ASSIGNMENT OF MANAGEMENT

OF WORKING CAPITAL ON CASH

MANAGEMENT

SUBMITTED
SUBMITTEDBY:-
BY:- SUBMITTED
SUBMITTEDTO:-
TO:-
SHUBHAM SINGH
SHUBHAM SINGH PROF.
PROF. GEETIKAGROVER
GEETIKA GROVER
M.B.A-II
M.B.A-II
ROLL
ROLLNO.-21
NO.-21
CASH MANAGEMENT

Cash management refers to management of cash balance & the bank balance and also include
the short term deposits. The cash is obviously the most important current assets, as it is the
most liquid and can be used to make immediate payments. Inefficiency of cash at any stage
may prevent a firm from discharging its liabilities or force it sell its other assets immediately.
On the other hand , extreme liquidity may take the firm to make uneconomic investments.
This underlines the significance of cash management.

The term cash may be used in two different ways:

1) It may include currency, cheques ,drafts, demand deposits held by a firm i.e., pure
cash or generally accepted cash equivalents
2) In a broader sense, it also includes near cash assets such as marketable securities and
short term deposits with banks
For cash management purpose, the term cash is used in this broader sense i.e., it covers
cash , cash equivalents and those which are immediately convertible into cash.

OBJECTIVES OF CASH MANAGEMENT

The cash management strategies are generally built around two goals.

1.TO PROVIDE CASH NEEDED TO MEET THE OBLIGATIONS

2.TO MINIMIZE THE IDLE CASH HELD BY THE FIRM.

The financial manager of a firm has to strike a balance between holding too much cash & too
little cash. This is the focal point of the cash risk return trade-off .
This risk-return trade-off of any firm can be reduced to two prime objectives for the firm’s
cash management system , as follows:

1.Meeting the cash outflows:

   This is the primary objectives of cash management. Enough cash must be on hand to     
meet the disbursal needs that arise in the normal course of business. It means that the firm
should have sufficient cash to meet the payment schedules & disbursement needs. It will help
the firm  in meeting unexpected cash outflows without much problem &  availing the
opportunities of getting cash discounts by making early or prompt payments
2.Minimizing cash balance:

Investment in idle cash balance must be reduced to a minimum. The funds locked up is a
dead investment & has no earning. Therefore,whatever cash balance is maintained, the firm is
foregoing interest income on that balance.

However , the objectives of cash management i.e., maintaining the minimum cash balance
must be looked into together with other objectives i.e., maintaining the payment schedule
etc., which require that the firm must have the sufficient liquidity (even at the cost of
reducing profitability). But the objective of minimum cash balance affects the liquidity &
thereby increasing the profitability. Thus, these objectives seems to be contradicting in nature
& hence the financial manager has to achieve a trade-off between them. He ha to ensure that
minimum cash balance being maintained by the firm is not affecting the payments schedule
& meeting all disbursement needs. However, meeting payments commitments takes higher
priority than minimizing the cash balance.

METHODS OF PREPARATIONS OF CASH BUDGET

1.    The Adjusted Net Income Method:

It require that a pro-forma income statement should be prepared for each desired interim
period of the budget period. The net income figures for each period are then adjusted to a
cash basis by deleting the transactions that are affecting  the income statement but not the
cash balance or the items which affect then one without affecting the other. This adjusted
figure is taken as  cash profit (or loss) during that period. This is taken as net increase or
decrease in cash balance during that period.

2.The Pro-forma Balance Sheet Method:

It require the preparation of as many as pro-forma sheets as there are interim periods in the
cash budget. Each item of the balance except cash is projected for each period and the cash
balance is ascertained in accordance with the accounting equation i.e., Total Assets = Total
Liabilities + Capital. The balancing figure of the pro-forma balance sheets is taken as the cash
balance. A negative cash balance or a cash balance falling below minimum desirable balance
would, of course , indicate a need for borrowing funds or otherwise adjusting the flow to
make up the anticipated shortage of cash.

3.Receipt and payment methods of cash budget:

Cash budget, under this method, is a statement projecting  the cash inflows & outflows
(receipt & disbursements) of the firm over various interim period  of the budget period . For
each period, the expected inflows are put against the expected outflows to find out if there is
going to be any surplus or deficiency in a particular period. Surplus, if any, during a
particular period may be carried forward to the next period or steps may taken to make short
term investments of this surplus. Deficiencies, if any, must be arranged for within the same
period from some short term sources of finance such as bank credit etc.

While preparing the cash budget, the desired minimum cash balance is considered at the end
of the cash budget period. I f a firm is preparing  monthly cash budget , then the cash balance
at the end of each month must be equal to the desired cash balance. If not ,then arranged must
be made /planned  to increase  the cash balance at that time by procuring funds from some or
other source.       

IMPORTANCE AND SIGNIFICANCE OF CASH BUDGET

Cash budget is an effective tool of cash management and it may help the management in the
following ways:
a)    Identification of the period of cash shortage so that the financial manager may plan well
in advance about arranging the funds at an appropriate time.

b)    Identification of cash surplus position & duration for which surplus would be available
so that alternative investment of this excess liquidity may be considered in advance.

c)    Better coordination of the timing of cash inflows & outflows in order to avoid chances of
shortages or surplus of cash etc.

