of sound financial position and efficient cash management of a business concern.
Meaning of Cash Management:
As Sydney Robbins “A business wants to get hold of it in the shortest possible time, but to keep the least possible quantity on hand.”
Cash Management is the management of the cash balances of a concern in such a manner as to maximize the availability of cash not invested in fixed assets or inventories and to avoid the risk of insolvency. According to Keynes there are three motives for holding cash, the transactions motive, the precautionary motive and the speculative motive. The most useful technique of cash management is the cash budget.
Factors of Cash management:
Baumol’s Model for cash management:
Most firms try to minimise the sum of the cost of holding cash and the cost of converting marketable securities to cash. Baumol’s cash management model helps in determining a firm’s optimum cash balance under certainty. As per the model, cash and inventory management problems are one and the same.
There are certain assumptions that are made in the model. They are as follows:
For example, let us assume that the firm sells securities and starts with a cash balance of C rupees. When the firm spends cash, its cash balance starts decreasing and reaches zero. The firm again gets back its money by selling marketable securities. As the cash balance decreases gradually, the average cash balance will be: C/2. This can be shown in following figure:
The firm incurs a cost known as holding cost for maintaining the cash balance. It is known as opportunity cost, the return inevitable on the marketable securities. If the opportunity cost is k, then the firm’s holding cost for maintaining an average cash balance is as follows:
Holding cost = k (C/2)
Whenever the firm converts its marketable securities to cash, it incurs a cost known as transaction cost. Total number of transactions in a particular year will be total funds required (T), divided by the cash balance (C) i.e. T/C. The assumption here is that the cost per transaction is constant. If the cost per transaction is c, then the total transaction cost will be:
Transaction cost = c (T/C)
The total annual cost of the demand for cash will be:
Total cost = k (C/2) + c (T/C)
Optimum level of cash balance
As the demand for cash, ‘C’ increases, the holding cost will also increase and the transaction cost will reduce because of a decline in the number of transactions. Hence, it can be said that there is a relationship between the holding cost and the transaction cost.
The optimum cash balance, C is obtained when the total cost is minimum.
Optimum cash balance C
Where, C is the optimum cash balance.
T is the total cash needed during the year.
k is the opportunity cost of holding cash balances.
With the increase in the cost per transaction and total funds required, the optimum cash balance will increase. However, with an increase in the opportunity cost, it will decrease.
Formula of cash management:
The determination of the optimum cash balance, when variations can be predicted, can be done with the help of formula for economicorder quantity of inventory management. The formula for EOQ can be used with slight changes:
C = Optimum cash balance
B = transaction costs
I = Rate of interest on securities
T = Total demand of cash
Illustration:
Suppose, a firm needs Rs.1,20,0000 during a month. The transaction cost per unit is Rs.100 and the rate of interest on marketable securities is 6% (it means monthly 0.5%). On that balance the optimum cash balance can be determined as follows:
C = = Rs.69282
Cash Budget:-
The cash budget is a part of cash management. The cash budget is of use to non-seasonal industries as well. The cash budget focuses on the incidence of cash receipts and cash payments and is the net result of the sales, manufacturing and staff budgets as also the investments and financial outlays envisaged by a company according to its corporate plan for the year. The cash budget points out periods when cash would be plentiful and when borrowing would be required. It helps the company in better management of working capital and enables the bank to take credit decision realistically. This method is useful for determining working capital requirements, as long as the company can separate cash inflows and outflows relating to purely working capital purposes from others.
The cash budget is intended:
For the months from 1st April,2012 to 31st June,2012.
Particulars
Cash Balance
Receipts:
Payment:
Closing Cash Balance (A-B)
Importance of Cash Management :
Conclusion:
Good cash management is simple. It involves:
The starting point for good cash management is developing a cash flow projection. Smart business owners know how to develop both short-term cash flow projections to help them manage daily cash and long-term cash flow projections to help them develop the necessary capital strategy to meet their business needs. They also prepare and use historical cash flow statement to understand how they used money in the past.
REFERENCES :
***************************************************
Prof. K.S.Parmar
(Asst. Professor in Accountancy)
Govt. Arts & commerce College,Kadoli
kesarisinhparmar@gmail.com
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