Topic 14: Cash management

Question 1

What are the different motives for holding cash?

Answer 1

Transaction motive - Cash for day to day expenditure e.g wages, suppliers.
Precautionary motive - a buffer for unforeseen expenses
Investment motive - Financial suitable investments usually in the short term.

Question 2

What is the importance of cash forecasts?

Answer 2

It will help understand and predict future cashflows, help decision making such as do we have enough this month, do we have too much cash, should we invest.

Question 3

What is the difference between cash forecasting and cash budgeting?

Answer 3

Cash forecasting - predicts future cashflows based on previous years data.
Cash budgets is a plan that predicts future transactions, the cashflows are intentional.

Question 4

What is the proforma used for a cash forecast?

Answer 4

Month 1 | Month 2 | Month 3| Month 4| Ect
Cash Sales
Credit Sales
Total Receipts
Purchases
Bills
Ect
Total Payments
Opening balance
Closing balance

Note: We are only using cashflows = No depreciation, no profit on sales and watch out for timings

Question 5

1.) How to forecast future cash flows budgets from a statement of financial position 2.) and working capital ratios?

Answer 5

1.) We take last periods statement of financial postion and bring it forward with the expectation notes (Depreciation and other non cash items) and it is balancing figure between net assets and Net liabities & equity.
2.) Workout receivable day, Payable days and inventory days, for the next period using last periods information and then the difference is the cash flow for the next period.

Question 6

Why/How can cash surplus?

Answer 6

Profitable trade
Seasonality
Lack of long term opportunities
Disposal of asset
There is plans to use cash in the future

Question 7

What do we do with a cash surplus?

Answer 7

Investments
Interest bearing deposit account
Money market deposit
Negotiable instruments, Bills of exchange, letter of credit
Short dated government bonds (Treasury bonds)

Question 8

What should the comapany be cautious of when investing in short term cash surplus options?

Answer 8

How liquid are the investments, how quickly can we get teh cash back out.
Safety - How much risk is associated with the investment, is there a chance of losing capital value.
Profitability - How much will the investment return, what we expect the return to be, The aim is to maximise returns.
Note: Risk and profitability clash so companies have to decide based on their values.

Question 9

How to deal with a short term cash deficit?

Answer 9

This means there wont be enough cash for day to day expenses. need to use eitehr bank overdraft or short term bank loan.

Question 10

Explain the Baumol Model for managing the cash balance? and what are the terms?

Answer 10

Its is a model similar to teh EOQ model but instead of optimal inventory, The Baumaol model finds the optimal level of cash to raise each timethe cash balance needs to be replenished.
Same formula as EOQ SQRT(2CoD/CH)
Co = The administration cost of sellign sercurities or withdrawl for deposit.
D=Annual Demand for cash for day to day operations.
CH = The opportunity cost of holding cash, which is either teh return on sercurities or interest received from interest bearing deposit account.

Question 11

What are the assumptions that need to be made for the Baumol model?

Answer 11

Demand for cash is constant.
Current assest - Assumes day to daycash flows are funded by companies current account and they have a deposit account.
Buffer inventory - Any buffer of cash is either held on deposit or in an investment, this means buffer cash doesnt exist in this model.

Question 12

Explain the Miller-Orr Model of managing Cash? and explain the formula

Answer 12

It doesnt assume cash is consumed at a constant rate, they understand its flexible.
Return point = Lower limit + (1/3 x Spread)
Spead = 3x((3/4 x transcations costs x Variance of cashflows) / Interest rate)^(1/3).
The interest rate used is the daily interest rate.
Variance of cashflow = standard deviation of cash flow^2

Question 13

How to calculate the variance of cashflows for the Miller-Orr Model?

Answer 13

Standard deviation (Squared)

Question 14

How to calculate the higher limit on the Miller-Orr Model for managing short term cash surplus or deficit options?

Answer 14

Lower limit + Spread = Higher Limit

Question 15

What is treasurary managment?

Answer 15

The treasury management relates to activites that manage teh liquidity (or cash) of a company. Activities include:
Short term cash management e.g investing/borrowing in teh short term.
Currency risk management
Interest risk management
Raising long term debt or equity finance
Dividends policy
Investment appraisal evaluations

Question 16

What is a centralised and decentralised tresury and what is the advantages and disadvanatges of both?

Answer 16

Centralised = based in one single location but responsible for treasury across the company.
Postives:
Cash pooling - pool all cash together, each operating company holds minimum and any surplus goes back to the pool.
Avoids duplicating skills and can be highly skilled.
Currency risk easier to manage and more efficent.
Decentralised = based in different locations with each department responsible for the treasury of that country.
Positives:
Local treasury can do better at understanding local conditions
Greater responsibility due to money may motivate to make more.