The Concept of Cash Management

Concept  of Cash

“Cash, like the blood stream in the human body, gives vitality and strength to business enterprises.”

Though cash hold the smallest portion of total current assets. However, cash is both the beginning and end of working capital cycle – cash, inventories, receivables and cash. It is the cash, which keeps the business going. Hence, every enterprises has to hold necessary cash for its existence.  Moreover, steady and healthy circulation of cash throughout the entire business operations is the basis of business solvency.

Cash Management

In the words of R.R. Bari, “Maintenance of surplus cash by a company unless there are special reasons for doing so, is regarded as a bad sigh of cash management.”

Cash may be interpreted under two concepts. In narrow sense, cash is very important business asset, but although coin and paper currency can be inspected and handled, the major part of the cash of most enterprises is in the form of bank checking accounts, which represent claims to money rather than tangible property. While in broader sense, cash consists of legal tender, cheques, bank drafts, money orders and demand deposits in banks. In general, nothing should be considered unrestricted cash unless it is available to the management for disbursement of any nature. Thus, from the above quotations we may conclude that in narrow sense cash means cash in hand and at bank but in wider sense, it is the deposit in  banks, currency, cheques, bank draft etc. in addition to cash in hand and at bank.

Motives for Holding Cash

A distinguishing feature of cash as an asset, irrespective of the firm in which it is held, is that it does not earn any substantial return for the business. In spite of this fact cash is held by the firm with following motives.

  1. Transactions Motive – This motive refers to the holding of cash, to meet routine cash requirements in the ordinary course of business. A firm enters into a number of transactions which requires cash payment. For example, purchase of materials, payment of wages, salaries, taxes, interest etc. Similarly, a firm receives cash from cash sales, collections from debtors, return on investments etc. But the cash inflows and cash outflows do not perfectly synchronize. Sometimes, cash receipts are more than payments while at other times payments exceed receipts. The firm must have to maintain sufficient (funds) cash balance if the payments are more than receipts. Thus, the transactions motive refers to the holding of cash to meet expected obligations whose timing is not perfectly matched with cash receipts. Though, a large portion of cash held for transactions motive is in the form of cash, apart of it may be invested in marketable securities whose maturity conform to the timing of expected payments such as dividends, taxes etc.
  2. Precautionary Motive – Apart from the non-synchronisation of expected cash receipts and payments in the ordinary course of business, a firm may be failed to pay cash for unexpected contingencies. For example, strikes, sudden increase in cost of raw materials etc. Cash held to meet these unforeseen situations is known as precautionary cash balance and it provides a caution against them. The amount of cash balance under precautionary motive is influenced by two factors i.e. predictability of cash flows and the availability of short term credit. The more unpredictable the cash flows, the greater the need for such cash balances and vice versa. If the firm can borrow at short-notice, it will need a relatively small balance to meet contingencies and vice versa. Usually precautionary cash balances are invested in marketable securities so that they contribute something to profitability.
  3. Speculative Motive – Sometimes firms would like to hold cash in order to exploit, the profitable opportunities as and when they arise. This motive is called as speculative motive. For example, if the firm expects that the material prices will fall, it can delay the purchases and make purchases in future when price actually declines. Similarly, with the hope of buying securities when the interest rate is expected to decline, the firm will hold cash. By and large, firms rarely hold cash for speculative purposes.
  4. Compensation Motive – This motive to hold cash balances is to compensate banks and other financial institutes for providing certain services and loans. Banks provide a variety of services to business firms like clearance of cheques, drafts, transfer of funds  etc. Banks charge a commission or fee for their services to the customers as indirect compensation. Customers are required to maintain a minimum cash balance at the bank. This balance cannot be used for transaction purposes. Banks can utilize the balances to earn a return to compensate their cost of services to the customers. Such balances are compensating balances. These balances are also required by some loan agreements between a bank and its customers. Banks require a chest to maintain a minimum cash balance in his account to compensate the bank when the supply of credit is restricted and interest rates are rising.

Thus cash is required to fulfill the above motives. Out of the four motives of holding cash balances, transaction motive and compensation motives are very important. Business firms usually do not speculate and need not have speculative balances. The requirement of precautionary balances can be met out of short-term borrowings.

