Definition Of Cash

Theory Question

1. Define the function of cash management.Explain Different methods to speed up cash collection. (2019-3a,)
2. Explain the concept of concentration banking.
3. Explain how the lockbox system can improve the efficiency of cash management.
4. Money market instruments are used as investment vehicles for otherwise idle cash. Discuss the most important criterion for
asset selection in investing temporarily idle cash.
5. Discuss the impact of lockbox banking on corporate cash balances.
6. A firm desires to maintain a certain portion of its marketable securities portfolio to meet unforeseen cash needs. Would
commercial paper or Treasury bills be better suited as short-term investments in this ready cash segment? Why? (2021-3 no b)
(2019,3b)
7. What are compensating bank balances, and why are they not the same for all depositors?
8. What is net float? How might a company “play the float” in its disbursements?
9. Assuming that the return on real assets of a company exceeds the return on marketable securities, why should a company
hold any marketable securities?
10. Under what conditions would it be possible for a company to hold no cash or marketable securities? Are these conditions
realistic? (2020-3a,)
11. What are the three motives for holding cash? (2020-3a,)
12. Compare and contrast bankers’ acceptances and Treasury bills as marketable security investments for the corporation.
13. What are the advantages of decentralized collection over a centralized collection?
14. What is a lock-box system? How does it help to reduce the cash balances?
15. Explain the criteria that a firm should use in choosing the short-term investment alternatives in order to invest surplus cash.
16. What are the three components of collection float? how can this float be reduced?
17..Define cash collection and cash disbursement of a firm. Explain various cash collection instruments with their pros and
Cons.
18.what is markatable security? How would you determine a firm's portfolio of marketable security?
19.What do you mean by acceleration of collection? EXPLAIN different methods of accelerating the collection of a firm.
20. Why and how is the market of Treasury bill deep and liquid? Distinguish Between competitive and non competitive bidding
of treasury bills.
21. What are the three motives for holding cash? Under what conditions would it be possible for a company to hold no cash or
marketable securities? Are these conditions realistic?
22.. Briefly explain some money market instrument.
23.. "Marketable securities act as reserve, controllable cash and/or extra cash for a company" Explain this statement
considering certain key variables.
24. What are the major reasons for deciding to invest excess cash balances in marketable securities?
25.What characteristics should an investment have to qualify as an acceptable marketable security?
26. Imagine yourself as the finance manager of a leading firm. What are the basic criteria you would follow in making optimum
investment decisions on a portfolio of securities with the surplus cash available with the firm?

Math
#Book_VAN_HORNE

1. Sitmore and Dolittle, Inc., has 41 retail clothing outlets scattered throughout the country.Each outlet sends an average of
$5,000 daily to the head office in South Bend, Indiana,through checks drawn on local banks. On average, it takes six days
before the company’sSouth Bend bank collects the checks. Sitmore and Dolittle is considering an electronic
funds transfer arrangement that would completely eliminate the float.
a. What amount of funds will be released?
b. What amount will be released on a net basis if each local bank requires an increase in compensating balances of $15,000 to
offset the loss of float?
c. Suppose that the company could earn 10 percent interest on the net released funds in Part (b). If the cost per electronic
transfer were $7 and each store averaged 250 transfers per year, would the proposed arrangement be worthwhile? (Assume
that the cost of issuing checks on local banks is negligible.)

2.c) A company estimates its total cash requirement of Tk.50 million next year. The company's opportunity cost of funds is 16%
p.a. and it will have incurred Tk.250 per transaction when it converts its short-term securities to cash. Determine total ammual
cost of the demand for the optimurn cash balance and number of deposits to be made during the year.
d) Sheet example.

3. The Zindler Company currently has a centralized billing system. Payments are made by all customers to the central billing
location. It requires, on average, four days for customers’ mailed payments to reach the central location. An additional day and
a half is required to process payments before a deposit can be made. The firm has a daily average collection of $500,000. The
company has recently investigated the possibility of initiating a lockbox
system. It has estimated that with such a system customers’ mailed payments would reach the receipt location two and one-half
days sooner. Further, the processing time could be reduced by an additional day because each lockbox bank would pick up
mailed deposits
twice daily.
a. Determine how much cash would be freed up (released) through the use of a lockbox system.
b. Determine the annual gross dollar benefit of the lockbox system, assuming the firm could earn a 5 percent return on the
released funds in Part (a) by investing in short-term instruments.
c. If the annual cost of the lockbox system will be $75,000, should such a system be initiated?

