CASH MANAGEMENT

INTRODUCTION After a firm has determined suitable policies and procedures for managing working capital, the next step is to manage three important constituents of working capital that is, cash, inventories and receivables. Cash is neither profit nor loss and hence, is not accounted for in the profit and loss account of a firm. Cash is one of the current assets which is always required for the smooth operations of a business. It acts as a common denominator to which all the current assets can be converted into. A minimal shortage of cash will create hurdles in the business operations. Yet cash is the most unproductive assets, as it yields nothing if it is lying idle with the firm. Hence, cash is considered as most significant yet least productive current asset. Management of cash is concerned with using the cash effectively and efficiently and also controlling its use in the business. This chapter will throw light on various aspects of cash management. MEANING OF CASH Two viewpoints are there as far as the meaning of cash is concerned. As per narrow point of view, the term cash signifies currency or equivalents of cash like cheque, drafts and demand deposits in a bank. The broader point of view of cash includes among others near cash assets like marketable securities and time deposits with a bank. These viewpoints reflect the degree of freedom in using the cash. Cash itself generates nothing but is a medium to generate other assets. MOTIVES FOR HOLDING CASH Cash is considered to be the lifeblood of a business. A business cannot be run without cash. Even a minor deficiency of cash can impede the business activities. Also cash as an asset yields nothing and has no earning power but still the firms keep a large amount of cash in hand or in bank. A business is required to hold cash for number of reasons. John Maynard Keynes has identified three basic reasons or motives for holding cash either by an individual or a firm. But recently one more motive has been added in the list. These basic motives are: 1. Transaction Motive: Every business needs cash for carrying out the routine activities like purchase of raw material, payment of expenses etc. To carry out various activities in routine life, a firm enters into number of transactions that involve the movement of cash in one form or another. However, the movement of cash that is, cash inflow on account of sale and cash outflow on account of purchases and other expenses are noon-synchronous in nature. Sometimes the inflow may be more than cash outflow and in some situations it may be viceversa. Also the cash flows can not be anticipated with certainty. So to ensure that a firm can meet its obligations on time, it is necessary that it should hold

sufficient amount of cash with itself. Thus, the requirement of cash to meet routine needs is referred to as transaction motive for holding cash. 2. Precautionary Motive: Due to non-synchronous nature of cash flows, sometimes a firm requires cash for certain contingencies as future is uncertain. For this, the firm may go for forecasting of cash flows but the forecast itself does not ensure 100% accuracy. The situations where a firm may need cash at short notice are like: Strikes, failure of particular customer, slow down of accounts receivables, increase in cost of raw material etc. Such contingencies usually arise in a normal course of business activities. Hence, a firm is always required to keep some cash for such situations. The cash balance held for such contingencies is termed as precautionary motive for holding cash or precautionary cash balance. It provides a cushion to the firm to meet the unexpected fluctuations. 3. Speculative Motive: This motive for holding cash relates to exploitation of opportunities whenever they arise. Always a firm desires to take advantage of the opportunities that may come up from time to time at unexpected moment and is not in the normal routine of business. This motive represents the aggressive attitude of the firm. The opportunities may be like: fall in prices of raw-material, interest rate movement speculation etc. A firm can exploit such opportunities if it has reserved cash for such purposes or extra cash is held over and above the normal requirements. 4. Compensating Motive: yet another motive for holding cash is compensating motive. Every business has a relation with the bank and they operate number of accounts. For providing the services, bank charges the fee. Such fee can be charged in the form when bank requires the customers to keep a minimum balance in the account that cannot be utilized for other purposes. Such balance is termed as compensating balance. It can be either absolute minimum like Rs1 lakh or it can be average minimum like Rs 1 lakh over a quarter. FACTORS DETERMINIG CASH NEEDS For keeping the cash balance with itself, a firm has to consider number of factors that will influence the size of cash balance. The factors that help in determination of cash balance are: 1. Synchronization of Cash Flows: The first and foremost factor that influences the cash balance with a firm is the study of alignment of cash flows. Since, we know that the cash flows are non-synchronous in nature; a firm is required to study the extent of non-synchronisation so as to make a decision regarding the balance of cash to be maintained. For this, a firm should make a forecast of cash flows for a particular time period. This forecast will help the firm in identifying the time of excess cash and deficient cash and accordingly it can decide about the cash balance.

