SHAH SIR’S

ARIHANT COMMERCE CAREER ACADEMY

-a step towards excellence
Campus 1: C/o Mahatma Fule School, Mudholkar Peth, Amravati.
Campus 2: Raghunandan Terminal, Opp. Govt. Polytechnic,Amravati.

Class: - MBA 2nd 3rd SEM Subject:- Working Capital Management

Unit – Cash Management

Introduction
Cash is the lifeblood of a business firm; it is needed to acquire supplies, resources,
equipment, and other assets used in generating the products and services provided by the
firm. It is also needed to pay wages and salaries to workers and managers, taxes to
governments, interest and principal to creditors, and dividends to shareholders. More
fundamentally, cash is the medium of exchange, which allows management to carry on
the various activities of the business firm from day to day. As long as the firm has the
cash to meet these obligations, financial failure is improbable. Without cash, or at least
access to it, bankruptcy becomes a grim possibility. Such is the emerging view of modern
corporate cash management. On the other hand, marketable securities come in many
forms and will be discussed later, but their main characteristic is that they represent “near
cash” in that they may be readily sold. Hence marketable securities serve as a back up
pool of liquidity that provides cash quickly when needed. Marketable security also
provides a short-term investment outlet for excess cash and is also useful for meeting
planned outflows of funds.
In the previous units we introduced the general concepts associated with managing the
firm’s current assets and liability positions. In this unit, we look in more detail at the
problem involved with managing two very important components of current assets; cash
and marketable securities.
Aspects of Cash Management
Business analysts report that poor management is the main reason for business failure.
Poor cash management is probably the most frequent stumbling block for entrepreneurs.
Understanding the basic aspects of cash management will help you plan for the
unforeseen eventualities that nearly every business faces.
Cash vs. Cash Flow
Cash is ready money in the bank or in the business. It is not inventory, it is not accounts
receivable (what you are owed), and it is not property. These can potentially be converted
to cash, but can’t be used to pay suppliers, rent, or employees.
Cash flow refers to the movement of cash into and out of a business. Watching the cash
inflows and outflows is one of the most pressing management tasks for any business. The
outflow of cash includes those checks you write each month to pay salaries, suppliers,
and creditors. The inflow includes the cash you receive from customers, lenders, and
investors.
Motives for Holding Cash and Marketable Securities
Cash and short-term, interest-bearing investments, (marketable securities) are the firm’s
least productive assets. They are not required in producing goods or services, unlike the
firm’s fixed assets, they are not part of the process of selling as are inventory and
accounts receivable. When firms hold cash in currency or in non-interest-bearing
accounts, they obtain no direct return on their investment. Even if the cash is temporarily
invested in marketable securities, its return is much less than the return on other assets
held by the firm. So why hold cash or marketable securities at all? Couldn’t the firm’s
resources be better deployed elsewhere?
Despite the seemingly low returns, there are several good reasons why firms hold cash
and marketable securities. It is useful to think of the firm’s portfolio of cash and
marketable securities as comprised of three parts with each part addressing a particular
reason for holding these assets.
1. Cash for Transactions:
One very important reason for holding cash in the form of non-interest-bearing currency
and deposits is transactions demand. Since debts are settled via the exchange of cash, the
firm must hold some cash in the bank to pay suppliers and some currency to make change
if it makes sales for cash.
2. Cash and Near-cash Assets as Hedges:
Unfortunately, the firm’s future cash needs for transactions purposes are often quite
uncertain; emergencies may arise for which the firm needs immediate cash. The firm
must hedge against the possibility of these unexpected needs. Several types of hedges are
possible. For example, the firm can arrange to be able to borrow from its bank on short
notice should funds suddenly be needed. Another approach is to hold extra cash and near-
cash assets beyond what would be needed for transactions purposes. By “near-cash
assets,” we mean interest-earning marketable assets that have very short maturities (a few
days or less), and thus can be liquidated to provide funds on short notice with very little
risk of loss.
Clearly, the more of this total hedging reserve held in near-cash assets and the less held
in cash, the greater the interest earned. However, there is a trade-off between this interest
revenue and the transactions costs involved in purchasing and selling such near-cash
assets. These transactions costs have a fixed cost component; the firm bears these fixed
costs when it buys or sells these assets regardless of the size of investment. Thus, whether
it is economical to invest part or all of the hedging reserve in near-cash assets depends on
the amount of the reserve. Firms that keep smaller reserves (because their transactions
needs are either smaller or more certain) are more likely to hold these reserves in cash,
while firms with larger reserves keep them in near-cash assets.
3. Temporary Investments:
Many firms experience some seasonality in sales. Often, there will be times during the
year when such firms have excess cash that will be needed later in the year. Firms in this
situation have several choices. One alternative is to pay out the excess cash to its security
holders when this cash is available, and then issue new securities, later in the year when
funding is needed.
However, the costs of issuing new securities usually make this a disadvantageous
strategy. More commonly, firms will temporarily invest the cash in interest-earning
marketable securities from the time the cash is available until the time it is needed.
Proper planning and investment selection for this strategy can yield a reasonable return
on such temporary investment. All of these are valid reasons for holding cash and
marketable securities in response to the needs and uncertainties faced by the firm. In fact,
firms generally hold a surprisingly large portion of their assets in these forms, despite the
disadvantage of low returns.
Managing the cash flow
Components of Cash Flow
A “Cash Flow Statement” shows the sources and uses of cash and is typically divided
into three components:
1. Operating Cash Flow:
Operating cash flow, often referred to as working capital, is the cash flow generated
from internal operations. It comes from sales of the product or service of your business,
and because it is generated internally, it is under your control.
2. Investing Cash Flow:
Investing cash flow is generated internally from non-operating activities. This includes
investments in plant and equipment or other fixed assets, non-recurring gains or losses,
or other sources and uses of cash outside of normal operations.
3. Financing Cash Flow:
Financing cash flow is the cash to and from external sources, such as lenders, investors
and shareholders. A new loan, the repayment of a loan, the issuance of stock, and the
payment of dividend are some of the activities that would be included in this section of
the cash flow statement.
Managing the Cash
Cash management has assumed importance because it is the most significant of all
current assets. It is required to meet business obligations and it is unproductive when not
used. Cash management deals with the following:
1. Cash inflows and outflows
2. Cash flows within the firm
3. Cash balances held by the firm at a point of time.