4. Speedway Owl Company franchises “Gas and Go” stations in North Carolina and Virginia.All payments by franchisees for
gasoline and oil products, which average $420,000 a day,are by check. At present, the overall time between the mailing of the
check by the franchisee to Speedway Owl and the time the company has collected or available funds at itsbank is six days.
a. How much money is tied up in this interval of time?
b. To reduce this delay, the company is considering daily pickups from the stations. In all,three cars would be needed and three
additional people hired. This daily pickup wouldcost $93,000 on an annual basis, and it would reduce the overall delay by two
days. Currently, the opportunity cost of funds is 9 percent, that being the interest rate on marketable securities. Should the
company inaugurate the pickup plan? Why?
c. Rather than mail checks to its bank, the company could deliver them by messenger service. This procedure would reduce the
overall delay by one day and cost $10,300 annually. Should the company undertake this plan? Why

#Book_PANDEY

4. XYZ Company has a policy of maintaining a minimum cash balance of `50 lakh. The standard deviation of the company’s
daily cash flows is `20 lakh. The annual interest rate is 14 per cent. The transaction cost of buying or selling securities is `150
per transaction. Determine XYZ’s upper control limit and the return point as per the Miller-Orr model.(Pandey Book)

5. Nice Furniture Ltd is currently following a centralized collection system. Most of its customers are located in the cities of
Northern India. The remittances mailed by customers to the central location take three days to reach. Before depositing the
remittances in the bank, the firm looses two days in processing them. The daily average collection of the firm is `12 lakh. The
company is thinking of establishing a lock-box system. It is expected that such a system will reduce mailing time by one day
and processing time by one day.
(i) Find out the reduction in cash balances expected to result from the adoption of the lock-box system.
(ii) Determine the opportunity cost of the present centralized collection system if the interest rate is assumed to be 15 per cent.
(iii) Should the lock-box system be established if its annual cost is `24,500? (Pandey book)

THEORY ANSWER

1. Define the function of cash management. Explain different methods to speed up cash collection.

Cash Management Definition:

Cash management involves planning, monitoring, and optimizing the inflows and outflows of cash within a business. Its primary
functions are ensuring liquidity, minimizing idle cash, and maximizing returns on surplus funds.
Methods to Speed Up Cash Collection:
1. Lockbox System: Customers send payments directly to a bank-managed P.O. box, reducing mail and processing float. The
bank immediately processes and deposits payments, improving fund availability.
2. Concentration Banking: Establish collection centers in key locations close to customers. Payments are deposited locally and
then transferred to a central account, speeding up collection.
3. Electronic Funds Transfer (EFT): Allows instant payments through digital systems, eliminating mail and clearing delays.
4. Pre-authorized Debits: Customers authorize automatic deductions for recurring payments, ensuring timely receipts.
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2. Explain the concept of concentration banking.

Concentration banking is a collection strategy where businesses establish multiple collection centers in key geographic regions.
Payments are deposited at these centers and then transferred to a central account.

Advantages:
1. Reduces Mail Float: Payments are processed faster because they are sent to nearby centers.
2. Improves Liquidity: Funds are collected more quickly, making them available for use sooner.
3. Customer Convenience: Local payment options enhance customer satisfaction and may encourage prompt payments.
4. Better Cash Control: Centralized oversight of funds ensures efficient cash utilization.
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3. Explain how the lockbox system can improve the efficiency of cash management.

A lockbox system improves efficiency by automating the payment collection process. Payments are sent directly to a P.O. box
managed by the bank.
Efficiency Improvements:
1. Reduces Mail Float: Payments reach the bank faster than a company's internal processing.
2. Speeds up Deposit Processing: Banks handle the checks immediately, reducing time for clearance.
3. Increases Cash Availability: Collected funds are deposited directly into the firm’s account, allowing for quicker investment or
use in operations.
4. Cost Savings: Though there is a fee for the service, the savings from reduced delays and administrative work often outweigh
the costs.
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4. Money market instruments are used as investment vehicles for idle cash. Discuss the most important criterion for asset
selection in investing temporarily idle cash.

