Chapter 16 - Cash management Flashcards
Businesses need to hold enough cash to ensure that they can meet their…
short term liabilities.
Surplus cash should not be held in the bank if it can earn what elsewhere?
Higher interest
What are the three main reasons for holding cash?
▪ Transactions motive
▪ Precautionary motive
▪ Investment motive
What is transaction motive?
– to meet day to day expenses
What is precautionary motive?
– as a cushion against unplanned expenditure
What is investment motive?
– to finance suitable investments as and when they arise
What do cash budgets include?
- Cash inflows
- Cash outflows
What do cash budgets not include?
All non-cash items
▪ Depreciation
▪ Notional rent
▪ Notional interest
What are the two types of cash models in the F9 syllabus?
▪ The Baumol Model
▪ The Miller-Orr Model
What does the Baumol model assume?
Baumol assumed that many companies would hold an inventory of marketable securities, which could be sold in order to replenish the cash balance
What forumla is the Baumol model based on?
The EOQ
What are Co, D and Ch in the Baumol model?
Co = the administration cost of selling or buying treasury bills D = annual demand for cash (cash consumed in a year) Ch = interest rate
What does the EOQ give in the Baumol model?
The optimum amount of treasury bills to sell by value each time the cash balance needs replenishing
What does the Miller Orr Model NOT assume?
Miller and Orr did not assume that cash is consumed at a constant rate.
What does the Miller Orr Model assume?
Cash flows were entirely unpredictable.
What does the Miller Orr Model determine?
The upper and lower cash limits of a company
When a company hits the upper limit of the Miller Orr Model, what should they do?
Buy up short term investments to reduce the cash in the bank
When a company hits the lower limit of the Miller Orr Model, what should they do?
Sell these investments to increase the cash in the bank
Whether buying or selling investments, what is the goal of the Miller Orr Model?
To always bring the cash balance back to the same return point
What is the forumula for spread between upper and lower limit? (look in book if easier)
3[(3/4 x Transaction cost x Variance of cash flows) ÷ Interest rate ]^1/3
What terms should variance and interest rates be expressed in?
Daily terms
How to find the lower limit?
This will be given
How to find upper limit?
𝐿𝑜𝑤𝑒𝑟 𝑙𝑖𝑚𝑖𝑡 + 𝑆𝑝𝑟𝑒𝑎𝑑
How to find return point?
𝐿𝑜𝑤𝑒𝑟 𝑙𝑖𝑚𝑖𝑡 + 1/3(𝑆𝑝𝑟𝑒𝑎𝑑)
Why does cash surplus arrive? 4 things
▪ Profitable trading
▪ Uneven trade cycle
▪ Lack of long term investment opportunities
▪ Disposal of assets
What are the three objectives of short term cash investing?
Liquidity
Low risk
Profitability
How can short term borrowings be achieved?
Bank overdraft or bank term loan
What are the two advantages of a bank overdraft?
Flexible
Save interest compared to a bank loan
What is a disadvantage of a bank overdraft?
Repayable on demand
What is another name for investment motive?
Speculative motive
What is described below?
This is an estimate of cash receipts and payments for a future period under existing conditions.
Cash forecast
What are the four assumptions of the Baumol model?
- Cash use is steady and predictable
- Cash inflows are known and regular
- Day to day cash needs are funded from the current account
- Buffer cash is held in short term investments
What advantage does the Miller Orr model have over the Baumol model?
It incorporates uncertainty
Who is the lower limit set by?
Management
What is the matching approach to finance?
When the duration of the finance is matched to the duration of the investment.
Which one is the Baumol model?
The EOQ one?
Which one is the Miller Orr method?
The return point one
