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Cash Management
Cash CycleFactors that influence the desired level
of cashOptimal cash inventories
Short-term investment strategies
The Manager
Resource Decisions
Information Decisions
Financing Decisions
Investment Decisions
Human ResourcesDecisions
Managing an entity’s Resources
Cash ManagementInventory ManagementWorking Capital ManagementInvestment in Human CapitalLong-term AssetsAccounts Receivable
Economics of InformationDatabase ManagementData ModelingIS Planning & Development
Debt vs. Tax Financing Cost ofCapital
Discount Rate
Value Creation
FinancialMarkets
Cash Inflows
OperatingDecisions
Recruitment, SelectionTraining, ProductivityPerformance AppraisalCompensationUnions & Labor Relations
Life cycle effects,Business cycle, public events,etc.
Overview
ST fin’l planning = deals w/ short-lived assets and liabilities (working capital management);
concerned w/ 1) size of investment in CA like cash, A/R, Inventory…a tool is cash budget analysis and 2) how to finance ST assets…a tool is performing credit analysis
Managing WC involves determing:
• How much to invest in CA?- CA vs. FA- Nature of activities/programs
• In each CA?- Cash, A/R, Inventory
- Cash Mgt- A/R is Credit Mgt- Inv = POM & Cash balance
models
Our objectives
• Learn about the Cash Cycle• Understand the factors that influence the
desired level of cash• Learn two models that calculate the optimal
level of cash• Gain an overview of what factors/areas are
inputs to a cash budget and how they affect the cash balance
Objectives of Public Money Managers
Bringing the entity’s cash resources within controlAchieving optimum conservation and utilization of the funds
Key areas of Public Cash Management
OrganizationCollection and disbursement of fundsNetting of interagency paymentsInvestment of excess fundsOptimal level of cash balancesCash planning and budgetingBank relations
Treasury Management of Cash Balances
Operate with smaller amount of cashSupervision is centralizedBetter service from banksProper allocation of funds
How much cash should a organization keep on hand?
• Enough cash to make payments when needed. (transactions motive)– (Daily or Weekly Cash Budget helpful)
• Additional cash may be held for unexpected requirements. (precautionary motive)
The size of the minimum cash balance depends on:
• How quickly and cheaply a organization can raise cash when needed.
• How accurately managers can predict cash requirements.– (Cash Budget helpful)
• How much precautionary cash the managers need for emergencies.
The organization’s maximum cash balance depends on:
• Available (short-term) investment opportunities– e.g. money market funds, CDs, commercial paper
• Expected return on investment opportunities.– e.g. If expected returns are high, organizations should
be quick to invest excess cash• Transaction cost of withdrawing cash and making
an investment • Demand for Cash for daily transactions
– (Cash Budget helpful)
Consider Cash an ‘Inventory’
Grantsville has a daily demand for cash of $10,000.Grantsville’s treasurer invests excess cash in the state investment pool that earns .01% per day. In order to transfer funds from the state pool, Grantsville must pay a transaction cost of $20. How much cash should it transfer when it runs out. (Grantsville can complete the cash transfer electronically so it waits until the cash balance is zero).
An inventory approach to CashBalance decisions:
the trade-offs: - hold little cash = invest remainder in M/S to earn interest
- if hold too little cash = incur transactions costs to meet cash needs
- hold lots of cash = forgo investing in M/S and earning interest
50000000 1002 504 339.3333333 258 210
Order Quantity (Z)
Cost ($)
Z*
Total Costs
Holding Costs: (Z/2)*r
Order Costs:(M//Z)*TC
Optimal Cash Balance via Baumol Model
Z*Z*= [(2M*TC)/r]
M = $10,000 r = .01% .0001 TC = $20
Z = $63,246
Problems with the Baumol Model
• Cash flows may not be very predictable, much less constant
• Treasurers may want a ‘safety stock’ of cash
The Miller - Orr Model
• The Miller-Orr Model provides a formula for determining the optimum cash balance (Z), the point at which to sell securities to raise cash (lower limit L) and when to invest excess cash by buying securities and lowering cash holdings (upper limit H).
• Depends on: – transaction costs of buying or selling securities– variability of daily cash (incorporates uncertainty)– return on short-term investments
Days of the Month
Dol
lars
in th
e C
ash
Acc
ount
The Miller - Orr Model
Lower Limit
Upper Limit
Z
Sell Securities
Buy SecuritiesH
L
The Miller-Orr Model- Target Cash Balance (Z)
3 x TC x V 4 x rZ = + L
3
where: TC = transaction cost of buying or selling securities
V = variance of daily cash flows r = daily return on short-term
investments L = minimum cash requirement
• Example: Suppose that short-term securities yield 5% per year and it costs the organization $50 each time it buys or sells securities (TC). The daily variance of cash flows is $1000 (V) and your bank requires $1,000 minimum checking account balance (L).*
The Miller-Orr Model- Target Cash Balance (Z)
3 x 50 x 1000 4 x .05/360
Z = + $1,000
= $3,000 + $1,000 = $4,000
3
The Miller-Orr Model- Upper Limit
• The upper limit for the cash account (H) is determined by the equation:
H = 3Z - 2Lwhere:Z = Target cash balanceL = Lower limit
• In the previous example:H = 3 ($4,000) - 2($1,000) = $10,000
Days of the Month
Dol
lars
in th
e C
ash
Acc
ount
The Miller - Orr Model
Lower Limit
Upper Limit
$4000
Sell Securities
Buy Securities$10,000
$1000
Cash PoolingCentralized cash management involves
transferof an agency’s cash in excess of minimaloperating requirements into a centrally
managedaccount also known as a cash pool.
Procedureand
Benefits
Investment of excess funds
The Collection & Disbursement of Public Funds
Controlling Cash Collection & Disbursement
• Dual responsibility• Receipts maintained in a
location separate from cash & checks
• Certification of vouchers
Managing Cash Balances• Safety • Liquidity• Maximize pool of funds
available for investment– Concentration Accounts– Zero-balance accounts
• Highest yield
Collection of fundsNeed for accelerating collectionsHow to accelerate collection of receivables
Disbursement of fundsImportance of disbursement of fundsReview of disbursements
Payment instruments being used (checks, drafts, wire transfers, etc.)Bank charges and internal costsTechniques being usedTime involved for processing of instruments
Payments Netting in Public Cash
ManagementNeed for payments nettingProcedure involved
Only netted amount is transferred (bilateral netting)Netting center (multilateral netting)
Our objectives
• Learn about the Cash Cycle• Understand the factors that influence the
desired level of cash• Learn two models that calculate the optimal
level of cash• Gain an overview of what factors/areas are
inputs to a cash budget and how they affect the cash balance
Stop Here
Payments netting in Public Cash Management
(contd.)
Payments Netting in Public Cash Management
(contd.)
Cash Planning and Budgeting
Cash Planning and Budgeting (contd.)