2. Cash Balance Cost: Another factor that should be considered while determining the cash balance is the cost associated with it. The cash forecast will point out the time period of excess cash and cash deficiency and both the situation involve cost. Excess Cash balance: If a firm has excess cash with itself, then the cash is lying idle and generates nothing. It represents the notional loss of return that could have been earned if that excess cash balance could have been invested in some investment avenue. So, in case of excess cash balance, a firm will incur cost in the form of opportunity cost. Cash balance Deficiency: If the cash with a firm is less than the required, again the firm will incur cost. The cost will arise as a firm has to borrow the funds to meet the required gap involving borrowing cost or it may have to liquidate its marketable securities involving transaction cost. So, the cost associated with sort cash balance includes: borrowing cost, transaction cost, loss of cash discount (losing the opportunity to earn discount), deterioration of goodwill (not able to meet the obligations on time) etc. 3. Administrative Cost: A firm has to incur cost in terms of expenses incurred on cash management staff and other related activities like salary, storage etc. Such cost though fixed in nature should be considered while deciding about the cash balance. 4. Uncertainty: As we know that cash inflows and outflows are not synchronized and no one can predict the cash flows with accuracy, so the finance manager has to consider the effects of uncertainty while deciding the cash level. The uncertainty may result from a number of factors like slow down of payments by the customers, increase in default rate, increase in cash needs due to shoot up of demand etc. The impact of uncertainty can be reduced to some extent by having proper system of forecasting the cash flows and having the arrangements with the lenders so as to borrow the funds whenever the need arises. CASH CYCLE Cash is a factor that fuels value chain of a firm. It is used to acquire and support the other activities and shares in enabling their productivity. Like any of these factors, its availability for service constrains its utilityi.e., when it is not available, it cannot be adding value and therefore is simply waste. In layman terms, cash cycle refers to the time gap between the purchase of raw material and the accounts receivables realization. It is a metric that depicts the time a firm takes in order to convert the inputs into monetary resources, that is, realizing the sales. This metric considers the time needed to sell the inventory, the amount of time required to realize the receivables and the length of time the company is given to pay its bills without any impact on the profits and goodwill. In general, cash cycle measures the time gap between the cash outlays and cash inflows. It represents the number of days it takes a firm to purchase raw materials, convert it into finished goods, sell the finished product to a customer and receives payment from the customer. It can be calculated as:

Cash Cycle= DIO+DSO-DPO Where: DIO stands for days inventory outstanding DSO stands for days sales outstanding DPO stands for days payable outstanding It can also be represented as: Cash Cycle= Stock days + Debtor days Creditor days Where, Stock days represent stock turnover and is calculated as: (stocks cost of sales) 365 A debtor day represent the time involved in realizing the payments and is calculated as: (trade debtors sales) 365 A creditor day represent the time involved in making payments and is calculated as: (trade creditors annual purchases) 365 Cash cycle helps in analyzing the firms capability to convert its production into sales and realizing the cash. It is an important analysis tool that helps the analyst to determine why and when the business needs more cash to operate, and when and how it will be able to repay the cash. The length of the cash cycle indicates the amount that is required to be tied up in the form of working capital. The shorter the cash cycle, the less will be the capital tied up in the inventory. It means a firm can make use of the capital efficiently without having any need to keep excess cash in balance.

Length of Cash Cycle

Working Capital requirements

Cash Balance The cash cycle of a firm depicts how efficiently the value chain of a firm is. This is so because the longer the cash cycle, the more cash will be locked up and more will be the requirement of working capital. If a firm wants to optimize its cash cycle, it has to align its value chain.

Alignment of Value Chain and Cash Cycle Value Chain Components

Suppliers Supplies Raw material Indicates number of days the payable are not paid

Firm Convert Raw material into Finished goods Indicates number of days inventory is piled up Cash Cycle of a Firm

Customers Buys the finished goods Indicates number of days receivables are outstanding

How to Compute the Cash Cycle Method to calculate it Components of Cash Cycle Inventory Number of Days Cash is Locked-Up in the form of Inventory Average Rupee Value Inventory During the Reporting Period Average Rupee Value of Accounts Receivable During the Reporting Period (Cost of Goods Sold) / Number of Days in the Reporting Period)

Receivables Number of Days Cash is Locked-Up in Receivables

(Sales / Number of Days in the Reporting Period)

Average Rupee Value of Accounts Payables Number of Days Cash Is idle Payable During the with the firm because the Reporting payables are yet not paid Period

(Cost of Goods Sold / Number of Days in the Reporting Period)

To improve the cash cycle, a firm needs to begin internally. Start by reducing the inventory and increasing inventory turnover. This will speed up the cash cycle. Speed the invoicing process, reduce billing errors, speed response to overdue bills, and reduce the incidence of bad debts. Companies that receive cash from their customers at the time of sale and that have their stock under good control will have short cash days in the cash cycle. CASH: OPTIMUM BALANCE Cash is considered the base of every business but it generates nothing. Still, every business organization is required to keep cash with itself for the above mentioned motives. Cash is one of the liquid assets of a firm and protects the firm from chances of insolvency. One of the tasks of finance manager is to maintain sufficient level of liquid resources without affecting the companys solvency. In other words, the cash should be so maintained that enough liquidity is there with no risk of insolvency. But if cash is there with the firm, it means no return. Thus, the determination of optimum cash balance should be based on liquidity-return trade-off.

Cash Cash

Liquidity Liquidity

Firms Solvency and Firms Solvency and

Risk but Risk but

Returns Returns

The above given equation shows the trade-off between liquidity, risk and return. If a firm increases the cash to be held as balance, then the liquidity of firm increases. Also more liquidity reflects the capacity of a firm to meet its obligation on time, reducing the risk of insolvency. But greater the liquidity, more the idle cash and lower the returns. The opposite will hold true when the firm will decrease the cash balance. Further, the optimum level of cash balance can be decided with the help of study of cost involved in maintaining the cash. Also the help of EOQ model of inventory can be taken. Basically, two costs are involved in maintaining the cash balance. One is the transaction cost that will be incurred whenever the current assets are converted into cash or viceversa. The second is the holding cost or opportunity cost, incurred for maintaining a particular level of cash balance and losing the chance of earning return by investing the cash in an investment avenue. With the increase in cash balance, the transaction cost will come down as there is no need of converting current assets into cash and holding cost will increase because of more cash. So there is inverse relationship between level of cash and transaction cost but level of cash and holding cost shares direct relationship.

