Chapter 16 - Cash management

Question 1

Businesses need to hold enough cash to ensure that they can meet their…

Answer 1

short term liabilities.

Question 2

Surplus cash should not be held in the bank if it can earn what elsewhere?

Answer 2

Higher interest

Question 3

What are the three main reasons for holding cash?

Answer 3

▪ Transactions motive
▪ Precautionary motive
▪ Investment motive

Question 4

What is transaction motive?

Answer 4

– to meet day to day expenses

Question 5

What is precautionary motive?

Answer 5

– as a cushion against unplanned expenditure

Question 6

What is investment motive?

Answer 6

– to finance suitable investments as and when they arise

Question 7

What do cash budgets include?

Answer 7

• Cash inflows

- Cash outflows

Question 8

What do cash budgets not include?

Answer 8

All non-cash items

▪ Depreciation
▪ Notional rent
▪ Notional interest

Question 9

What are the two types of cash models in the F9 syllabus?

Answer 9

▪ The Baumol Model

▪ The Miller-Orr Model

Question 10

What does the Baumol model assume?

Answer 10

Baumol assumed that many companies would hold an inventory of marketable securities, which could be sold in order to replenish the cash balance

Question 11

What forumla is the Baumol model based on?

Answer 11

The EOQ

Question 12

What are Co, D and Ch in the Baumol model?

Answer 12

Co = the administration cost of selling or buying treasury bills
D = annual demand for cash (cash consumed in a year)
Ch = interest rate

Question 13

What does the EOQ give in the Baumol model?

Answer 13

The optimum amount of treasury bills to sell by value each time the cash balance needs replenishing

Question 14

What does the Miller Orr Model NOT assume?

Answer 14

Miller and Orr did not assume that cash is consumed at a constant rate.

Question 15

What does the Miller Orr Model assume?

Answer 15

Cash flows were entirely unpredictable.

Question 16

What does the Miller Orr Model determine?

Answer 16

The upper and lower cash limits of a company

Question 17

When a company hits the upper limit of the Miller Orr Model, what should they do?

Answer 17

Buy up short term investments to reduce the cash in the bank

Question 18

When a company hits the lower limit of the Miller Orr Model, what should they do?

Answer 18

Sell these investments to increase the cash in the bank

Question 19

Whether buying or selling investments, what is the goal of the Miller Orr Model?

Answer 19

To always bring the cash balance back to the same return point

Question 20

What is the forumula for spread between upper and lower limit? (look in book if easier)

Answer 20

3[(3/4 x Transaction cost x Variance of cash flows) ÷ Interest rate ]^1/3

Question 21

What terms should variance and interest rates be expressed in?

Answer 21

Daily terms

Question 22

How to find the lower limit?

Answer 22

This will be given

Question 23

How to find upper limit?

Answer 23

𝐿𝑜𝑤𝑒𝑟 𝑙𝑖𝑚𝑖𝑡 + 𝑆𝑝𝑟𝑒𝑎𝑑

Question 24

How to find return point?

Answer 24

𝐿𝑜𝑤𝑒𝑟 𝑙𝑖𝑚𝑖𝑡 + 1/3(𝑆𝑝𝑟𝑒𝑎𝑑)

Question 25

Why does cash surplus arrive? 4 things

Answer 25

▪ Profitable trading
▪ Uneven trade cycle
▪ Lack of long term investment opportunities
▪ Disposal of assets

Question 26

What are the three objectives of short term cash investing?

Answer 26

Liquidity
Low risk
Profitability

Question 27

How can short term borrowings be achieved?

Answer 27

Bank overdraft or bank term loan

Question 28

What are the two advantages of a bank overdraft?

Answer 28

Flexible

Save interest compared to a bank loan

Question 29

What is a disadvantage of a bank overdraft?

Answer 29

Repayable on demand

Question 30

What is another name for investment motive?

Answer 30

Speculative motive

Question 31

What is described below?

This is an estimate of cash receipts and payments for a future period under existing conditions.

Answer 31

Cash forecast

Question 32

What are the four assumptions of the Baumol model?

Answer 32

• 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

Question 33

What advantage does the Miller Orr model have over the Baumol model?

Answer 33

It incorporates uncertainty

Question 34

Who is the lower limit set by?

Answer 34

Management

Question 35

What is the matching approach to finance?

Answer 35

When the duration of the finance is matched to the duration of the investment.

Question 36

Which one is the Baumol model?

Answer 36

The EOQ one?

Question 37

Which one is the Miller Orr method?

Answer 37

The return point one