Lecture Notes on Treasury Management and Control

A firm’s cash when defined in a broader sense includes money in hand, demand deposits
and marketable securities (also referred to as cash or Cash equivalents).

Objectives of Cash Management

1. To make short-term forecasts about cash inflows and outflows of the firm ; i.e. Cash
Forecasting
2. To find out profitable avenues for investing surplus cash.
3. Arranging finance in case of cash deficit.

Motives behind Holding Cash :

(a) Transaction Motive: It reflects the need to hold cash to meet normal disbursement
and collection activities associated with a firm’s ongoing operations.

(b) Precautionary motive: According to the precautionary motive, firms need to hold
cash to meet contingencies in the future. The amount of cash to be maintained
depends upon the predictability of cash flows. If the cash flows can be predicted with
greater accuracy, less cash will be maintained for unforeseen contingencies and vice-
versa. The cash held for precautionary motives can be invested in high-liquid and
low-risk marketable securities.

(c) Speculation Motive: It reflects the need to hold cash to take advantage of additional
investment opportunities such as discount on purchases, attractive interest rates and
favourable exchange rates.

(d) Compensating Balances: In return for the services provided by banks, firms have to
maintain a minimum amount of compensating balance with the bank. This balance
results into blocking of certain amount of of cash which is known as compensating
balances.

Cash Forecasting and Budgeting

Cash budget is a vital tool used for planning and controlling cash receipts and payments.
A cash budget is a summary statement about the firm’s expected cash inflows and
outflows over a short period of time. With the help of the information given in the cash
budget, the finance manager can estimate the timing and magnitude of the expected cash
flows and can use it to determine the future needs of the firm; for planning the sources of
finance for these needs and for exercising control over the cash and liquidity of the firm.
The time horizon for which the cash budget is prepared varies from firm to firm.

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Firms that are affected by seasonal variations would usually prepare monthly budgets.
Firms whose cash flows are relatively unstable in nature and are affected by extreme
fluctuations prepare daily or weekly cash budgets.

Short-term forecasts will help in determining the cash requirements for a pre-determined
period by making projections about the expected cash flows. These forecasted figures are
used in the preparation of cash budget. The other utilities of short-term forecasts are:
(1) The short-term forecasts will enable the finance manager to adjust the differences in
the cash receipts and cash payments.
(2) They help in planning the investment of surplus cash in marketable securities.
(3) They help in choosing securities with appropriate maturities and acceptable levels of
risk.
(4) They help in planning short-term financing arrangements with banks and are useful in
determining the minimum and maximum balances to be maintained with the bank.
One of the commonly used methods of forecasting short-term cash flows is the receipts
and disbursements method.

Proforma of Cash Budget

Particulars January February March April

Opening Balance of Cash XXX XXX XXX XXX
Cash Inflows :
Sales XXX XXX XXX XXX
Receipts from Debtors XXX XXX XXX XXX
A. Total Inflows : XXX XXX XXX XXX
Cash Outflows :
Purchase of Raw Materials XXX XXX XXX XXX
Manufacturing Expenses XXX XXX XXX XXX
Loan Installment XXX XXX XXX XXX
B. Total Outflows XXX XXX XXX XXX
Closing Balance ( A-B) XXX XXX XXX XXX

Practical Problems on Cash Budget :

Q.1 The Following forecasts have been made for Bhanu Limited for the period January to
April 2019 :

Particulars January February March April

Sales Rs 75,000 Rs 105,000 Rs 1,80,000 Rs 105,000
Raw Materials 70,000 1,00,000 80,000 85,000
Manufacturing 10,000 20,000 29,000 16,000
Expenses
Loan Installment 1000 11,000 21,000 21,000

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Additional Information :
i) All Sales are made on credit basis; 2/3 of debtors are collected in the same
month and balance in the next month. There are no expected bad debts. The
debtors on January 1 2019 were Rs 30,000.
ii) The minimum cash balance, the firm must have is estimated to be Rs 5,000,
however, the cash balance on January 1 was Rs 6500.
iii) Borrowings, if any, can be made in multiples of Rs 100 only.
Prepare Cash Budget for the period of 4 month. (Ignore Interest on
borrowings)
Ans. Cash Balance: Jan: 5500 Feb: - 30500 March: 30,000 April: 13000

