1. Chapter Introduction

2. Cash Management: Introduction

3. Factors

1.   Chapter Introduction:

This chapter discusses the planning & management of cash needs. Cash is vital for a business and is like blood stream in human body. Cash denotes the liquidity of a business enterprise and plays an important role in nurturing and improving the profitability of the organization. It is, therefore, essential to make a proper estimate of the cash needs and plan for it so as to avoid technical or legal insolvency.

2. Cash Management: Introduction:

For the purpose of working capital management the most important element is the cash management. A firm should make proper assessment of cash requirements. Assessment of requirements for cash (cash planning) involves formulation of two types of cash policies, viz.; normal policies and abnormal policies. Normal cash policies are concerned wit4 determination and procurement of such needs, which can be anticipated, with a reasonable degree of accuracy. Abnormal cash requirements arise out of unpredictable events.

There are three motives for cash:

1. the transaction motive,
2. the precautionary motive, and
3. the speculative motive. ,

Cash balance is required for making payments for purchases, wages, administrative and selling expenses, taxes dividends, etc. Such payments occur in the routine course of business:

An ideal situation is when there is perfect synchronization between the inflow (cash coming in the business) and outflow (cash going out of business) of cash. But this ideal situation is found the firm needs only a small cash balance. In order to determine the amount of cash needed for transaction purposes, the activities of the should be analyzed for isolating the causes for normal, discrepancies 1eaverages the "outflow" and "inflow" there, may be two causes for such discrepancies:

1. The difference between the credit-period allowed by the forms to its customer and the credit period availed of by the forms from its suppliers (for example, a firm is selling to its customers on any month's credit and is purchasing from its supplying on two month's credit).
2. Extra-ordinary payments and extra-ordinary receipts (for example, purchase of fixed assets and ,sale of shares debentures and unneeded 'plant).

Floods, strikes, the failure of important customers to make payments are some of the factors, which cause unpredictable discrepancies between cash inflows and outflows. For meeting such unexpected contingencies, precautionary cash reserves are maintained. There is direct relationship between the size of precautionary cash balance and the ability of the firm to assume risk. If the firm is willing to assume risk, the precautionary cash balance will be smaller than that when the firm is not willing to assume risk. If the firm has good credit standing and has the capacity to borrow for short term as and when need arise precautionary cash balance would be smaller. We know that cash as an asset, does not earn any profit: It is, therefore, found that majority of the firms invest a large part of precautionary cash balance in marketable recruiting (which can be easily sold for realizing cash) for offsetting a complete loss of return on precautionary cash balance.

"The speculative motive for keeping Cash is a result of seeking opportunities, such as buying inventory at favourable prices either at depressed prices or at normal prices just before an anticipated rise." (Nemmers and Grunewald, Basic Managerial Finance).

In other words, cash balance kept for taking advantage of profitable opportunities is said to have been kept with speculative motive. As a matter of sound financial management, speculation with cash balances should be avoided. A firm should not speculate on inventory purchases. It does not mean that purchase of large inventory loss at favourable prices should not be made. But the purposes should be to economize on the cost of inventory and not to hold large amount of inventory just to take advantage of an anticipated rise in prices. While assessing the requirement for cash balances, minimum possible weight age should be given to speculative motive.

While determining the amount of Transaction and Precautionary Balances, certain possible 'influences' must be considered. These influences are:

1. The Expected Net Cash Flows: For determining the expected net cash flows in the future, a 'Cash Budgeted' is prepared. Cash budgeted shows a particular period. It shows the short term and long term cash needs of the firm. It is a device, which helps in controlling cash expenditures. It helps, in advance, in testing the impact of proposed programs on cash position. It suggests the term form of financing that should be used for meeting any cash needs. It aids in maintaining a suitable dividend policy.
2. Possible Deviation from Expected Net Cash Flow: An effort should be made to predict the variation in cash outflows and inflows under different situations. Applying probability concepts can make this prediction.
3. The Maturity structure of the firm's Debt: A firm borrowing funds from time to time will-have a schedule of repayment of loans. This schedule should be analyzed to find out cash outflows in different periods as it would influences the Cash balances need in different periods of time.
4. Borrowing capacity: The firm's capacity to borrow funds for meeting cash needs arising out of emergency also influences the size of cash needs, especially for precautionary purposes.
5. The Efficiency of Cash Management: The efficiency of cash management refers to the time value of funds concept. This concept emphasizes that one rupee received to day in the near future has more value than one rupee received after a long interval of time. In order to gain efficiency in managing cash, efforts should be made to speed-up cash inflows and delay in payments adversely affect the goodwill and credit standing of the delay the out flowing of funds. Greater the efficiency on managing cash smaller will be size of cash balances.'

3. Factors:

Factors Affecting Requirements for Cash

The amount of cash, which is needed for transaction purposes can be easily, be predicted. It depends upon a number of factors. Some more important factors are:

1. Credit Position.
2. Status of Receivables.
3. Status of Inventory Accounts.
4. Nature of Enterprise.
5. Attitude of Management of the Firm toward Risk.

1. If an enterprise has good credit standing, on the basis of its past behaviour and present resources, in the eyes of creditors – present as well as prospective - it may carry its activities with a small cash balances. As and when will need additional cash, it can easily get from bankers and creditors because of its reputation.
2. Because of good credit position, the enterprise can meet a large part of its inventory requirements by purchasing inventory on credit. '

Status of Inventory accounts affects cash requirements: At any particular time, the size of inventory held by a firm governs the amount of cash blocked inventory. Inventory policies affect the amount of cash tied up. If there are two firms - A &B, and firm A, as a matter of policy, intends to keep inventory stock equal to the requirement for three months while from B wants to keep inventory stock equal to the requirement for two months, firm A will be required to maintain larger investments in cash for financing the purchase of inventory than the firm B.

Nature of enterprise refers for to the nature of demand for the product of the firm. If the demand for the products of the firm is fairly stable throughout the accounting period, the firm can carry on with relatively smaller cash balance whereas the firm that having fluctuating demand for its products will need a large cash balance. The amount of sales in relation to assets also affects the cash reserves required. A firm having sales revenue four times the investments in fixed assets. It may be noted that cash requirements do not increase in the same proportion in which sales increase. Cash requirements increase at a decreasing rate.

Attitude of management towards risk may be either conservative or modem: A firm which formulates working capital policies keeping in view the current circumstances and plans for working capital requirements, a firm can be able to predict future cash needs and can keep cash balance according to expected needs without going against liquidity consideration. A firm do not resorting to planning, is likely to hold a large cash reserves for maintaining liquidity requirements which are not determined on scientific basis and therefore, are quite uncertain.