16) cash management Flashcards
What are the reasons for holding cash?
Transactions motive – to meet day to day expenses
Precautionary motive – as a cushion against unplanned expenditure
Investment/speculative motive – cash kept available to take advantage of market investment opportunities, such as the opportunity to buy a strategically useful piece of land once its current owners have taken it through the planning permission process and made it available for sale
What is a cash budget?
A cash budget is a commitment to a plan for cash receipts and payments for a future period after taking any action necessary to bring the forecast into line with the overall business plan.
What are cash budgets used for?
assess and integrate operating budgets
plan for cash shortages and surpluses
compare with actual spending.
what is a cash forecast
A cash forecast is an estimate of cash receipts and payments for a future period under existing conditions.
What can cash forecasts be based on?
…
Receipts and payments forecast. This is a forecast of cash receipts and payments based on predictions of sales and cost of sales and the timings of the cash flows relating to these items.
Statement of financial position forecast. This is a forecast derived from predictions of future statements of financial positions. Predictions are made of all items except cash, which is then derived as a balancing figure.
Working capital ratios. Future cash and funding requirements can be determined from the working capital ratios seen in the chapter on working capital management.
..What are the steps to prepare a forecast using Receipts and payments forecast.
Step 1) Prepare a proforma
Step 2) Fill in the simple figures
- Wages and salaries
- Fixed overhead expenses
- Dividend payments
- Purchase of non current assets
Step 3) Work out the complex figures
The information on sales and purchases can be more time consuming to deal with, e.g.:
• timings for both sales and purchases must be found from credit periods
• variable overheads may require information about production levels
• purchase figures may require calculations based on production schedules and inventory balances.
What are the steps to prepare a forecast using statement of financial position to predict the cash balance as at the end of the given period?
This method will require forecasts of:
changes to non-current assets (acquisitions and disposals)
future inventory levels
future receivables levels
future payables levels
changes to share capital and other long-term funding (e.g. bank loans)
changes to retained profits.
What are the steps to prepare a forecast using working capital ratios?
The first stage is to use the ratios to work out the working capital requirement, as we have already seen in the working capital management chapter.
Operating profit
+ Depreciation
= Cash flow from operations
\+ Cash from sale of non-current assets \+ Long term finance raised - (Purchase of non current assets) - (Redemption of long term funds) - (Interest paid) - (Tax paid) - (Dividend paid) - (Increase in working capital)
= Net cash flow
0.What are the two cash management models?
Baumol model
Miller-Orr Model
What is the baumol model and it’s assumptions?
Baumol noted that cash balances are very similar to inventory levels, and developed a model based on the economic order quantity (EOQ).
Assumptions:
cash use is steady and predictable
cash inflows are known and regular
day-to-day cash needs are funded from current account
buffer cash is held in short-term investments
;
Baumol assumed that many companies would hold an inventory of marketable securities, which could be
sold in order to replenish the cash balance
What does the formula for EOQ for baumol calculate and disadvantage of this model
The EOQ now gives the optimum amount of treasury bills to sell by value each time the cash balance needs replenishing.
he model suggests that when interest rates are high, the cash balance held in non-interest-bearing current accounts should be low.
However, its weakness is the unrealistic nature of the assumptions on which it is based.
What is the miller Orr Model and what is it used for?
The Miller-Orr model controls irregular movements of cash by the setting of upper and lower control limits on cash balances.
The Miller-Orr model is used for setting the target cash balance.
It tries to minimise the cost of cash
What is an advantage of the miller orr model?
It has the advantage (over the Baumol model) of incorporating uncertainty in the cash inflows and outflows.
The model sets higher and lower control limits, H and L, respectively, and a target cash balance, Z.
The lower limit, L is set by management depending upon how much risk of a cash shortfall the firm is willing to accept, and this, in turn, depends both on access to borrowings and on the consequences of a cash shortfall.
Explanation
When the cash balance reaches Higher balance, then (H-Z Return point) dollars are transferred from cash to marketable securities, i.e. the firm buys (H-Z) dollars of securities.
Similarly, when the cash balance hits L, then (Z-L) dollars are transferred from marketable securities to cash.
What is the formula that’s given in the sheet for miller?
3 x [ (3/4 x Trasaction cost x Variance of daily CF) / Interst rate ] ^1/3
Variance and interest rates should be expressed in daily terms. If the question provides you with the standard deviation of daily cash flows, you will need to square this number to obtain the variance.
What are the disadvantages of Miller?
The model has some fairly restrictive assumptions, e.g. normally distributed cash flows but, in tests, Miller and Orr found it to be fairly robust and claim significant potential cost savings for companies.