Q.2 Following is the sales forecast for first five months of the coming Year :
Month Sales
April Rs 40,000
May 45,000
June 55,000
July 60,000
August 50,000
Other Information :
1. Debtors and Creditors balance at the beginning of the year are Rs 30,000 and
14,000 respectively. The balance of other relevant assets and liabilities are :
Cash Balance – Rs 7500, Stock- 51,000 and Accrued Sales Commission Rs 3500
2. 40% Sales are on cash basis. Credit sales are collected in the month following the
sale.
3. Cost of Sales is 60% of Sales
4. The only other variable cost is a 5% commission to Sales agents. The Sales
commission is paid a month after it is earned.
5. Stock is kept equal to sales requirements for the next two months budgeted sales.
6. Trade Creditors are paid in the following month after purchases.
7. Fixed costs are Rs 5000 per month including Rs 2000 depreciation.
You are required to prepare a Cash Budget for the month of April, Many and June
Respectively.

Ans : Closing Cash Balance : April Rs 33,000, May Rs 37,000 and June Rs 44,750

Q.3 Prepare a Cash Budget for Juhi Limited on the basis of the following information for
the six months commencing from April 2016 :
i) Cost and Prices remain unchanged and firm maintains a minimum cash balance of
Rs 4,00,000 for which bank overdraft may be availed, if required.
ii) Cash Sales are 25% of the total sales and the balance 75% will be credit sales.
60% of credit sales are collected in the month following the sales, balance 30%
and 10% in the two following months thereafter. No Bad Debts are anticipated.
iii Sales Forecasts are as follows :

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Month Sales ( In Rupees) Month Sales ( In Rupees)
Jan 12,00,000 June 8,00,000
Feb 13,33,333 July 12,00,000
March 16,00,000 August 10,00,000
April 6,00,000 September 8,00,000
May 8,00,000 October 12,00,000

iv Gross Profit Margin 20%

v Quarterly Interest Payable Rs 30,000, Rent Payable Rs 8000 per month
vi Capital Expenditure expected in September is Rs 1,20,000
v Anticipated Purchases and Wages for the year 2016 are as follows :

Month Purchases ( In Rupees) Wages ( In Rupees)

April 6,40,000 1,20,000
May 6,40,000 1,60,000
June 9,60,000 2,00,000
July 8,00,000 2,00,000
August 6,40,000 1,60,000
September 9,60,000 1,40,000
Ans . Closing Balance : April 8.92 lacs, May 10.14,June 6.31, July 5.08 , August
7.30,Sept 4.52 lacs

Cash Reports:

Cash reports are prepared in situations where cash inflows and outflows do not fluctuate
much and the collection and payment patterns are stable. They help in comparing the
actual figures with forecasted figures and in controlling the deviations that exist. If the
fluctuations in the cash position are high, then the reports are prepared on a weekly and
sometimes even on a daily basis. The important categories of cash reports are:

1. Daily Cash Report: It provides information about the daily cash position. It
indicates opening and closing cash balances, payments made to creditors, repayments
of loans and other cash flows.

2. Daily Treasury Report: A daily cash report does not indicate the position of
accounts receivables, accounts payables and marketable securities. The daily treasury
report fulfils the requirement of presenting a comprehensive statement about the
opening, the closing and the net balances of cash, marketable securities, accounts
receivable and accounts payable.

3. Monthly Cash Report: It shows the cash receipts and payments over an entire
month.

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Factors for Efficient Cash Management: Cash management can be exercised
efficiently and effectively by keeping in mind the followings:

1. Prompt billing and mailing: Sometimes the reason for delay in remittance is the
time gap that exists between the date of preparing the invoice documents and the date
on which they are mailed to the customers. Firms should try to prepare the invoice
documents immediately after the dispatch of goods and should mail them to the
clients at the earliest.
2. Accelerating cash collections: Collections can be accelerated by reducing the lag
between the time a customer pays the bill and the time the cheque is collected and
funds made available for the firm’s use.

