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WHAT IS CASHMANAGEMENT??????
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MANAGEMENT OF CASH
Determination of optimum amount of cash
required in the business
Keep the cash balance at optimum level andinvestment of surplus cash in profitable
manner.
Prompt collection of cash from receivables and
efficient disbursement of cash.
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MOTIVES OF HOLDING CASH
Transaction Motive
Precautionary Motive
Speculative Motive
Compensating Motive
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FACTORS DETERMINING CASH
NEEDS
Timing of Cash Flows
Cash Shortage Costs
Cash Excess Costs
Cash Management Costs
Uncertainty
Firms Capacity to Borrow in EmergentSituations
Attitude of Management
Efficiency of Management
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METHODS OF CASH
MANAGEMENT
Cash Budget
Cash Flow Statements
Cash Management models
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CASH BUDGET
A cash budget is a summary ofmovement of cash during a particularperiod.It is also known as short term cash
forecasting.Benefits:
In estimating the extent of short fall if any
and to arrange it from some reliable andcheap sources.
In preparing a detailed purchase andpayment schedule in respect toac uirin some ca ital oods(fixed
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COMPONENTS.
The three main componentsnecessary for preparing a cashbudget :-
Time period.
Desired cash position.
Estimated sales and expenses.
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FOUR MAJOR SECTIONS OFCASH BUDGET
Receipts Section-It consists of listingof all of the cash inflows, except forfinancing.
Disbursements Section-It consists ofall cash payment planned for thebudgeted period. These paymentswill include rawmaterial purchases, direct labourpayments.
The Financing Section-It deals the
borrowings and repayments
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ADVANTAGES
It provides a comprehensive pictureof cash inflows and cash outflows asalso the resultant surplus and deficit.
It may also duly alert themanagement of any possible deficitso that a little more vigorous controlon cost and cash outflows can beexercised.
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DISADVANTAGES
The system may not prove to bereliabe incase of delay in receipts ofdues(cash inflow) or sudden
payment(cash outflow) due to someunexpected and urgent needs.
The system does not reveal andreflect the changes in the movementof working capitalcomponents,mainly in regard toinventories andsundry debtors.(bills
receivable or accounts receivable).
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BAUMOL MODEL
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Baumol Model of Cash ManagementThe Baumol model of cash management is
one of many by which cash is managed bycompanies. It is extensively used and highlyuseful for the purposeof cash management.
Use of Baumol ModelThe Baumol model enables companies to
find out their desirable level of cash balanceunder certainty.
RelevanceAt present many companies make an effortto reduce the costs incurred by owning cash.
They also strive to spend less money onchanging marketable securities to cash. The
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50000000 1002 504 339.3333333 258 210
Order Quantity (Z)
Cost ($)
Z*
Total Costs
Holding Costs:(Z/2)*r
Order Costs:(M//Z)*TC
imal Cash Balance via Baumol Mod
Z*Z*= [(2M*TC)/r]
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Q.
A Firm estimates that it isrequired to make cashdisbursements of Rs 567 lakh in
a year which is spread overuniformly at Rs 47.25 lakh permonth.
The firm invests only in treasurybills for cash managementpurposes. The present yield is 8
percent p.a .It costs the firm Rs
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C
[(2*900*56,700,00)/0.08= 1,129,491 OR Rs
11.30 Lakh.
C= [(2M*TC)/r]=
SOLUTION
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Assumptions
There are certain assumptions or ideas that arecritical with respect to the Baumol model of cashmanagement. The particular company should beable to change the securities that they own intocash, keeping the cost of transaction the same.
Under normal circumstances, all such deals havevariable costs and fixed costs.
The company is capable of predicting its cashnecessities
They should be able to do this with a level ofcertainty
The company should also get a fixed amount ofmone . The should be ettin this mone at
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Problems with the Baumol
Model
ash flows may not be very predictable, much lessonstant
Treasurers may want a safety stock of cash
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CONT.
The company is aware of theopportunity cost required for holdingcash. It should stay the same for a
considerable length of time.
The company should be making its
cash payments at a consistent rateover a certain period of time. In otherwords, the rate of cash outflow
should be regular.
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The Miller - Orr Model
The Miller-Orr Model provides a formulafor determining the optimum cashbalance (Z), the point at which to sell
securities to raise cash (lower limit L)and when to invest excess cash bybuying securities and lowering cashholdings (upper limit H).
