Chapter 3 Flashcards
Definition of Cash Management
the corporate process of collecting, managing and investing cash (short-term)
- A key component of ensuring a company’s financial stability and solvency
- Ensures a company is able to meet unexpected expenses
Cash management formula
cash in hand+cash equivalents+short term marketable instruments
Short term marketable instruments
T-Bills, Certificates of deposit
Compensating Balances
Cash balances, held at a company’s bank, which compensate for services rendered to the company (like loans and credit lines)
Transaction Balances
- Cash balances used to pay day-to-day expenses such as raw material, wages, interest
- A certain level of minimum cash balance needs to be maintained to prevent cash shortage from occurring
Target Cash Balance
Compensating Balance + Transaction Balance
Objectives of Cash Management
- Meet requirements of compensating and transaction balance
- Keep cash balances as low as possible
- Ensure cash is fully utilised
- > Deposit additional cash in bank to earn interest
- > Borrow at the lowest possible interest rate to fund the cash balances
Cash Disbursement Delay
-Delay is to the payer’s benefit as cash stays in the account until cheque is cleared
Disbursement Float
-The sum of money payer has temporarily at their disposal
Availability Float
-The sum of money in the payee’s bank balance before the cheque is being cleared
Company gains from disbursement float and loses from availability float. Net float
Disbursement Float - Availability Float
Optimal level of cash balance involves a trade- off between:
Holding too much cash, as firm can earn interest using the cash &
Holding too little cash, firm may have to sell off marketable securities to raise cash
Trading Cost
(Cash Disbursement / Target Cash Balance) x Cost per Transaction
Opportunity costs of holding cash balance
(Target Cash Balance / 2) x Interest Rate
Total Managing Cost
Opportunity Cost + Trading Cost
Short-term Securities - Treasury Bills
Short-term government obligations that are issued at a discount and repaid at face value
Short-term Securities - Certificates of Deposit
– A receipt issued by a bank to a investor to confirm
the rate of interest for the principal – Investor has to hold till maturity
– Highly liquid secondary market
Commercial Paper
– Short term debt of highly rates corporations – Investor has to hold till maturity
– Not an active secondary market
Repurchase Agreements*
– Sales of government securities with an agreement
to repurchase at a higher price *
– Repos are short term and have short maturity dates