Float is an important technique used to reduce the length of the cash cycle. The time
gap between the date of writing a cheque and the date of its clearing is known as
float.
Float is of two types :

A) Disbursement Float : It is the time that elapses between the point when the firm
issues a cheque and the time at which the fund is actually debited from its
account. Disbursement float can also be calculated in terms of rupee.

Disbursement Float (in terms of Rs) = Amount of cheque issued in a day X

Disbursement Float (in terms of Days)

Disbursement Float (in terms of Balance) = Firm’s available Bank balance –

Firm’s Book Balance

B) Collection Float: It refers to the time gap between the receipt of cheque and
clearing of its amount in the bank account. Collection float can also be calculated
in terms of rupee.
Collection Float = Amount of Cheques received in a day X collection Float (in
terms of Days)
Net Float = Disbursement Float – Collection Float

Q. Gulati Limited issues Cheques of Rs 3000 Per day and receives cheques of Rs
2000 per day. The payment or disbursement float is 7 days while the collection float
is 2 days on an average. Find out different floats for the firms and comment.

Ans . Disbursement Float = Rs 21000 Collection Float Rs 4000

There are two techniques that are used by firms to reduce deposit float:

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 (i) Decentralized collection system: This technique is particularly useful for
large firms that have their business spread over a large geographical area.
The concept of concentration banking is used under this system. In
concentration banking, a firm operates through a number of collection
centres rather than from a single collection centre at the head office. This
minimizes the lag between the mailing time from customers to the firm and
the time when the firm can actually use the funds. Depending upon the
volume of billing, collection centres are established at the branches to collect
cheques from customers and deposit them in their local bank accounts. The
collection centre will transfer funds beyond a certain limit to a central or
concentration bank account, generally located at the head office, by wire
transfer, fax or electronic mail. Thus, a decentralized collection system
results in potential savings but it should be implemented only if the resultant
savings are more than the costs involved in implementing the system.

(ii) Lock-box system: This system helps in reducing the time lag between the
receipt of cheques and their deposit in the bank. Under this system, a number
of collection centres are established by the firm depending upon the
customer locations and volume of remittances. The firm hires a post office
box at each collection centre and instructs its customers to mail their
remittances to the box. The firm’s local bank is given the authority to pick
up the remittances directly from the box. The bank then deposits the cheques
in the firm’s account. The bank also prepares detailed records of the
cheques, which is then used by the firm for the internal accounting purposes.

Q. Shruti Limited is planning to set up a lock box system to expedite the cash
collection. With the help of following information suggest whether it should
install it or not ?
Average number of Daily Payments = 25
Average Size of Payment = Rs 4000
Savings in mailing time = 2 Days
Annual Rent of Lock Box = Rs 5000
Bank Charges for operating the lock box = Rs 36000
Rate of Interest = 15%

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 3. Controlling disbursements: The effective control of disbursements can also help
the firm in conserving cash. Disbursements usually arise due to trade credit which
acts as a spontaneous source of fund. The suppliers provide trade credit upto a
specified date. The firm will not have any substantial advantage if it makes the
payment before the agreed date unless a cash discount is being offered by the
suppliers for early payment. So it should try to delay the payments as much as
possible, which will imply availability of more funds. However, the firm should
remember that delays in making payments may sometimes adversely affect its credit
standing and it might face some problems in obtaining enough trade credit in future.
Hence while framing the policy for disbursements the firm should keep in mind the
terms offered by the supplier and the norms followed by the industry.
For a proper control over disbursements, the firm should follow a centralized system
in which the payment of bills is made from a single central account. Because of the
centralized system the transit time will increase for suppliers who are far from the
central account and the firm will gain by this delay.