Cash balance Cash Balance

Transaction Cost but Transaction Cost but

Holding Cost Holding Cost

Algebraically, it can be shown as: Q = 2CB/K Where, Q = optimum level of cash C = Transaction cost B = Projected requirement of cash K = Holding cost or opportunity cost of maintaining cash balance

Graphically, the optimum level can be shown as below:

Total Cost Holding Cost E Cost

Transaction Cost

Cash Balance

The above figure depicts the point of optimum cash balance (E) where total cost of maintaining cash balance is lowest. MEANING OF CASH MANAGEMENT As we know that cash is one of the important yet unproductive current assets. It acts as a basic input which gives a momentum to the business. Hence, a firm is required to keep cash at a level where it should neither be excess nor deficit. Thus, one of the major functions of a firm is to manage cash. Cash management is the process of efficiently managing the three broad areas of cash viz. cash collection, cash disbursement and investment of surplus cash. The basic aim of cash management is to keep cash at such a level that sufficient liquidity is maintained and on the other hand, excess cash is being invested in order to earn returns. Basically, cash management deals with managing: Cash inflows and cash outflows Cash flows within a firm Cash balance decision, that is, investing in case of surplus cash balance and borrowing in case of deficiency The cash management of a firm can be represented in the form of cash management cycle as given below:

CASH MANAGEMENT CYCLE

Business Operations Cash Collections Information and control Cash Disbursement Deficit- Borrow cash Surplus- Invest Cash

The above figure depicts the cash management cycle of a firm. It starts with the first stage where the business operations are being conducted which involves purchase of raw material, incurring various expenses and selling the goods. Each business operation is being reported in the Management Information System of a firm. The impact of the business operations will be in two forms, either there will be inflow of cash in the form of cash collections or there will be cash payments or disbursements. The result will be a firm either will be in the position of cash deficit or surplus because the cash flows are non-synchronized in nature. If a firm faces cash shortage then the decision will be to borrow cash and if the firm has excess cash, then it will go for investment in various securities. OBJECTIVES OF CASH MANAGEMENT The basic objective of cash management is to mange cash in such a way that a firm maintains an adequate level of cash without having any effect on its liquidity and profitability position. The objectives of cash management are: 1. To keep optimum level of cash: One of the main objectives of cash management is to keep optimum level of cash by minimizing the cash balance. In order to achieve this objective, a firm has to go for the trade-off between liquidity and profitability. As keeping excess cash balance means less profits but good liquidity and vice-versa if the firm keeps low level of cash than required. 2. To meet cash needs: Yet another objective of cash management is to meet the commitments on time. A firm while conducting its operations, has to make payments to number of parties and on the same hand, it is getting cash from its customers. Keeping in view the cash inflows and outflows, a firm has to manage cash in such a way it should have sufficient cash to meet its payment schedule. A firm which will be able to meet its payments on time will enjoy good reputation in the market, ultimately resulting in good credit rating, the relations with the suppliers of raw material will improve and it can also earn cash discounts.

However, these benefits will be available only if a firm keeps sufficient or optimum level of cash, which never means excess cash. CASH SYSTEM OF A FIRM A firms cash system represents the framework reflecting the points of cash flows and the linkages between those points. The cash flow in a firm can be either the inflows or outflows representing the collection system in the former case and disbursement system in the latter case respectively. The collection system of a firm deals with the system of getting the cash into the firm while the disbursement system deals with the mechanism of payments to the outsiders. Within the collection and disbursement system lays the concentration bank. The basic role of a concentration bank is to enable the movement of cash from the collection system to the disbursement system so as to enable the smooth flow of cash. Basically, it is the central pool where excess cash is kept. All this requires the strong relationship of the finance manager with the representatives of all the component systems (generally banks) of cash system. CASH SYSTEM OF A FIRM

Customers 1 Collection point 1 Concentration Bank 3 Collection point 2 Disbursement point 1

Suppliers 1

3 Disbursement point 2 4

CASH COLLECTION SYSTEM The cash collection system of a firm refers to the methods and techniques adopted by the firm in order to get the payments from its customers. In other words the collection system is concerned with the methods leading to the flow of cash into the firm. When a firm makes sales, there arise accounts receivables or cash depending on whether it is cash sale or credit sale. The firm in case of cash sale will witness no problem. But the situation will be different where the sale is credit sale. In this situation, a firm has to ensure that a foolproof collection system is in place to extract the payments from the customers as

soon as possible without tampering the relationship. In case of payments by cheques, some time lag is there in converting it into cash. The collection system should be so designed that the overall time lag is reduced in realizing the payments and converting it into cash and on the same hand maintaining good relations with the customers. Another factor that should be considered while designing the collection system is that the overall cost should be minimized. The cost in collection system may be like mailing cost, bank charges, administrative cost etc. Thus, the overall objective of a collection system is to minimize the time lag, also referred to as Float and maximising value of the firm. DESIGNING CASH COLLECTION SYSTEM While designing the cash collection system of a firm, the focus should be on reducing the float. Basically a firm has to keep in mind the following factors like: Scale of firms operations Method of collection to be adopted Number of collection points required Location of collection points Operations of collection points Establishing the relationship between a particular collection point and a set of customers A strong Management information system Before starting with various collection systems, let us first of all understand what float actually means. FLOAT In narrow sense, float refers to the difference between the cash balance in the books of the firm and cash balance in the firms account with the bank. In other words, float is the difference between cash ledger and bank account of a firm. In broader sense, float includes not only the difference between the cash ledger and bank account but it also include the time lag between two points viz. the time when cheques is issued and the time when it is received. So, in broad sense, float is the combination of both the time lag and the amount difference. TYPES OF FLOAT 1. On the basis of Amount difference: On this basis, float is said to exist when there is a variation between the cash ledger and the bank account. In this case, two types of float can be there: Collection Float: It arises when a firm receives cheques. When a cheque is received, the amount is immediately added up in the account books but in the bank account, the amount will be shown when actually it has been received in cash from the customer. The moment you write the cheque and

