Cash Management

Question 1

When is cash management important/needed

Answer 1

-> day to day transactions
-> precautionary balances (holding cash for unseen circumstances) IMP
-> speculation balances (investing cash) IMP
-> compensation balances (holding cash balance with commercial bank gains access to specific services) IMP
-> obtaining discounts (surplus cash enables you to pay suppliers early)
-> avoid liquidation and receivership (having enough cash to pay creditors when credit becomes due)

Question 2

Cash management problems

Answer 2

• overtrading = company doesn’t have sufficient assets to meet liability requirements
• growth = where a company tries to be too profitable too quickly
• inflation = results in supplies revived and fixed assets purchased increasing in cost
• payment delays = where corporate customers do not pay on time
• bad debts = customers not paying at all
• large items of expenditure = fixed assets company plans to buy
• seasonal trading = certain industries are subject to cyclical revenue (hospitality)

Question 3

Remedies to deal with short term cash shortages

Answer 3

-> accelerating cash inflows from debtors by offering discounts to review cash earlier
-> postponing cash outflows by delaying payment to creditors
-> postponing capital expenditure until have cash to pay
-> reversing past investments
-> rescheduling loan repayments to reduce interest payments in the short term

Question 4

Miller or model

Answer 4

1. The organisation allows its cash balance to fluctuate between the upper and lower control limits.
2. This model provides two control limits
3. When the cash balance reaches the upper control limit cash is invested / the firm buys sufficient market securities to get us back to the target cash balance
4. When the cash balance reaches the lower limit the investments are sold / firm sells sufficient marketable securities to raise cash to the target cash balance

Question 5

Diagram

Answer 5

-> manages a cash position of an organisation where it’s cash levels are not predictable

Learn diagram

Question 6

The baumol model

Answer 6

-> helps in determining a firms optimum cash balance under certainty and assuming variables are constant

Question 7

Assumptions of baymol model

Answer 7

1. Known demand for cash
2. Constant usage of cash over the period
3. Quantity ordered doesn’t vary over time
4. There are only two types of cost to be considered
   - the order cost of cash can be estimated and is constant
   - the holding cost of cash can be estimated and is constant
5. The cash replenishment is instantaneous (cash arrives when needed)

Question 8

Process

Answer 8

-The optimal quantity of cash is ordered and used over time until a minimum level of cash is reached
-When this is forecasted to arise (point 1) the company needs to ensure that the optimal quantity of cash ordered is then received
-The process is repeated throughout the period until a change in any of the input variables occurs

Learn diagram 1

Question 9

Diagram 2

Answer 9

-> the investment income foregone when holding cash
-> trading costs increase when the firm must sell securities to meet cash needs