Idle cash refers to surplus funds that are not immediately needed for operations. To invest idle cash, the following criteria are
essential:
1. Liquidity: The investment should be easily converted to cash without significant loss. Examples include Treasury bills and
commercial papers.
2. Safety: Investments should have minimal risk to preserve the firm’s principal. Government securities are often preferred for
their low default risk.
3. Short Maturity: The maturity period should align with the cash flow needs of the firm, ensuring funds are available when
required.
4. Yield: While safety and liquidity are primary, a reasonable return on investment is also important.
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5. Discuss the impact of lockbox banking on corporate cash balances.

Lockbox banking significantly enhances corporate cash management by increasing the efficiency of cash collections.
Impact on Cash Balances:
1. Faster Collections: Reduces mail and processing float, increasing the availability of cash for use.
2. Reduced Idle Cash: Companies can invest cash sooner, reducing the need to hold large idle balances.
3. Lower Operational Costs: Administrative costs for processing collections are reduced as the bank handles most tasks.
4. Improved Liquidity: Increased cash inflow helps maintain a healthy liquidity position, allowing for better financial planning.
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6. Would commercial paper or Treasury bills be better suited as short-term investments for unforeseen cash needs? Why?

Treasury Bills (T-Bills) are better for unforeseen cash needs because:
1. Liquidity: They can be quickly sold in the secondary market without significant loss.
2. Safety: Backed by the government, T-bills have virtually no default risk, unlike commercial papers, which depend on a
company’s credit rating.
3. Short Maturity: T-bills are available in maturities as short as one month, making them ideal for managing temporary cash
requirements.

Why Not Commercial Paper?

While they may offer slightly higher returns, commercial papers are riskier and less liquid, making them less suitable for
emergency needs.
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7. What are compensating bank balances, and why are they not the same for all depositors?

Compensating Bank Balances Definition:

Compensating balances are minimum balances that a business must maintain in its bank account as a condition for obtaining
loans or accessing certain bank services.

Why They Differ for Depositors:

1. Borrower’s Creditworthiness: High-credit borrowers may negotiate lower balances.
2. Loan Size: Larger loans may require higher compensating balances.
3. Bank Policy: Different banks have varying terms based on their service agreements.
4. Services Used: Depositors who use more banking services may be required to maintain higher balances to offset service
costs.
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8. What is net float? How might a company “play the float” in its disbursements?
Net Float:
The difference between the cash balance shown in a company’s books and the available balance in the bank account.

Types of Float:
1. Mail Float: Time taken for a check to reach its destination.
2. Processing Float: Time to process the check.
3. Clearing Float: Time taken by the bank to clear the funds.

Playing the Float:

A company strategically times disbursements to maximize its available funds:
1. Delaying Payments: Issuing checks late to extend float.
2. Timing Deposits: Depositing funds early to increase available balances.
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9. Why should a company hold marketable securities if the return on real assets is higher?

While real assets may offer higher returns, marketable securities are crucial for:
1. Liquidity: They can be quickly converted into cash to meet short-term needs.
2. Risk Management: Marketable securities like Treasury bills are safer and less volatile than real assets.
3. Emergency Needs: They act as a reserve to handle unexpected expenses.
4. Flexibility: Enables the firm to seize immediate opportunities without selling long-term assets.
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10. Under what conditions would it be possible for a company to hold no cash or marketable securities? Are these conditions
realistic?

Conditions:

1. Predictable and steady cash inflows and outflows.

2. Reliable short-term credit facilities for emergencies.
3. Highly efficient cash management systems, such as just-in-time (JIT) operations.

Are They Realistic?

In theory, it is possible. However, in practice, unforeseen events like delayed receivables or unexpected expenses make it
necessary to hold some cash or marketable securities for liquidity and risk mitigation.
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11. What are the three motives for holding cash?