the time the bank encashes it, there is a difference in book balance and the balance the bank shows in your account. That difference is float. Assume a company has a balance of Rs. 5, 00, 000 in cash ledger. Suppose a customer makes a payment by cheque of Rs. 50, 000 on 1 st January. The firm on receiving the cheques will add the amount in the cash ledger. But the cheques is realised on 4th January. So, between 1st and 4th January, the collection float will arise to the extent of Rs. 50, 000. It can be calculated as: Float= Bank account balance- Firms book balance = Rs 5, 00, 000- 5, 50, 000 = - Rs 50, 000 Disbursement Float: It arises when a firm issues a cheque for payment. Taking the same example as given above, suppose a firm has issued cheque worth Rs 50, 000. The disbursement float will arise because the firm will immediately reduce the amount in its books but in bank account it will not be reduced till the time cheque is being presented for payment. Float= Bank account balance- Firms book balance = Rs 5, 00, 000- 4, 50, 000 = Rs 50, 000 2. On the basis of time lag: On the basis of time difference, float again can be divided in two categories: Collection Float: It refers to the time difference between the point when the payment has been initiated and the time when cash is available in the bank account. Assuming that a firm receives cheques through mail from its customers, the float will include different sub-parts as shown below:

Customer mails the cheque

Firm receives the cheque

Firm deposits the cheque in bank

Amount available

Mail Float (External Float)

Processing Float (Internal Float) Deposit Float Collection Float

Availability Float or Clearance Float (External Float)

The above figure depicts the collection float. It starts with when the customer mails the payment through cheque. There is a time gap between the mail pint and the point when the firm receives the cheque. The delay

arises on account of mailing time and is referred to as mail float. On receiving the cheque, a firm will take some time to deposit it in bank. Here delay is on account of firms operations and is referred to as processing float. After the cheque has been deposited with bank, it will take time in clearance and the availability of funds in the bank account. So this time delay is termed as availability float. It is also referred to as clearance float. The delay on account of processing and availability is termed as Deposit float and all the three delays make up the Collection float. The mailing float and clearance float arises outside the firm on which firm has no control and is termed as external float while the processing delay is by the firm due to is internal operations and is termed as internal float. The float is calculated in terms of Rupee days. It can be measured in time period. Suppose that a customer mails the cheque of Rs 50, 000 but it took 5 days to realise the amount. So, collection float can be calculated as: Collection Float= Amount*Time involved = 50, 000*5 days =Rs 2, 50, 000 days Disbursement Float: It is the time lag when the firm issues the cheque and the time when it is being realised by the payee. The components of float will be same as we have assumed that it is a mailed payment system and payment is through cheque. The working will be same as that of collection float.

Firm mails the cheque

Supplier receives the cheque

Supplier deposits the cheque in bank

Amount available

Mail Float (External float)

Processing Float (Internal Float) Disbursement Float

Availability Float or Clearance Float (External Float)

TYPES OF COLLECTION SYSTEM 1. Over the counter Collection System: One of the basic collection systems followed by the firms is over the counter. In such a system, the payment is received from the customers in a personalized manner. It means face-to-face contact is there. The firms who have cash sales or where the business is concentrated at one place only generally adopt this system for collections. The payments are received at the point where services are being rendered. In this type of collection system, mail float will be nil and only deposit float will arise. This method is suitable for small firms having cash sales. However, all types of

payments can be accepted in this method whether it is cash payment or cheque payment. WORKING OF OVER THE COUNTER COLLECTION SYSTEM Customer makes payment

Firm receives the payment

Amount deposited in Bank

Information updated in MIS

The above figure depicts the working of over the counter collection system. It starts when a customer makes the payment to the firm in a direct meeting. On receiving the payment, it will be deposited in the bank and the information in the Management information system of the firm will be updated. In this system, only two delays, that is, processing delay and clearance delay will be there giving rise to deposit float. However, deposit float will further be reduced if the payment is in cash form rather than in cheque. It is so because the clearance time will be reduced in making the amount available in the account of the firm. 2. MAILED PAYMENT COLLECTION SYSTEM: The over the counter collection system is suitable for the companies that are operating at local level or for retailers having cash sales. But in case of companies operating at large scale having number of branches, over the counter system may not be advantageous. This is because most of the customers will make their payments in the form of cheque and they will mail the cheque, as it will not be possible to make the payment over the counter in this case. So, where the company is operating through number of branches, in that case, mailed payment collection system can be used. This system requires the allocation of different collection points for different set of customers where they can mail their payment. The selection of collection points will be decided after considering the customers in that area. From those collection points, the payment will be transferred to the local banks and from local banks to the central account of a firm. This system since is based on the assumption that payment is mailed, so it will include all the three floats viz. mail float, processing float and clearance or availability float. The working of mailed payment system can be depicted as follows:

WORKING OF MAILED PAYMENT COLLECTION SYSTEM

Customer 1

Customer 2

Customer 3

Customer 4

Payment Collection Point 1

Payment Collection Point 2

Deposit Bank 1 Bank 2

Deposit

Centralised Account Concentration Bank

Information updated Central MIS

The above figure depicts the working of mailed payment collection system. The working starts with allotting different collection centres to different set of customers. The customers will mail the payment to the concerned collection centre. The head of the collection point will deposit the payment on the local bank with which the account of the firm has been opened up. The excess cash balance will be transferred to the concentration bank that can be the centralised firms account and the information for each activity will be updated in the central management information system of the firm. 3. LOCK BOX SYSTEM: Yet another cash collection system is the lock box system. In this system, a firm hires the post office box. A specific number is allotted to these lock boxes and the customers are directed to send their payments to the specific lock box. Further, the arrangement is made with the bank in which a banks official is given the authority to operate that lock box. So the concerned bank can open the lock box and can get the payments, which will then be deposited, with the bank. In this case, the processing float arising on account of internal delays will be nil. This system also results in saving the firms time.

4. PREAUTHORIZED PAYMENTS: This system is used where the payments amount as well as date is being specified in advance. This system reduces the mail float as the customer deposits the pre-signed cheques with the firm. As the date comes, the firm can deposit the cheque with the bank for realizing the amount. 5. ELECTRONIC FUNDS TRANSFER: In this type of collection system, rather than receiving the payment in physical form, the payment is routed to the firms bank in the electronic form and immediately the account will be credited. 6. CONTRACTING OUT: In this type of collection system, a firm rather than having its own system for cash collections, hires an outside agency, may be even bank for monitoring and accepting its collections. As soon as the payment is received, immediately the information will be provided to the firm. This system however, suffers from the drawback that the firm cannot go for monitoring its customers and credit information might not be available. WORKING OF CONTRACTING OUT COLLECTION SYSTEM
Collection Agency Information sent regarding the collections Deposits the payment Communication sent Local Bank

Central MIS of the firm

Amount credited in firms account Firms Account Information updated

The above figure depicts the working of contracting out collection system. It starts where the collection agency receives the payment from the customer. The payment is deposited in the bank and information is provided to the firms MIS. On receiving the payment by the bank, the bank informs the firms MIS. As soon as the firms account is updated, the information is again sent to the firms MIS. DISBURSEMENT SYSTEM The disbursement system of the firm operates on the same level as the collection system depending that whether it is centralised or decentralised.

1. CENTRALISED DISBURSEMENTS In this method rather than keeping the minimum cash balance in number of banks, it is kept only in one bank from where issues are made. In this way, the firm is required to keep low level of cash balance with itself.

Supplier 1

Transfer of funds Concentration Bank

Issuing cheques and making payments Supplier 2

Disbursement Bank

Supplier 3

The above figure represents the process of centralised disbursements. The process starts where the funds are transferred from the concentration bank account of the firm to the central disbursement bank. Then the cheques will be issued to the suppliers. Once the suppliers receive the cheques, they are presented for payment and after getting cleared the amount will be transferred to the suppliers account. The advantage of this system is that this whole process will take more time and for the time being, the firm can use the cash, as it will be transferred only when the firm expects the cheques to be presented. The result will be that firm is not required to keep excess cash balance with it and excess cash can be used more efficiently for other activities. 2. DECENTRALISED DISBURSEMENTS In this method of disbursements, a firm keeps account with number of banks rather than having one account. This method is generally adopted where the firm is operating through number of branches in different areas.

WORKING OF DECENTRALISED DISBURSEMENT SYSTEM

Supplier 1 Cheque presented & realised Disbursement Bank 1 Cheques issued Local Issuing Bank 1

Supplier 2 Concentration Bank Cash transferred Supplier 3 Cheques presented & realised Disbursement Bank 2 Cheques issued Local Issuing Bank 2

Supplier 4

The above figure depicts the working of disbursement system when it is decentralized. The systems working starts with the transfer of funds from the concentration bank to the disbursements banks for the payments to be made. The local issuing banks will issue the cheques to their respective set of suppliers. The suppliers on the due date will present the cheques to their disbursement bank for realizing the payments. The basic drawback of this system is that the cash has to be kept in the disbursement banks as the system is decentralized and it will increase the balance of cash to be held with the firm. MANAGING CASH FLOWS OR CASH MANAGEMENT STRATEGIES In order to manage the flow of cash and ending up with an adequate level of cash, a firm is required to adopt some strategies by managing its cash cycle and cash turnover. Cash turnover is the number of times cash is being used in a year. The aim of the cash management strategies is to minimize the cash balance with a firm. If the cash turnover of a firm is high, then lower will be the cash balance and vice-versa.