Depends on: transaction costs of buying or selling
securities
variability of daily cash (incorporatesuncertainty)
return on short-term investments
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Days of the Month
DollarsintheCashAccount
The Miller - Orr Model
Lower Limit
Upper Limit
Z
Sell Securities
Buy Securities
H
L
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CONT.
The Miller and Orr Model of Cash Managementis one of the various cash management models inoperation.
It is an important cash management model as well. Ithelps the present day companies to manage their cashwhile taking into consideration the fluctuations in dailycash flow.
As per the Miller and Orr model of cash management
the companies let their cash balance move within twolimits - the upper limit and the lower limit.
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CONT
The companies buy or sell the marketable securities only if the
cash balance is equal to any one of these when the cash
balances of a company touches the upper limit it purchases a
certain number of salable securities that helps them to come
back to the desired level
If the cash balance of the company reaches the lower level then
the company trades its salable securities and gathers enough
cash to fix the problem. It is normally assumed in such casesthat the average value of the distribution of net cash flows is
zero. It is also understood that the distribution of net cash flows
has a standard deviation. The Miller and Orr model of cash
management also assumes that distribution of cash flow isnormal
Application of Miller and
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Application of Miller andOrr Model of Cash
Management The Miller and Orr model of cash management is widelyused by most business entities. However, in order for itapplied properly the financial manages need to makesure that the following procedures are followed:
Finding out the approximate prices at which the salablesecurities could be sold or bought
Deciding the minimum possible levels of desired cashbalance
Checking the rate of interest
Calculating the SD (Standard Deviation) of regular
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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 flowsr = daily return on short-term
investments
L = minimum cash requirement
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Day 1 2 3 4 5 6 7
Cash flowForecast
+24 +13-12 -16 +36 +4 +28
Q: A company projects the daily netcash flows for the next seven days asfollows:
The policy of the company is to maintaina minimum cash balance of Rs 10,000 at
all times.Fixed cost for every security transactionis Rs 1600 and return on marketablesecurities is 10% p.a. The company
desires to know the target cash
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(Xi) (X) (Xi-X) (Xi-X)2 V
24 Xi/n=2
1/7
21 441 (XI-
X)2/n
13 =RS 3 10 100 =3178/7
-16 -19 361 =Rs
454
-12 -15 22536 33 1089
4 1 1
-28 -31 961
TOTAL= 0 3178
Calculation of the Variance of cashFlows Forecast
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Findings
These two findings signify that thefinance manager will allow the dailycash balance to fluctuate till it
reaches the upper limit of Rs185,104.
When the balance becomes greater
than this figure he will purchasesufficient worth of securities toreduce the cash balance to Z of Rs
68,368
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On the lower side when the cashbalance drops to the minimumbalance of Rs 10,000 he will sell
adequate amount of securities toraise the cash balance to Rs 68,368
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Z-Score 1968 model
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 +
.999X5 where:
X1 is working capital total assets
X2 is retained earnings (profit) totalassetsX3 is EBIT total assetsX4 is market value ofequity
book value of debtX5 is sales total assets
Zones of Discrimination:
Z > 2.99 -Safe Zone
http://moneyterms.co.uk/working_capital/http://moneyterms.co.uk/retained-profit/http://moneyterms.co.uk/ebit/http://moneyterms.co.uk/equity/http://moneyterms.co.uk/book-value/http://moneyterms.co.uk/revenue-recognition/http://moneyterms.co.uk/revenue-recognition/http://moneyterms.co.uk/book-value/http://moneyterms.co.uk/equity/http://moneyterms.co.uk/ebit/http://moneyterms.co.uk/retained-profit/http://moneyterms.co.uk/working_capital/8/2/2019 Wcm Ppt Cash Mgt..New
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Z-Score cont
A more recent estimate by Altman (in2000) is significantly different:
Z = 0.72X1 + 0.85X2 + 3.1X3 +
0.42X4 + X5 Once again, this has been rounded to
two significant figures.
Altman's 2000 paperrevisits the z-score and his proprietary z.
Other single number measures of
financial strength exist, including'
http://www.brianzatrading.com/trading_masters/Altman/predicting_financial_distress_of_companies_revisiting_the_zscore_and_zeta_model.pdfhttp://moneyterms.co.uk/f-score/http://moneyterms.co.uk/f-score/http://www.brianzatrading.com/trading_masters/Altman/predicting_financial_distress_of_companies_revisiting_the_zscore_and_zeta_model.pdf8/2/2019 Wcm Ppt Cash Mgt..New
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