1. Transaction Motive: To meet regular operating expenses such as wages, inventory purchases, and utilities.
2. Precautionary Motive: To handle unexpected situations like economic downturns or delayed payments from customers.
3. Speculative Motive: To take advantage of short-term investment or purchase opportunities.
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12. Compare bankers’ acceptances and Treasury bills as marketable security investments (Summary).

Bankers’ Acceptances (BA) are short-term instruments primarily used in international trade, guaranteed by a bank, making
them moderately risky but offering higher returns. In contrast, Treasury Bills (T-Bills) are government-issued short-term
securities, considered risk-free due to government backing, but they provide lower returns.
Bankers’ Acceptances are less liquid compared to T-Bills but are still widely used in trade financing. T-Bills, on the other hand,
are highly liquid and actively traded in the secondary market, making them ideal for managing surplus cash. While BAs are
used for financing trade transactions, T-Bills are a safe investment for companies seeking to park excess funds temporarily.
In summary, BAs suit businesses involved in international trade with a higher risk appetite, while T-Bills are best for those
prioritizing security and liquidity.

13. Advantages of decentralized collection over centralized collection

Decentralized Collection: Payments are collected at multiple local centers close to customers instead of a single central office.

Advantages:
1. Reduced Collection Time: Payments are processed faster as they are sent to nearby centers, reducing mail and processing
float.
2. Improved Cash Flow: Funds reach the company's bank accounts more quickly, enhancing liquidity.
3. Customer Satisfaction: Customers can send payments to local centers, which is convenient and improves relationships.
4. Lower Transportation Costs: Reduces the need to transfer checks or cash to a central location.
5. Operational Flexibility: Local branches can address collection issues promptly, leading to better efficiency.

Example: A company operating nationwide can establish collection centers in major cities to speed up cash inflows from
customers.
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14. What is a lockbox system? How does it help to reduce cash balances?

Definition:
A lockbox system is a cash management service where customers send payments directly to a bank-operated P.O. box. The
bank processes the payments and deposits them directly into the company's account.
How It Reduces Cash Balances:
1. Speeds Up Deposits: Payments are processed and deposited quickly, reducing the need to maintain high idle cash balances.
2. Reduces Float: Minimizes mail float and processing float by directly routing payments to the bank.
3. Improves Liquidity: Funds become available faster, reducing the need for large reserve balances.
Benefits:
Faster cash inflow.
Lower administrative burden.
Enhanced cash availability for operational or investment use.

Example: A retail company using a lockbox system can access funds from customer payments within 24 hours instead of
waiting several days for processing.
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15. Criteria for choosing short-term investment alternatives for surplus cash

Key Criteria:
1. Liquidity: The investment must be easily convertible into cash without significant loss in value.
2. Safety: The principal amount should be secure, with minimal risk of default.
Example: Treasury bills are highly secure because they are government-backed.
3. Return on Investment: The investment should provide reasonable returns, balancing risk and liquidity.
4. Maturity Period: Should align with the firm's cash needs; short maturities are preferred to avoid locking up funds.
5. Marketability: The investment should be actively traded, ensuring it can be sold when required.
Example Investments:
Treasury Bills (secure and liquid).
Certificates of Deposit (CDs) (slightly higher returns).
Commercial Paper (higher returns but moderate risk).

By balancing these criteria, firms ensure efficient use of surplus cash while maintaining financial stability.
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16. Components of collection float and how to reduce it

Collection Float: The time delay between when a payment is initiated by a customer and when the funds become available for
use by the company.
Components:
1. Mail Float: Time taken for a payment to reach the company by mail.
2. Processing Float: Time taken by the company to process the payment.
3. Clearing Float: Time taken by the bank to clear and credit the payment.
How to Reduce Collection Float:
1. Lockbox System: Reduces mail and processing float by routing payments directly to the bank.
2. Electronic Payments: Eliminates mail and clearing float as funds are transferred instantly.
3. Concentration Banking: Establishes local collection centers to minimize mail delays.
4. Automation: Using technology for processing payments speeds up processing float.

Example: A company implementing electronic funds transfer (EFT) can reduce float from several days to a few hours.
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17. Define cash collection and cash disbursement of a firm. Explain various cash collection instruments with their pros and
cons.

