Chapter 5 and 6 of Treasury Management which include a well shortcut study for the student

1. Chapter 3:
cash Management
Treasury Management

2. introduction
Cash is the most liquid asset.
Cash is common denominator to which all other current assets
can be reduced because receivables and inventories get
converted into cash.
Cash is lifeblood of any firm needed to acquire supply
resources, equipment and other assets used in generating the
products and services.
Marketable securities also come under near cash, serve as back
pool of liquidity which provide quick cash when needed.

3. Management of cash
Although cash is only 1-3% of total current assets but
its management is very important.
Management of cash includes the following objectives:
Determination of optimum amount of cash required in the
business.
To keep the cash balance at optimum level and
investment of surplus cash in profitable manner.
Prompt collection of cash from receivables and efficient
disbursement of cash.

4. MEANING OF CASH
For the purpose of cash
management, the term cash not only
includes coins, currency notes,
cheques, bank draft, demand
deposits with banks but also the near
cash assets like marketable securities
and time deposits with bank because
they can readily be converted into
cash

5. MOTIVES FOR HOLDING CASH
• In business cash is needed for the following motives:
• Transaction Motive: i.e. to purchase raw material & to pay for
operating expenses
• Precautionary Motive: To meet the future contingencies such as:
Floods, strikes and failures of important customer
Bills may be presented for settlement earlier than expected
Unexpected slow down in collection of accounts receivables.
Cancellation of some order for goods as the customer is not
satisfied
Sharp increase in cost of raw materials

6. • Speculative Motive: The speculative motive helps to take
advantages of:
An opportunity to purchase raw materials at a reduced price on
payment of immediate cash.
A change to speculate on interest rate movements by buying
securities when interest rates are expected to decline.
Delay purchase of raw materials on the anticipation of decline in
prices.
Make purchase at favorable prices.
• Compensating Motive: Yet another motive to hold cash balances is
to compensate banks for providing certain services and loans.

7. floats
•The amount of money tied up in cheques that have been
written but yet to be collected and encashed.
•Types of Floats:
Collection Float
Mail Float
Processing Float
Availability Float

8. Collection Float: It refers to the total time gap between
the mailing of the payment by the payer and the
availability of cash in bank.
Mail Float: It results from the time that elapse from the
mailing of cheque until it receipt.
Processing Float: It is due to the processing time before
the cheque is deposited into the bank.
Availability Float: It includes the time gap which is
consumed in the clearance of cheque.

10. Management of Cash
•Cash Management involves the following 4 problems
•1. Controlling the level of cash
•2. Controlling the level of inflow of cash
•3. Controlling the level of outflow of cash
•4. Optimum investment of surplus cash

11. 1. Controlling the level of cash
The Level of cash locked up in the cash balances should be only that
amount which is required.
This is achieved by preparing what is called the “Cash Budget”
• Cash Budget
Cash budget is the cash forecast which involves the future
projection of the cash receipts as well as the cash disbursement.
It reveals the “timing” and “amount” of cash inflow and outflow
over a period studied and thus is a tool by which the finance
manager is able to plan things in a better way.
Cash budget is prepared by estimating the cash receipts from
various sources and the cash payments to different agencies

12. • Cash Receipts
• The cash receipts and payments are divided in to two categories:
• 1. Capital Receipts
All the money that is coming by way of capital fund raising like issue of
shares, loan raised by issuing debentures or preference shares.
Cash received when some long term asset has been sold.
• 2. Revenue Receipts
Cash received by sales of goods /services
Commisions

13. • Payments
• 1. Capital Payment
 The amount given to the bond holders on the maturity of the bonds
 Payment of long term loan
 Purchase of some long term fixed assets like plant or machinery etc.
• 2. Revenue Payment
Payment for raw materials purchases
Payment of wages, bills, rents
Payment of interest on long term loans
Payment of dividends on shares etc.

14. Preparing the cash balance (for a specific time period)
Three basic steps:
1.Opening Balance.
2.Add cash receipts and deduct the payments made.
3.Prepare the closing balance (which will be the opening
balance for the next time period).

15. Example
•

17. example

18. •

19. 2. Controlling the level of inflow of cash
 After preparing the cash budget the finance manager should ensure that there is
no deviation in the inflow of the cash.
 Any deviation from the expected cash inflow can lead to upsetting of the whole
budget activity.
 The Finance manager needs to devise appropriate techniques so that the cash
coming to the firm should not get diverted to anywhere else.
 The cash should also come on time.
 There are multiple types of collection systems to control the level of inflow of cash.

20. Types of collection systems
1. Over the counter collection
It is the system where the payment is received in face to face
meeting the customers.
Mostly retail or customer business receive full or at least some part
of their payments on the over the counter basis.
Since payments are not mailed, an over the counter system does not
contain mail float.
Basic Components It includes the field unit at which the payment is
received, a local deposit bank that serve as the entry point for the firms
banking system and an input into the firms central information system.

22. 2. MAILED PAYMENT COLLECTION SYSTEM
Many companies receive payments through cheques mailed by
customers in response to an invoice.
A mailed payment system contains all three components of collection
float i.e. mail float, processing float, float & availability float.
It consists of collection centers, deposit banks and an information
system.
Payments are mailed by customers to a designated collection centre
operated by company or by an outside agent.
Payments are processed at collection centre; cheques are encoded; the
deposit is prepared and made and the data are transmitted to the
companies information system.