4. Playing the float: When the firm’s actual bank balance is greater than the balance
shown in the firm’s books, the difference is called disbursement or payment float.
The difference between the total amount of cheques drawn on a bank account and the
balance shown in the bank’s books is caused by transit and processing delays.
Playing the float is a technique that is used to maximize the availability of funds. If
the finance manager can accurately estimate when the cheques issued will be
deposited and collected, then he can invest the ‘float’ during the float period to earn a
return. However, certain inherent risks are involved in playing the float. If the
clearing system of the bank operates at a faster pace than anticipated, the cheques
issued may come for payment earlier than expected and this would adversely affect
the image of the company. Such risks can be minimized by following certain
precautionary measures like:
 Maintenance of a minimum amount of cash with the bank.
 Avoiding the use of a larger proportion of the net float
 Having an overdraft arrangement with the bank in order to avoid financial
embarrassment.

5. Investment of Surplus Cash: The amount of cash in excess of the normal cash
requirement of the firm is referred to as surplus cash. Every firm maintains a
minimum level of cash termed as “safety level of cash”, which is different in normal
and peak periods. The minimum level of cash can be computed in the following
manner:

(i) Minimum level in normal period = Desired days of cash x Average daily cash
outflows
(ii) Minimum level in peak periods = Desired days of cash x Average of highest daily
cash outflows
The surplus cash amount can be arrived at by subtracting the safety level of cash from the
actual amount of cash with the bank. If the surplus cash is of a temporary nature then it
should be invested on short-term basis and if the surplus cash is of a permanent nature

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then it should be invested for a period ranging from six months to one year. The firm
should thus invest the surplus cash keeping in view the liquidity, security, maturity and
yield of the investment. The investment can be in treasury bills, G-Secs, Inter-Corporate
Deposits etc.

Optimum Cash Balance : Some Models

The Cash budget of a firm may indicate the period in which the firm may have a shortage
or surplus of funds. In case of expected shortage of funds, the firm may think of ways and
means to overcome it ; and in case of surplus explore the profitable options for parking
the surplus funds. However, before investing surplus into marketable securities, the firm
must determine the optimum cash balances for the firm.
The problem of determining optimum cash balance for a firm, implies a trade-off
between risk and return maintaining cash balance. There are several models which deal
with the problem of optimum cash balance. Two very important of them viz; Baumol’s
and Miller-Orr-Model are discussed as follows :

a) Baumol’s Model: Suggested by W.J.Baumol in 1952, this model of cash

management is the same as the EOQ of the inventory management.
The very assumption of this model is that the firm uses cash at an already known
rate per period and that this rate of use is constant.

Holding Cost: There is always a cost of holding cash by a firm. This cost may be
the opportunity cost of cash foregone by the firm. (Usually interest on cash)

Transaction Cost: Whenever the cash is converted into marketable securities or

vice-versa, there is always a cost involved in the form of brokerage, commission
etc.

This model is based on the proposition that in order to reduce the holding cost, a
firm keeps the least amount of cash in hand. However, as the level of cash
depletes, the firm can acquire cash by selling some of its marketable securities.
Each time the firm transacts this way, it bears some transaction cost, so it will
avoid frequent transactions. This can only be done by maintaining higher level of
cash involving a high holding cost.
Thus the firm has to deal with the holding cost as well as the transaction cost. The
optimum cash balance is found by controlling the holding cost and transaction
cost so as to minimize the total cost of holding cash.

2FT
C=
r

Where C= Cash Required each time to restore balance to minimum cash

F= Total Cash Required during the year
T= Transaction Cost
r = Rate of interest on Marketable Securities or Holding cost

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Limitations of Baumol’s Model :
1. It assumes a constant rate of use of cash which is not practical. Generally, the
cash outflow in any firm are not regular, hence it may not give correct results.
2. Measuring the transaction cost will also be difficult as it depends upon the type of
investment as well as the period of maturity.
In spite of these limitations, this model has a theoretical value as it gives an idea as to
how the holding cost and transaction cost should be optimized by the firm.

Q. Ashish Limited has a total cash requirement of Rs 500,000 per annum. It’s rate of
interest is 15% and for every transaction of marketable securities, the firm has to pay Rs
25. Calculate the optimum cash requirement of firm as per Baumol’s Model.

