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Merits & Demerits of Holding Cash
Managing Cash Meet various payment requirements of the firm,
e.g.,
suppliers,
MERITS & DEMERITS OF HOLDING wages and salaries to the work force,
CASH payment for repair & maintenance
and so forth.
NEED FOR HOLDING CASH Holding Idle cash has an opportunity cost.
CASH MANAGEMENT TECHNIQUES
THE CASH BUDGET
Need for Holding Cash Cash Management Principles
Transactional:
Quick Collection
Do not force premature collection.
Compensating:
Slow Disbursement
Precautionary: Do not delay payment beyond the deadline.
Speculative:
Cash Management Techniques Cash Flow Synchronisation
Cash flow Synchronisation Matching of receipts and disbursement
Reduces need for withdrawal from bank
Cheque Clearing Process Decreases transactional balance,
decreases bank loans,
Floats lowers interest expenses
Thereby boosting profits.
Acceleration of Receipts.
Disbursement Control
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Cheque Clearing Process Using Floats
Confirmation by payer’s bank that adequate
Time difference between
money is available
Cheques sent by sender and Cash available to receiver.
Expedite the process of cheque clearing.
Collection float:
Cheque clearance time is a function
Disbursement float:
ofthe distance between payer’s and payee’s banks
Net Float:
possible mail delays.
Collection float ˜ Disbursement float.
The clearinghouses.
Privateclearinghouses
Electronic clearinghouses
can make cheque clearance almost immediate.
Acceleration Of Receipts Acceleration Of Receipts
Lock boxes Preauthorised debits
Post office boxes at strategic collection locations. Periodic fund transfer from customer’s account to the
Geographically located in areas where a large number of seller’s account against payments of bills.
customers operate.
local bank collects cheques and deposits them firm’s
Concentration banking
checking account with the bank.
Used to collect funds from decentralised locations to one
Bank provides daily record of collections.
or more central pools.
Collected funds used for short-term investment or
reallocated among the firm’s bank.
Acceleration Of Receipts Disbursement Control
Cheque transfer Mechanisms Payables concentration:
Depository Transfer Cheques Payments should be made from one or a few centralised
Non-negotiable and unsigned instrument locations.
Used for the sole purpose of transferring between banks.
Paper DTC: cheap but takes more time.
Forecast of payments to become due and arrange funds
Electronic DTC: Costly but affords quicker transfer. accordingly.
Wire Transfer
Made via telephone lines. Decentralised offices might face problems making prompt
Costly but affords immediate transfer. payments.
Used for transferring large sum of money.
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Disbursement Control The Cash Budget
Zero balance accounts (ZBA): Schedule firm’s estimation of cash receipts,
Special checking account with zero balance when there is no payments and balances over a specified period in the
disbursement. future.
ZBAs may be maintained.
As cheques are presented to a ZBA for payment, funds are
automatically transferred from the master account. Budget period is broken down to number of time
periods.
Controlled disbursement accounts (CDA):
Checking account where funds are not deposited until
cheques are presented for payments, usually on a daily Ethe firm to estimate the fund requirement during
basis. the individual periods contained in the budget.
Cash Budget Format
Indicators of Cash Management Efficiency
Description JAN FEB MAR APR MAY JUN ...
Cash collections/receipts Current Assets
Less Cash disbursments/payments
Current Ratio
Current Liabilioties
= Net cash flow
Add Beginning cash balance
= Ending cash balance Current Assets - Stock
Less Target cash balance*
Quick Ratio
Current Liabilioties
=Surplus/shortage
*Target balance refers to the minimum cash balance that the firm desires to
maintain at all time to meet its various needs such as transactional,
compensating, precautionary and emergency needs.
THANK YOU Problem 20-8
Ilene Malitz recently leased space in the southside
mall and opened a new business, Ilene’s Dress Shop.
Business has been good, but Ilene has frequently run
out of cash. This has necessitated late payment on
certain orders, which in turn is beginning to cause a
problem with suppliers. Ilene plans to borrow from
the bank to have cash ready as needed, but first she
Intermediate Financial Management, 5th ed. needs a forecast of just how much she must borrow.
Eugene F. Brigham & Louis C. Gapinsky Accordingly, she asked you to prepare a cash budget
The Dryden Press, Hartcourt Brace College Publishers for the critical period around Christmas, when need
1996 will be specially high.
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Problem 20-8
Problem 20-8
Illene’s Dress Shop: Cash Budget for December, January and February
Sales are made on a cash basis only. Ilene’s purchases must be paid November December January February
for during the following month. Ilene pays herself a salary of Sales $160,000 $40,000 $60,000
$4,800 per month, and the rent is $2,000 per month. In addition, Purchases $140,000 $40,000 $40,000 $40,000
she must make a tax payment of $12,000 in December. The current Collections $160,000 $40,000 $60,000
cash on hand (on December 1) is $400, but ilene has agreed to
Payments
maintain an average bank balance of $6,000—this is her target Payments on purchase $140,000 $40,000 $40,000
balance. Salaries 4,800 4,800 4,800
The estimated sales and purchases for December, January, and Rent 2,000 2,000 2,000
Tax 12000
February are shown below. Purchases during November amounted
Total payments $158,800 $46,800 $46,800
to $140,000.
December Sales $160,000 Purchases $40,000 Net cash flow $1,200 ($6,800) $13,200
January 40,000 40,000 Beginning cash 400 $1,600 ($5,200)
Ending cash $1,600 ($5,200) $8,000
February 60,000 40,000
Target cash 6,000 6,000 6,000
Prepare a cash budget for December, January, and February. Surplus (shortage) ($4,400) (11,200) $2,000