Managing Cash Flows

After estimating the cash flows, efforts should be made to adhere to the estimates of
receipts and payments of cash. Cash management will be successful only if cash
collections are accelerated and cash disbursement, as far as possible, are delayed. The
following methods of cash management will help:
Methods of Accelerating Cash Inflows
1. Prompt Payment by Customer.
2. Quick Conversion of Payment into Cash.
3. Decentralized Collection.
4. Lock Box System.
1. Prompt Payment by Customers:
In order to accelerate cash inflows, the collections from customers should be prompt.
This will be possible by prompt billing. The customers should be promptly informed
about the amount payable and the time by which it should be paid.
It will be better if self addressed envelope is sent along-with the bill and quick reply is
requested. Another method for prompting customers to pay earlier is to allow them a
cash discount. The availability of discount is a good saving for the customer and in an
anxiety to earn it they make quick payments.
2. Quick Conversion of Payment into Cash:
Cash inflows can be accelerated by improving the cash collecting process. Once the
customer writes a cheque in favour of the concern the collection can be quickened by its
early collection. There is a time gap between the cheque sent by the customer and the
amount collected against it.
This is due to many factors,
(i) Mailing time, i.e. time taken by post office for transferring cheque from customer to
the firm, referred to as postal float;
(ii) Time taken in processing the cheque within the organisation and sending it to bank
for collection, it is called lethargy and,
(iii) Collection time within the bank, i.e. time taken by the bank in collecting the
payment from the customer’s bank, called bank float. The postal float, lethargy and bank
float are collectively referred to as deposit float.
The term deposit float refers to the cheques written by the customers but the amount not
yet usable by the firm. An efficient cash management will be possible only if the time
taken in deposit float is reduced and make the money available for use. This can be done
by decentralising collections.
3. Decentralised Collections:
A big firm operating over wide geographical area can accelerate collections by using the
system of decentralised collections. A number of collecting centres are opened in
different areas instead of collecting receipts at one place. The idea of opening different
collecting centres is to reduce the mailing time from customer’s despatch of cheque and
its receipt in the firm and then reducing the time in collecting these cheques.
On the receipt of the cheque it is immediately sent for collection. Since the party may
have issued the cheque on a local bank, it will not take much time in collecting it. The
amount so collected will be sent in the central office at the earliest. Decentralised
collection system saves mailing and processing time and, thus, reduces the financial
requirements.
4. Lock Box System:
Lock box system is another technique of reducing mailing, processing and collecting
time. Under this system the firm selects some collecting centres at different places. The
places are selected on the basis of number of consumers and the remittances to be
received from a particular place. The firm hires a Post Box in a post office and the
parties are asked to send the cheques on that post box number.
A local bank is authorised to operate the post box. The bank will collect the post a
number of times in a day and start the collection process of cheques. The amount so
collected is credited to the firm’s account. The bank will prepare a detailed account of
cheques received which will be used by the firm for processing purpose.
This system of collecting cheques expedites the collection process and avoids delays due
to mailing and processing time at the accounting department. By transferring clerical
function to the bank, the firm may reduce its costs, improve internal control and reduce
the possibility of fraud.