Cash Turnover Cash Turnover

Cash Balance Cash Balance

Some of the basic strategies that a firm can adopt in order to manage cash are: 1. Speeding up the Cash Collections: The first strategy that a firm can adopt in order to manage its cash is to speed up its cash inflows. The impact of speeding up the collection process will ultimately result in maintaining low level of cash. It can be made clear through following relation:

Speeding Up Collections a firm Cash Turnover

Accounts receivables period Cash Balance

Cash Cycle of

Number of techniques and methods can be employed in order to fasten the collection process of the firm. Some strategies to speed up the collections by a firm are: o Ensuring prompt payment by the customers: A firm in order to ensure prompt payment from its customers should take some steps like regularly informing the customers about the due dates of payments and offering some schemes like cash discounts. Offering a cash discount will act as an incentive for the customers and payment can be extracted quickly from them. Further, the firms can make use of computerized billings in order to avoid any delays. o Ensuring control over Deposit Float: A firm has to exercise strict control over its deposit float that is; it should avoid the processing and availability delay in converting the payments into cash. Since there is a time lag between the times a customer makes the payment and its deposit in bank along with the availability in firms account, a firm should ensure that as soon as the payment from the customer is received, it is being deposited in bank without any delay.

o Decentralised Collection system: Generally, a firm that is operating at a wide scale having number of branches should go for decentralised collections in order to speed up their collections. It can open up number of collection centres in order to avoid the mailing delay. As soon as the payment will be received at a collection point, immediately it will be routed to the bank, thereby reducing the chances of deposit float. This is because, the cheques received at a local collection pint will be deposited in the local bank account and from there the surplus will be transferred to the concentration account of the firm. The decentralised system helps in reducing the mailing as well as deposit float and the firm can quickly convert the payments received into cash. o Lock Box system: It is yet another technique for reducing the mailing and deposit delays. In this technique, the customers are asked to mail their payments to post office boxes that are hired by a firm. A local bank is authorized to operate those lock boxes. The payment will be collected the bank itself from the lock box and the amount will be credited in the firms accounts. 2. Slowing down Cash Disbursements: Another aspect of cash management strategies deal with the methods that a firm can adopt to slow down its cash outflow. It is also referred to as Stretching Accounts Payable. It means a firm should try to make its payments as late as possible without damaging its reputation. The impact of slowing down the payables can be depicted in the form of following relation:

Stretching Accounts Payable Cash Balance

Cash Cycle of a firm

Cash Turnover

Some of the methods for avoiding early payments or to delay payments are: o Rule of 2-10/Net 30: This rule represents the credit terms of a firm. In this rule, 2 represents rate of cash discount, 10 is cash discount period and 30 is the credit period. If a firm has lost the opportunity to avail cash discount that is payment was not made within 10 days, then it is advisable for the firm to pay on 30th day as it will not make any difference then that whether the payment is made on 11th day or 30th day. In this way, the firm can make use of the cash for the time gap, which will reduce its dependence on external sources. o Centralised Disbursements: In order to delay the payments, the firm can adopt the method of centralised disbursements. When the payment will be initiated from the central system, then it will involve mailing delay and

disbursement delay as well. So, the firm can take the benefit of delay and can use the cash for the time being. o Payments through Drafts: A firm should make payments through draft because it is not payable on demand rather its presentation is must. When draft is presented to the issuer, only then the issuer deposits the funds. So, actually it takes number of days for getting cleared. o Payroll Management: Another method to slow down cash outflow is to adjust the payroll on the basis of the past experience of the firm. A firm has to forecast that when the payroll cheques will be presented for payments, accordingly cash can be transferred. o Playing the float: Yet another method is to play the float. A firm knows that there is a time gap between the point when the cheques are issued and the point when it will be presented for payment. A firm may issue cheques even when the bank balance is low, as it knows that the amount will be required after a time gap only. This is based on the experience of the firm regarding cheques encashment analysis in the past. In this way, a firm can make use of float to manage its cash. 3. Efficient Inventory Management: Yet another strategy to manage the cash is to have efficient inventory management system in place. A sound inventory management means increasing the inventory turnover ratio, thereby reducing the need for cash. The relation can be depicted as:

Efficient Inventory Management Cash Turnover

Inventory Period Cash Balance

Cash Cycle

4. Combination of Strategies: At last, a firm can at the same time, can go for a different combination of strategies to manage cash.

INVESTMENT IN MARKETABLE SECURITIES The function of Finance manager does not end with just arranging the funds as per the requirements but he has also to ensure that the funds are being utilized properly. The decision to invest in marketable securities is one of the responsibilities of the Finance manager. The firms while deciding the cash balance to be maintained always focus on the aspect that the resultant balance is the optimum level of cash. That is, the firms should end up neither with more nor with less cash balance. This is so because the cash if it is in excess will be lying idle with the firm and would generate nothing. However, by investing this excess cash, firms could earn a return by investing it in different investment avenues. At one end, it can be invested in government securities or in the form of fixed deposit with the bank as it is a risk-free investment with moderate return and on the other hand, it can be invested in stock market offering high risk and high return. A large number of other investment avenues lie within these two categories that can ensure the safety of investment along with promising a good rate of return. Such investment avenues are termed as marketable securities. MEANING OF MARKETABLE SECURITIES Marketable securities are short-term investment avenues that provide a good rate of return on the temporary idle funds. In other words, these securities are termed marketable as they can be converted into cash within a short time period and vice-versa. A ready market is available to deal in such securities. To be termed a security as marketable security, two characteristics should be there viz. ready market and liquidity. Ready market means that whenever a security has to be converted into cash or vice-versa, minimum time will be involved and liquidity ensures the safety of investment amount on the conversion without a little or negligible loss. SELECTION CRITERIA A major decision that a Finance manager has to take is the decision regarding the cash and marketable securities mix. For deciding the cash balance percentage, number of models has been devised. However, the decision in general will be influenced by the liquidity and profitability trade-off of keeping cash. Once a decision has been taken to go for investment in marketable securities, then another problem area arises that is the selection of portfolio. While selecting the portfolio of marketable securities, due consideration is required to be given to certain key variables that are related to specific marketable security. Some of the key variables are: Safety: The first key variable that every marketable security should possess is the safety of investment. It means ensuring that at least the amount originally invested will be realised either at maturity or sale. From the safety point of view, government dated securities are considered more safe. However, another fact that has to be kept in mind is that the return on safe investment avenue is always low as compared to risky investment. So a firm should go for risk-return trade-off while selecting the safe investment avenue.