Ans. Rs 12,910

b) Miller-Orr-Model: Miller and Orr (1966) expanded the Baumol’s model which
was not applicable in case the demand for cash is not steady. As per this model, in
case uncertainty over cash flows is large, the inventory type model can not be
used.
This model argues that changes in cash balance over a given period are random in size as
well as in direction. The cash balance of a firm may fluctuate irregularly over a period of
time.
Assumptions:
1. Out of the two assets ;i.e. cash and marketable securities , the later has a marginal
yield, and
2. Transfer of cash to marketable securities and vice-versa is possible without any
delay but of course at some cost.

The model specifies two control limits for cash balance, an upper limit , ‘H’ beyond
which cash balance need not be allowed to go and a lower limit , ‘L’ below which the
cash level is not allowed to reduce. The cash balance should be allowed to move within
these limits.
If the cash level reaches the upper limit ‘H’ ,then a part of the cash should be invested in
marketable securities in such a way that the cash balance comes down to a pre-
determined level called the return level ‘R’. When the cash balance reaches the lower
level, ‘L’ then sufficient marketable securities should be sold out to realize cash so that
the cash balance is restored to the return level ‘R’. No transaction between cash and
marketable securities is undertaken so long as the cash balance is between the two limits
of ‘H’ and “L’.

3bV
RP= 3  LL
4I

Where RP= Return Point

b= Fixed cost per order of converting marketable securities into cash
V= Variance of daily changes in the expected cash balance or  2

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I = Daily Interest rate earned on marketable securities
LL = Lower Control Limit

UL = 3RP - 2LL

Where UL = Upper Limit

This model has superiority over Baumol’s Model because it is more realistic due to the
assumption that cash balance may fluctuate between the higher and the lower limits.

Forms of liquidity
Firms can maintain liquidity in the following ways:
(a) Cash balance: Maintenance of cash balance in current account is the highest form of
liquidity. But the percentage of cash balance in the current account should not be too
high as it does not yield any returns.
(b) Credit/overdraft arrangement: Maintaining a reserve drawing power under cash
credit/overdraft arrangement is a preferable option as it not only gives access to bank
borrowings but also provides tax-benefit on the interest payments.
(c) Marketable securities: Short-term securities like treasury bills with zero default risk
are a good way of maintaining liquidity provided their maturity matches with the
likely periods of excessive cash drain on the company. If the maturity of the securities
matches with the company’s requirements, the transaction costs can be minimized;
otherwise liquidation prior to maturity may result in low return from these securities.
(d) Inter-corporate deposits: These are deposits which a company makes with other
companies for a short period of time. However these deposits involve considerable
risk due to their unsecured nature.

Internal Treasury Control:

Structure of Treasury Department:
The structure of an organization and the designations differ from company to company.
Generally, an organizational chart appears as:

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 BOARD OF DIRECTORS

CHIEF EXECUTIVE OFFICER

VICE PRESIDENT VICE PRESIDENT VICE PRESIDENT

(PRODUCTION) (FINANCE) (MARKETING)

TREASURER CONTROLLER

DATA
CASH MANAGER CREDIT MANAGER TAX MANAGER
PROCESSING MANAGER

As shown in the above chart, the vice president (finance) coordinates the activities of the
treasurer and the controller.

Treasurer and his functions

The treasury department deals with liquid assets of the firm. It is the responsibility of the
treasurer to act as the custodian of cash and other liquid assets. Besides these functions,
the treasurer is also responsible for the formulation of an optimal capital structure,
framing of trade discount policies, establishing relationship with the bankers and
investors, and performing the role of an authorized signatory.

Controller and his functions: The controller of the organization has to record
transactions associated with the liquid assets. Apart from this, he is also responsible for
matters related to taxes and insurance, regulatory aspects related to company’s policy,
maintenance of records required for payroll preparation, etc.

Measuring the Performance of the Treasury Department:

In order to measure the performance of treasury we need to analyze the extent to which it
has achieved the goals of the firm. A goal is a future target set by an organization. In
order to be effective, goals should be challenging, attainable, specific, quantifiable, time
bound and relevant. After setting the goals, the finance managers should develop the
plans to achieve the goals. They should also analyze the costs and risks involved in
achieving the goals. In order to review the achievement of goals, the profits generated in
the current year should be compared with previous years. The performance of the
treasury can be maximized by constantly reviewing the progress of the company’s
policies.

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