23. • Cash flow timeline overThe Mailed Collection system

24. •3. Pre authorized payments:
•Pre authorized cheques, drafts etc. are sometimes
used when the payment amount and payment dates
are specified in advance.
•On the agreed date the payee initiates the value
transfer from the payer through the banking system.
•This collection system eliminates the mail float, reduce
processing and availability and improve both parties
forecasting ability.

25. • 4. Cash Concentration
 Decentralized system of account receivables, for the firms having their operations
spread over a large geographical area.
 The firm establishes a large number of collection centers in different geographical
areas.
 The collection centers deposit the cheques from the debtors to the local branch of the
concentration bank.
 The local bank transfers a certain amount of money on daily basis to the Bank at Head
office.
 This results in the faster collection of the funds.

26. • Advantages Of Concentration
• 1.The collection process results in a larger pool of funds that makes
any temporary interest earning investment more economical.
• 2.With all the cash in the central location, control over the cash is
simplified.
• 3. It simplifies short-term financing and investment decisions.

27. •Concentration Banking

28. • 5. A Lock Box System
A lock-box is a post office box number to which some or all the
firm’s customers are instructed to send their cheques.
The firm grants permission to its bank to take these cheques and
immediately send them in the clearing process.
In lock-box location analysis the following areas should be taken
into mind:
Determining customer zone.
Obtaining bank cost data.
The cost of floats

29. 3. Controlling the level of outflow of cash
Known as disbursement system. This relates to the cash payment
to be given to the creditors.
Here the aim is totally opposite to what one has in controlling the
cash inflow. Delay the payment as much as possible and thus
want to slowdown the process.
The combination of the faster collection and slow disbursement
leads to maximum availability of funds.
It includes the banks, delivery mechanism and procedures the
firms used to facilitate the movement of cash from the firm’s
centralized cash pool to disbursement banks and then suppliers.

30. Disbursement banks are bank upon which disbursement
cheques are drawn. It may be more complex than collection
system. It generally falls under more direct control of head
Quarters.
The concentration bank serve as value between firm’s
collection system, liquidity portfolio and disbursement bank.

31. • Disbursement Banking

32. Types of disbursement systems
• 1. Zero Balance System:
 It is the common strategy for funding disbursement as the cheques are presented.
 Under this system the participatory bank does not keep any permanent stock of cash in this
account.
 Instead it agrees that when the morning disbursement for firm presented to it, bank will
advise to the firm of the amount of cash required to these disbursements.The money will
then be wire transferred into the zero balance account and the cheques will be honoured.
 In this way the disbursing firm’s cheques are honoured as they are presented, but the firm
does not tie up cash while the cheques are in mail and while they are clearing.

33. • 2. Controlled disbursement
If the zero balance system is not feasible, another system is the
use of controlled disbursement which is often used when the
firm’s disbursement bank receives cheques for clearance
throughout the day.
In this system, the firm projects the amount of cheques to
arrive each day at the disbursement bank and transfers the
amount of expected cheques to the account on that day or just
before.
Of course, the firm does not know what outstanding cheques
will be presented on any particular day; to hedge the
uncertainty the firm keeps a safety stock of cash in this
account.

34. 4. Optimum investment of surplus
cash
• Investment in Marketable Securities
The management of investment in marketable securities is an
important financial management responsibility because of the
close relationship in between cash and marketable securities.
Once the optimum level of cash is determined the residual of its
liquid assets is invested in marketable securities.

35. There are 2 problems that the firm face while taking the decision to invest
the surplus cash
1.Where to invest
1.Which type of security
2. For how much time
3. Liquidity etc
2. Determine the amount of surplus cash in hand.
The cash in excess of what is considered the “normal cash requirement” of
the firm is called the excess cash.
So FM needs to know what is the “ normal cash requirement”.
This “ normal cash requirement” is also called the safety level of cash.
How to determine this “safety/optimum level of cash”

36. • How to determine the safety level of cash?
Normal Period Safety level Cash
Safety Level of cash = Desired days of cash X Avg daily cash outflow
Example: A FM feels that I should have sufficient funds to meet the cash
requirement for 7 days and the average daily cash outflow for those 7 days
is Rs 6000/day
Safety Level of cash = 7 X 6000 = Rs 42,000
Peak Period safety Level of cash
Safety Level of cash = Desired days of cash X Avg daily cash outflow of
peak period
Example : Avg daily cash outflow for the peak days was Rs 4000 and a FM
wants to have sufficient cash for the 5 peak days
Safety Level of cash = 5X 4000 = Rs 20,000

37. Baumol Model
This model is based on minimization of 2 costs.
Carrying cost –When the firm holds cash and it is not in circulation the
firm is loosing the opportunity to invest it somewhere.This is also
called opportunity cost and in this model it is called the carrying cost
Transaction Cost –When a firm has kept its cash in securities that can
be converted in to cash , it has to pay certain costs like commissions,
admin costs etc.
As per this model that amount of cash( both in hand and in securities) is
the optimum where total of the 2 costs in minimum.
Models to determine the optimum level of cash

40. • Miller-Orr Model
Baumol model is suitable where the cash outflow is steady and
can be predicted with accuracy in advance.
Where the cash flows are random Miller-Orr model is used.
This model consists of setting an upper limit, lower limit and
return point for the cash.
Upper limit is represented = h
Lower limit = O
Return Point = z