Definitions:
Cash Collection: The process of receiving funds from customers for goods or services provided.
Cash Disbursement: The process of paying off liabilities, operating expenses, and other obligations.
Cash Collection Instruments:
1. Lockbox System:
Pros: Speeds up cash inflows, reduces float, and improves liquidity.
Cons: Costly to implement and manage.
2. Electronic Funds Transfer (EFT):
Pros: Instant transfers, eliminates float, and secure.
Cons: Requires customer and company to have compatible banking systems.
3. Credit/Debit Cards:
Pros: Convenient for customers and ensures faster payment.
Cons: Involves transaction fees for the company.
4. Online Payment Gateways:
Pros: Easy to use, faster payment processing.
Cons: May require integration with company systems and involve costs.

Example: A retail business using a lockbox system and EFT ensures faster cash inflows, improving operational efficiency and
reducing reliance on borrowing.
____

18. What is a marketable security? How would you determine a firm's portfolio of marketable securities?

Marketable Security:
A marketable security is a short-term, liquid financial asset that can be easily bought or sold in financial markets, typically within
a year. Examples include Treasury Bills (T-Bills), commercial paper, and money market funds. These are low-risk investments
that companies use to manage surplus cash.

Determining a Firm’s Portfolio: To create a portfolio, the firm should consider:

1. Liquidity Needs: Choose highly liquid assets (e.g., T-Bills) if cash is needed quickly.
2. Risk Tolerance: Prefer safe options (e.g., T-Bills) for low-risk tolerance or higher-yielding options (e.g., commercial paper) for
higher risk tolerance.
3. Return Expectations: Balance returns with risk. T-Bills offer low returns, while commercial paper offers higher returns but
more risk.
4. Investment Horizon: Match investment maturity with cash needs (e.g., short-term for immediate needs).
5. Diversification: Mix different securities to reduce risk and maximize returns.
Example: A firm may choose 60% T-Bills for liquidity and 40% commercial paper for higher returns.

19. What do you mean by acceleration of collection? Explain different methods of accelerating the collection of a firm.

Definition:
Acceleration of collection refers to reducing the time taken to convert receivables into cash, ensuring faster availability of funds
for operational use.
Methods to Accelerate Collections:
1. Lockbox System: Customers send payments directly to a bank-managed P.O. box, reducing mail and processing time.
2. Concentration Banking: Establishing collection centers closer to customers minimizes mail delays and expedites deposits.
3. Electronic Payments (EFT): Using electronic systems for direct fund transfers eliminates delays associated with checks.
4. Preauthorized Payments: Customers agree to automatic deductions for recurring bills, ensuring timely payments.
5. Early Payment Incentives: Offering discounts for early payments encourages customers to settle invoices quickly
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20. Why and how is the market for Treasury bills deep and liquid? Distinguish between competitive and non-competitive bidding
of Treasury bills.

Deep and Liquid Market for Treasury Bills:

Why: T-bills are backed by the government, making them virtually risk-free. They are widely traded, ensuring buyers and sellers
are always able to transact without significant price fluctuations. Their
short-term nature also makes them attractive for managing cash.

How:
1. Government Guarantee: Treasury bills are backed by the U.S. government, making them highly secure and desirable to
investors.
2. Large Volume: The U.S. Treasury issues a significant amount of T-bills, ensuring a large supply that meets investor demand.
3. Active Market: T-bills are actively traded in the secondary market, making them easy to buy or sell without a significant
impact on the price.
4. Short-Term Maturity: With maturities ranging from a few days to a year, T-bills provide liquidity for investors who need to
manage short-term cash.

Competitive vs. Non-Competitive Bidding:

1. Competitive Bidding:
Investors specify the interest rate they are willing to accept.
The lowest rates are accepted first.
This method is typically used by institutional investors.

2. Non-Competitive Bidding:
Investors agree to accept the discount rate determined by the auction.
This method ensures that all bids are accepted, making it easier for smaller investors to participate.
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21. What are the three motives for holding cash? Under what conditions would it be possible for a company to hold no cash or
marketable securities? Are these conditions realistic?

Three Motives for Holding Cash:

1. Transaction Motive: Cash is held to meet day-to-day operational needs like paying bills, salaries, and inventory purchases.
2. Precautionary Motive: Cash is held as a buffer for unforeseen events, such as economic downturns or unexpected expenses.
3. Speculative Motive: Cash is held to take advantage of unexpected investment opportunities, like the purchase of assets at a
discounted price.