Cash Management – Significance, Objectives and Principles

The term cash management refers to the management of cash resource in such a way that generally accepted business objectives could be achieved. In this context, the objectives of a firm can be unified as bringing about consistency between maximum possible profitability and liquidity of a firm. Cash management may be defined as the ability of a management in recognizing the problems related with cash which may come across in future course of action, finding appropriate solution to curb such problems if they arise, and finally delegating these solutions to the competent authority for carrying them out. The choice between liquidity and profitability creates a state of confusion. It is cash management that can provide solution to this dilemma. Cash management may be regarded as an art that assists in establishing equilibrium between liquidity and profitability to ensure undisturbed functioning of a firm towards attaining its business objectives.

Cash itself is not capable of generating any sort of income on its own. It rather is the prime requirement of income generating sources and functions. Thus, a firm should go for minimum possible balance of cash, yet maintaining its adequacy for the obvious reason of firm’s solvency. Cash management deals with maintaining sufficient quantity of cash in such a way that the quantity denotes the lowest adequate cash figure to meet business obligations. Cash management involves managing cash flows (into and out of the firm), within the firm and the cash balances held by a concern at a point of time. The words, ‘managing cash and the cash balances’ as specified above does not mean optimization of cash and near cash items but also point towards providing a protective shield to the business obligations. Cash management is concerned with minimizing unproductive cash balances, investing temporarily excess cash advantageously and to make the best possible arrangement for meeting planned and unexpected demands on the firms’ cash.

Significance of Cash Management

Cash is one of the most important components of current assets. Every firm should have adequate cash, neither more nor less. Inadequate cash will lead to production interruptions, while excessive cash remains idle and will impair profitability. Hence, the need for cash management. The cash management assumes significance for the following reasons.

  1. Cash planning – Cash is the most important as well as the least unproductive of all current assets. Though, it is necessary to meet the firm’s obligations, yet idle cash earns nothing. Therefore, it is essential to have a sound cash planning neither excess nor inadequate.
  2. Management of cash flows – This is another important aspect of cash management. Synchronization between cash inflows and cash outflows rarely happens. Sometimes, the cash inflows will be more than outflows because of receipts from debtors, and cash sales in huge amounts. At other times, cash outflows exceed inflows due to payment of taxes, interest and dividends etc. Hence, the cash flows should be managed for better cash management.
  3. Maintaining optimum cash balance – Every firm should maintain optimum cash balance. The management should also consider the factors determining and influencing the cash balances at various point of time. The cost of excess cash and danger of inadequate cash should be matched to determine the optimum level of cash balances.
  4. Investment of excess cash – The firm has to invest the excess or idle funds in short term securities or investments to earn profits as idle funds earn nothing. This is one of the important aspects of management of cash. Thus, the aim of cash management is to maintain adequate cash balances at one hand and to use excess cash in some profitable way on the other hand.

Objectives of Cash Management

There are two basic objectives of cash management:

  1. Meeting cash disbursements:  The first basic objective of cash management is to meet the payments Schedule. In other words, the firm should have sufficient cash to meet the various requirements of the firm at different periods of times. The business has to make payment for purchase of raw materials, wages, taxes, purchases of plant, etc. The business activity may come to a grinding halt if the payment schedule is not maintained. Cash has, therefore, been aptly described as the “oil to lubricate the ever-turning wheels of the business, without it the process grinds to a stop.”
  2. Minimizing funds locked up as cash balances:  The second basic objective of cash management is to minimize the amount locked up as cash balances. In the process of minimizing the cash balances, the finance manager is confronted with two conflicting aspects. A higher cash balance ensures proper payment with all its advantages. But this will result in a large balance of cash remaining idle. Low level of cash balance may result in failure of the firm to meet the payment schedule.

The finance manager should, therefore, try to have an optimum amount of cash balance keeping the above facts in view.

