Cash Management

Cash management : is one of the most critical processes for a company. If there is not enough cash at any point in time a company will face, at worst, bankruptcy or at least high interest charges to obtain the necessary cash from a bank on short notice. Therefore, a company needs to manage cash from both a short-term and a long-term perspective. In the short-term it is essential that the company have enough cash to pay its obligations as they come due, and in the long-term, it is critical that the company has enough cash to grow and expand as needed.

The amount of cash that a company will hold at any one point in time is influenced by a number of factors including the following : 

• How much cash will be needed in the near future?
• The amount of risk a company is willing to take in respect to solvency,
• The level of other short-term assets that a company holds,
• The available return on other short-term investments, (This is a very large part of the decision because cash is a non-interest bearing asset. If there is a very low interest rate in the marketplace, the opportunity cost of holding cash is reduced. However, when there is a higher interest rate, the cost of holding the cash rather than other investments is increased. As a result a company may be willing to accept more solvency risk by holding less cash in return for a more interest received.
• At what point in its business cycle it is in (if a business is a seasonal business it will have more cash at the peak periods than at the slow periods).

Reasons (motives) for holding Cash- Keynes view

The reasons that a company holds cash are many and varied. However, we can break the reasons for holding cash into the following categories :

1- As a medium of exchange (Transactional purposes): Cash is still needed for some business transactions.

Transactions balance is the amount of cash the firm needs on deposit to conduct day-to-day transactions.

2- As a precautionary measure: Cash, or other very liquid investments, may be held for use in unforeseen situations where cash is needed quickly.

Precautionary balance represents the balance available for emergencies Such as strikes, natural disasters, and cyclical downturns.

3- For speculation :  Cash may be held in order to be able to act quickly on good investment opportunities that arise. EX: purchase of inventory at a deeply discounted price.

Speculative balance represents the balance available for bargain purchases.

4- Still another reason for holding cash that is not mentioned by Keynes. Cash may be held as a compensating balance. This occurs when a bank requires that a company maintain a minimum balance in its bank account during the period that a loan is outstanding or for other services provided by the bank .

Notes :

• Firms and people de-motivated to hold cash during inflationary periods (tend to spend cash not keeping it).
• Holding cash reduces liquidity risk but has an opportunity cost, which is return foregone if liquid cash is invested.
• Liquidity risk is the possibility that an investment can’t be sold (converted into cash) for its market value at a short notice.
• As a good substitute for holding cash, is investing it in treasury Bills, which is near cash item, highly liquid and risk free because it is guaranteed by U.S. federal government.
• As liquidity increases, risk and return decreases, and vice-versa. Thus when managing cash and short-term investments, the treasurer is primarily concerned with liquidity and safety (decreasing liquidity risk) Because sufficient liquidity must be available to meet payments as they come due.

Accordingly the ratio of cash and short-term investments (as marketable securities) to total assets is based on Risk-profitability trade-off consideration (i.e.) as this ratio increases risk decreases but profitability decreases and vice- versa.

Conclusion: A firm should attempt to minimize the amount of cash on hand while maintaining a sufficient amount to :

1. take advantage of trade discounts,
2. maintain its credit rating, and
3. meet unexpected needs.

So that Firms prepare cash budgets to make sure that they have adequate cash balances.