MOTIVES FOR HOLDING CASH

It has been suggested that there are four primary motives for holding cash.
These are as follows:

1)    Transaction motive:

Business firm as well as individuals keep cash because they require it for meeting demand for
cash flow arising out of day to day transactions. In order t meet the obligations for cash flows
arising in the normal course of business , every firm has to maintain adequate cash balance. A
firm may require cash for making for purchase of goods & services.
These cash outflows are met out of cash inflows arising out of cash sales or recovery from the
debtors. Further, the cash inflows & outflows are not fully and exactly synchronized, a firm is
always required to maintain a minimum cash balance with it. The necessity of keeping a
minimum cash balance to meet payment obligations arising out of expected transactions, is
known as Transactions motive for holding cash.
2)    Precautionary motive :

The precautionary motive for holding cash is based on the need to maintain sufficient cash to
act as a cushion or buffer against unexpected events. A firm should maintain larger cash
balance than required for day to day transactions in order to avoid any unforeseen situation
arising because of insufficient cash. The necessity of keeping a cash balance to meet any
emergency situation or unpredictable obligation, is known as precautionary motive for
holding cash.

The amount of cash, a firm must hold for transaction & precautionary depends upon;
a)    Degree of predictability of its cash flows

b)    Its willingness and capacity to take risk of running hot of cash, and

c)    Available immediate borrowing powers.          

3)    Speculative motive:

Cash may be held for speculative purpose in order to take advantage of potential profit
making situations. A firm may come across an unexpected opportunity to make profit, which
is not possible in normal business routine. The motive to keep balance for these purpose is
obviously speculative in nature. The firm’s desire to keep some cash balance to capitalize an
opportunity of making an unexpected profit is known as speculative motive. The speculative
motive provide a firm with sufficient liquidity to take advantage of unexpected profitable
opportunity that may suddenly appear ( and just suddenly disappear if not capitalize
immediately.)
4)    Compensation motive:

 Commercial banks require that in every current account , there should always be a minimum
cash balance. This minimum cash balance is generally not allowed by  the bank to used for
transaction purpose and therefore , it becomes a sort of investment by the firm in the bank. In
order to avail the convenience of holding a current account , the minimum cash balance must
be maintained by the firm and this provides the compensation motive for holding cash.

Out of different motives, the transactions motive is the most obvious one and is found in
every firm. Even the precautionary motive is common & a firm maintains cash balance both
for the transactions motives & the precautionary motive. However , the speculative motive is
a subjective one may differ from one firm to another. Generally, the speculative motive is the
least important component for a firm’s preference for liquidity. The transaction &
precautionary motives account for most of the reasons why affirm holds cash balance. The
compensation motive may be a compulsion and the firm may not have many options. The
cash held for transaction motive is necessary, the cash held for precautionary motive provides
a margin of safety, but holding a cash does not generate any explicit monetary return, rather it
involves a cost. The main cost of holding  cash is the loss of interest which the firm could
otherwise earn by investment of cash elsewhere

CONTROLLING ASPECTS OF CASH MANAGEMENT

After the preparation of cash budget, the financial manager should ensure that there are no significant
differences between the expected/budgeted cash flows and actual cash flows. This requires controlling &
reviewing of the whole exercise on a regular basis. The financial manager should take appropriate steps for
preventing any unexpected deviation in both the inflows as well as the outflows.
The efficiency of the firm’s cash management program can be enhanced by the knowledge and use of
various procedures aimed at

a)    Accelerating cash inflows b)    Controlling cash outflows

Controlling Inflows:

 The financial manager should take steps for speedy recovery from debtors and for this
purpose proper internal control system should be installed in the firm. Once the credit sales
have been affected, there should be a built-in mechanism for timely recovery  from the
debtors. Periodic statements should be prepared to show the outstanding bills. Incentives
offered to the customers for early payments should be communicated to them. Once the
cheques/drafts are received from  the customers, no delay should be there in depositing these
receipt with the banks. The time lag in the collection of receivables can be considerably
reduced by managing the time taken by the postal intermediaries and banks. Concentration
banking and lock box system help reducing this time lag .

A firm may open collection centers ( banks) in different parts of the country to save the postal
delays. This is known as concentration banking.  Under this system, the collection centers
are opened as near as to the debtors as possible, hence reducing the time in dispatch
,collection etc. The firm may instruct their customers to mail their payments to a regional
collection centers/bank rather to the central office. The concentration banking results in
saving of time of collection and hence in better cash management .

Under Lock box system,  customer mail their payments to a post office near their work
place. The firm arranges with a local bank or some other agency to collect the payments and
credit to the firm’s account as quickly as possible. The lock box system is economical only if
there is a relatively large number of  payments being received in particular area.

The concentration banking & the lock box system attempt to

i)    reduce the mailing time of the customer payments
ii)    reduce the time during which payments received remained uncollected
iii)    speed the movement of cash to the main office for disbursement.

Controlling Outflows:

An effective control over cash outflows or payments also help a firm in better cash
management and reducing cash requirement. A financial manager should try to slow down
the payments as much as possible. However, care must be taken that the goodwill and credit
rating of the firm is not affected. Payments to the creditors need not to be delayed otherwise it
may be difficult to secure trade credits at a later stage. There is no need to make early
payment unless there is discount offered. The credit facility allowed by creditors should be
fully utilized. The discount offered by creditors for prompt payments must be evaluated
properly in terms of costs and benefits of the discounts.

Balance lying in the bank account should also be managed as to take maximum advantage out
of it. There may not be a balance in the bank account when a cheques is issued but there must
be sufficient balance when the cheques is expected to be presented for payments. Thus
effective control of disbursement /outflows can result in larger cash balances.