Principles of Cash Management

Harry Gross has suggested certain general principles of cash management that, essentially add efficiency to cash management. These principles reflecting cause and effect relationship having universal applications give a scientific outlook to the subject of cash management. While, the application of these principles in accordance with the changing conditions and business environment requiring high degree of skill and tact which places cash management in the category of art. Thus, we can say that cash management like any other subject of management is both science and art for it has well-established principles capable of being skillfully modified as per the requirements. The principles of management are follows as;

  1. Determinable Variations of Cash Needs:  A reasonable portion of funds, in the form of cash is required to be kept aside to overcome the period anticipated as the period of cash deficit. This period may either be short and temporary or last for a longer duration of time. Normal and regular payment cf cash leads to small reductions in the cash balance at periodic intervals. Making this payment to different employees on different days of a week can equalize these reductions. Another technique for balancing the level of cash is to schedule cash disbursements to creditors during that period when accounts receivables collected amounts to a large sum but without putting the goodwill at stake.
  2. Contingency Cash Requirement:  There may arise certain instances, which fall beyond the forecast of the management. These constitute unforeseen calamities, which are too difficult to be provided for in the normal course of the business. Such contingencies always demand for special cash requirements that was not estimated and provided for in the cash budget. Rejections of wholesale product, large amount of bad debts, strikes, lockouts etc. are a few among these contingencies. Only a prior experience and investigation of other similar companies prove helpful as a customary practice. A practical procedure is to protect the business from such calamities like bad-debt losses, fire etc. by way of insurance coverage.
  3. Availability of External Cash:  Another factor that is of great importance to the cash management is the availability of funds from outside sources. There resources aid in providing credit facility to the firm, which materialized the firm’s objectives of holding minimum cash balance. As such if a firm succeeds in acquiring sufficient funds from external sources like banks or private financiers, shareholders, government agencies etc., the need for maintaining cash reserves diminishes.
  4. Maximizing Cash Receipts:  Every financial manager aims at making the best possible use of cash receipts. Again, cash receipts if tackled prudently results in minimizing cash requirements of a concern. For this purpose, the comparative cost of granting cash discount to customer and the policy of charging interest expense for borrowing must be evaluated on continuous basis to determine the futility of either of the alternative or both of them during that particular period for maximizing cash receipts. Yet, the under mentioned techniques proved helpful in this context:
    1. Concentration Banking: Under this system, a company establishes banking centers for collection of cash in different areas. Thereby, the company instructs its customers of adjoining areas to send their payments to those centers. The collection amount is then deposited with the local bank by these centers as early as possible. Whereby, the collected funds are transferred to the company’s central bank accounts operated by the head office.
    2. Local Box System: Under this system, a company rents out the local post offices boxes of different cities and the customers are asked to\forward their remittances to it. These remittances are picked by the authorized lock bank from these boxes to be transferred to the company’s central bank operated by the head office.
    3. Reviewing Credit Procedures: It aids in determining the impact of slow payers and debtors on cash. The accounts of slow paying customers should be reviewed to determine the volume of cash tied up. Besides this, evaluation of credit policy must also be conducted for introducing essential amendments. As a matter of fact, too strict a credit policy involves rejections of sales. Thus, curtailing the cash in flow. On the other hand, too lenient, a credit policy would increase the number of slow payments and bad debts again decreasing the cash inflows.
    4. Minimizing Credit Period: Shortening the terms allowed to the customers would definitely accelerate the cash inflow side-by-side revising the discount offered would prevent the customers from using the credit for financing their own operations profitably.
    5. Others: Introducing various procedures for special handling of large to very large remittances or foreign remittances such as, persona! pick up of large sum of cash using airmail, special delivery and similar techniques to accelerate such collections.
  5. Minimizing Cash Disbursements:  The motive of minimizing cash payments is the ultimate benefit derived from maximizing cash receipts. Cash disbursement can be brought under control by preventing fraudulent practices, serving time draft to creditors of large sum, making staggered payments to creditors and for payrolls etc.
  6. Maximizing Cash Utilization:  Although a surplus of cash is a luxury, yet money is costly. Moreover, proper and optimum utilization of cash always makes way for achievement of the motive of maximizing cash receipts and minimizing cash payments. At times, a concern finds itself with funds in excess of its requirement, which lay idle without bringing any return to it. At the same time, the concern finds it unwise to dispose it, as the concern shall soon need it. In such conditions, efforts should be made in investing these funds in some interest bearing securities.

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