 Liquidity and Marketability: It is the basic feature of marketable security. One of the basic reasons of investment in marketable securities is that it can be converted into cash whenever the need arises. While choosing the portfolio of marketable securities, the finance manager should consider the amount of liquidity that the particular security will offer at the time of need or maturity. It will depend on the market type, time involved in conversion of security into cash and vice-versa and the expectation of selling the security at market price. Maturity: Yet another factor that should be considered while selecting the marketable security is the maturity period of the instrument. Generally, greater the maturity period, more will be the yield and at same time will also have more exposure to risk and vice-versa in case of short maturity period instrument. Risk: It is one of the most important factors that affect the decision to select a particular marketable security. It refers to the degree of uncertainty associated with realizing the expected rate of return. The risk may be the financial risk or interest rate risk. In the former case, the risk arises from the issuers side that whether he will be able to repay the amount on time while in later case, the risk arises due to change in interest rates. Yield: Considering all the above factors will give the result that is the yield on investment in a particular marketable security. In general, it is the interest earned by investing the amount. Calculating yield involves the study of both the risks as well as the benefits associated with a particular security. MARKETABLE SECURITIES OPTIONS OR ALTERNATIVES This section throws light at the options to park the surplus funds in the marketable securities or the various marketable securities alternatives that can be tapped to earn return by investing the temporary idle funds that are lying with the firm. 1. Treasury Bills: It represents the short-term obligations of the government. These do not carry any interest rate rather are issued on discount basis and are redeemed at par value. The return to the investor is the difference between the purchase price and the redeemed (face value) value. These are considered as the safest marketable security as they have the governments backing. The treasury bills are issued in bearer form means that the name of the investor is not mentioned on the security. Due to this, they can be easily negotiated. A very active secondary market exists for these bills which provide a good marketability to such securities. Thus, these securities are for those investors who want their investment to be riskfree. This security symbolizes the feature of low risk and row return. 2. Negotiable Certificate of Deposits: It is another short-term investment option that originated in the year 1961. It represents the receipt of funds that have been

invested or deposited in a bank for a fixed period getting a fixed or floating rate of interest. Generally fixed rate of interest is earned. This receipt is negotiable in nature. The deposits are tailor made that is the denomination of the deposit and the maturity varies with the needs of the investors. However, in order to be negotiable, some banks specify the minimum denomination of such deposits. But these are not considered safe as the degree of safety will depend on the reputation that a bank holds in the market. Thus, it involves comparatively high risk. The certificate of deposits can be domestic or international. If a bank issues these in domestic market, then theses are termed as domestic certificate of deposits. If suppose, a US dollar denominated certificate of deposit is issued in foreign country, it will be termed as Eurodollar certificate of deposits. 3. Commercial Papers: It is a short term, unsecured promissory notes issued by the large business houses that enjoy good reputation in the market and that are considered financially strong. Generally, the companies having good credit rating go for such an issue. They are sold at discount and redeemed at par. They can be sold by the issuers directly or through the dealers. If issued through dealers, they are termed as Dealer papers. However, no formal secondary market exists for such instrument. 4. Mutual Funds: These securities are issued by professional organisations that pool in the money and invest it in a portfolio of securities. These can be open-ended or close ended. Further, they can run into equity schemes, debt schemes or a combination and like. These funds proved good rate of return with moderate level of risk. 5. Bills Discounting: Bills of exchange are negotiable instruments and represent a bill draw by the seller on the buyer for the transaction amount. These may be payable on demand or after the fixed time period. On acceptance by the buyer, the bill may be presented to the bank for payment by the seller before time, if he is in need of money. However, these bills again depend on the credit worthiness of the parties involved. 6. Inter-corporate deposits: It represents the short term investment by one company in another company. The maturity period may vary from three days to six months. However, this investment option is an unsecured investment and the investor has to ensure the creditworthiness of the company. Thus, this investment option involves high degree of risk. 7. Repurchase Agreements: It is a contract between the borrower and the lender whereby the borrower commits to repurchase the securities from the latter after some time at the decided price. There is a limited marketability in this case. However, there is a security that the repurchase price is fixed in d\advance and the borrower is free from market risk. 8. Bankers Acceptance: It represents the draft drawn on a specific bank by the drawer, generally exporter. The bank on accepting the draft promises to pay the holder a stated amount at the maturity period. It may be discounted before the

maturity period in case of need. Accepted drafts by banks are negotiable instruments and are considered of high quality since they have the backing of the concerned bank.