Conditions to Hold No Cash or Marketable Securities:

1. Predictable Cash Flow: If a company’s cash inflows and outflows are highly predictable, it may reduce its cash reserves.
2. Access to Credit: Companies with strong credit ratings may rely on short-term borrowing to cover any liquidity gaps.
3. Efficient Cash Management: Companies with highly efficient systems, like just-in-time inventory, may not need to maintain
cash balances.

Realistic?:
While it’s theoretically possible, in practice, most companies need some cash or marketable securities to manage risks, handle
emergencies, and take advantage of opportunities.
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22. Briefly explain some money market instruments.

Money market instruments are short-term, low-risk debt securities used for managing liquidity. Some of the most common
instruments include:

1. Treasury Bills (T-Bills): Short-term government securities issued with maturities ranging from a few days to a year.
2. Commercial Paper: Unsecured short-term debt issued by corporations to meet immediate financial needs, typically with
maturities of 1 to 270 days.
3. Certificates of Deposit (CDs): Time deposits issued by banks, with fixed interest rates and specific maturity dates.
4. Repurchase Agreements (Repos): Short-term loans where securities are sold with an agreement to repurchase them later at
a higher price.
5. Bankers’ Acceptances: Short-term debt issued to finance international trade, guaranteed by a bank.
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23. "Marketable securities act as reserve, controllable cash, and/or extra cash for a company." Explain this statement
considering certain key variables.

Marketable securities are short-term, highly liquid investments that help companies manage their cash flow and reserves.

Key Variables:
1. Reserve: Marketable securities provide a financial buffer for emergencies, serving as a reserve when immediate cash needs
arise.
2. Controllable Cash: These securities offer flexibility because they can be easily sold or converted into cash as needed.
3. Extra Cash: They allow a company to earn returns on surplus cash that would otherwise be idle.

By holding marketable securities, companies can maintain liquidity while also earning a return on their cash reserves, thus
enhancing overall financial efficiency.
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24. What are the major reasons for deciding to invest excess cash balances in marketable securities?

1. Liquidity: Marketable securities can be easily converted to cash with minimal loss in value, ensuring liquidity for unexpected
needs.
2. Safety: These investments, especially government-backed securities, are low-risk, preserving the company’s capital.
3. Return on Idle Cash: Investing in marketable securities allows companies to earn returns on excess cash that would
otherwise remain idle.
4. Diversification: Helps diversify the firm’s portfolio, reducing risk exposure to specific asset types or market conditions.
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25. What characteristics should an investment have to qualify as an acceptable marketable security?

To be considered an acceptable marketable security, an investment should have:

1. Liquidity: The ability to be converted into cash quickly without significant loss of value.
2. Safety: The risk of losing principal should be minimal, typically by being backed by the government or a reputable institution.
3. Short-Term Maturity: It should have a maturity of one year or less to ensure funds are available when needed.
4. Low Transaction Costs: The cost to buy or sell the security should be minimal.
5. Marketability: The security should be actively traded in the market, ensuring ease of buying or selling.
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26. Imagine yourself as the finance manager of a leading firm. What are the basic criteria you would follow in making optimum
investment decisions on a portfolio of securities with the surplus cash available with the firm?

As a finance manager, the key criteria to consider when making investment decisions for surplus cash would be:
1. Liquidity: Ensuring that the investments are easy to convert into cash if needed for business operations or emergencies.
2. Safety: Prioritizing low-risk investments to protect the firm’s capital, such as government securities or high-grade corporate
bonds.
3. Return on Investment: Seeking a reasonable return on investments while balancing risk and liquidity needs.
4. Time Horizon: Considering the length of time the cash will be idle and choosing investments that align with the company’s
cash flow needs.
5. Diversification: Spreading the investments across various instruments to reduce risk exposure.
6. Economic Conditions: Evaluating market conditions to make informed decisions about interest rates and economic cycles,
influencing investment returns.

By following these criteria, the firm can effectively manage its surplus cash to ensure financial stability while optimizing returns.