STRATEGIES FOR MANAGING SURPLUS FUNDS Keith V. smith has given some strategies that should be adopted while managing excess cash with a firm. 1. Do Nothing: The first strategy is to do nothing and to accumulate the cash. It will enhance the liquidity position of the firm. This strategy basically deals with improving the liquidity position of the firm. It means that firm place more importance to liquidity rather than earning profits on the excess idle cash. 2. Go for Ad Hoc Investments: As per this strategy, the financial manager rather than keeping the excess funds in cash form should go for some sort of temporary investments where some return could be earned rather than maintaining the liquidity only. Here, the study for investments is not made in detail. 3. Ride the yield curve: The focus of this strategy is to get good returns from investment in the marketable securities. Thus, a financial manager has to make a thorough study of the market and the investment options while choosing the portfolio. Also he needs to be continuously analyzing the market movements in order to maximize the returns from the investments. Likewise, the decision to purchase or sell the securities can be taken keeping in view the interest rate movements but the ultimate aim is to maximize the yield on investments. 4. Formulate Guidelines: A firm may formulate certain set of guidelines regarding the investment decision and risk as well as return. Like, no speculation on interest rate movements, minimize the cost of transaction etc. 5. Establishing and relying on the control limits: While deciding the cash balance that a firm should hold, a finance manager may utilize number of models. Some cash models do specify the fixing of upper and lower limit of cash with a firm. A firm should try to establish the higher and lower limit of cash beyond which it should not be allowed to increase or decrease as the case may be. If cash moves towards upper limit and touches it, it means cash balance is increasing and firm should invest the excess cash. While in the opposite case, the firm should sell the securities to bring the cash to the desired level. 6. Having sound Portfolio Perspective: While selecting a portfolio of securities, an analyst should consider the efficient frontier and optimal portfolio. The efficient frontier implies set of efficient portfolio, that is, no alternative with same return but low risk or same risk with high return or high return with low risk. A portfolio is optimal if it lies on efficient frontier that is the tangency point of efficient frontier and indifference curve. 7. Follow mechanized system: A finance manager should use some models for deciding the cash and marketable mix. The above mentioned strategies can be used by the firm in order to manage the surplus funds and maximising the returns.

SUMMARY
Cash is the life blood of a business. Cash is considered the most liquid current assets but at the same time it is one of the least productive assets. Cash lying idle with the firm generates nothing. The basic motives to hold cash are: transaction motive, precautionary motive, speculative motive and compensating balance motive. Keeping cash involves both the positive aspects as well as negative aspects. The positive side is that a firm will enjoy sufficient liquidity but negative side is that it will earn no returns on the cash kept as balance. So, a firm should consider number of factors while deciding the optimum level of cash balance. Cash management involves the efficient management of cash flows and the decision to find out the optimum balance. It is considered as one of the important aspect of working capital management. The objectives of cash management is to minimize the cash balance and on the same time to ensure timely payments to its customers. Cash Management deals with designing the collection and disbursement systems and also to manage the cash flows. In designing the collection and disbursement systems, a firm has to consider one most important factor that is Float. It represents the difference between the account books of a firm and the bank account. It also represents the time delay between two points. The collection system of a firm refers to the method employed to get the payments from its customers. It can be in the form of over the counter, mailed payment system and lock box system. The disbursement system refers to the route followed by a form to make payments to the suppliers or others like employees. It can be in the form of mailed payment system, centralised system etc. Cash Management deals with the strategies that a firm should adopt to minimize the cash balance by speeding up the collections and slowing down the disbursements. Some methods to speed up the collections are like decentralised collections, use of lock box etc. Slowing down payments can be achieved through centralised payments, cheques encashment analysis, adjusting payrolls, playing the float and like. Further it should be supported by the efficient system of inventory management. The last aspect of cash management that was covered was to mange and invests the excess cash in marketable securities. While selecting the investment option, due consideration should be given to some factors like safety of amount, risk involved, interest etc. Number of investment options is there like commercial papers, treasury bills, negotiable certificate of deposits, repurchase agreements and others. The selection will depend on the portfolio offerings and the needs of the investor. The core of cash management lies in the fact that a firm should keep optimum level of cash without negatively influencing its liquidity, profitability and credit rating.

REFERENCES 1. Bhalla, VK, Working Capital Management, Anmol Publishers. 2. Chandra, Prasanna, Financial Management. 3. Keith V. Smith, Working Capital Management, Mc-Graw Hill Publishing Company, 1979. 4. Khan, MY and Jain, PK, Financial Management-Text and Problems, 3rd edition, Tata Mc-Graw Hill Publishing ltd., New Delhi. 5. Maheshwari, S.N., Financial Management- Principles and Practice. 6. Pandey, IM, Financial Management. 7. Van Horne, James C., Financial Management and Policy, 12th edition, Pearson education.

REVIEW QUESTIONS
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. What is the difference between cash and profit? Define cash. What are the motives for holding cash by a firm? Identify the factors the influence the decision of a firm to keep a particular level of cash balance. Illustrate the liquidity and profitability trade off while determining the cash balance. Define cash management. What are the objectives of cash management? Define the concept of float. Illustrate with example. Explain the cash system of a firm through an example. Define concentration bank. What role does it play in the cash system of a firm? Briefly outline the factors that have to be kept in mind while designing the collection and disbursement system. Explain various collection systems. Identify which system is best and why? Design a collection system for a firm having its branches all over India. Explain the working of lock-box system. Can this system be operationalised in the present scenario? Explain various disbursement systems in detail. What are the various cash management strategies? Explain in detail the strategies to speed up the cash collections. Explain how a firm can play the float to manage its cash. Define marketable securities. What are the factors that have to be considered while selecting the marketable security? Explain various marketable securities. Which is the best among all? Do you think that it is possible for a firm to operate with no cash or no marketable securities? Why? Explain the working of float.