Cash Management

Objectives of cash management

Motives for holding cash

1.Transaction motive

Firms need cash to meet their transaction needs. The collection of cash(from sale of goods and services, sale of assets, and additional financing) is not perfectly synchronized with the disbursement of cash (for purchase of goods and services, acquisition, of capital assets, and meeting other obligations. Hence, some cash balance is required as a buffer.

2.Precautionary motive

There may be some uncertainty about the magnitude and timing of cash inflow from sale of goods and services, sale of assets, insurance of securities. Like wise, there may be uncertainty about cash inflow on account of purchases and other obligations. To protect itself against such uncertainties a firm may require some cash balance.

3.Speculative motive

Firms would like to tap profit making opportunities arising from fluctuations in commodity prices, securing prices, & interest rates. Cash-rich firms is better prepared to exploit such bargains may carry additional equity. However for most firms their reserve borrowing capacity &marketable securities would suffice to meet their speculative needs. 

What is cash operating cycle?

The operating cycle can be shortened by the following means.

1.Raw materials procurement:

One should have a good supply network. This means that he should have a supplier who can provide him with his raw material requirement at the right time, place and in the required quantity at minimum amount of time. Thus this also implies that he should be in possession of automated machines in case the raw materials are large and bulky .this helps in reducing the time required for the transport and movement of the goods from one place to another.

2.Production process:

In the production process there should not be any time lag from the time of actually receiving the raw materials and the starting of production process. This means as soon as the materials arrive they should be introduced in the production process. This therefore meant that the company will be following the just in time policy(JIT) which simply means that the requirements of the company will be fulfilled at the time required thus reducing the work in progress and thus increasing the efficiency of the company.

3.Finished goods:

The goods once produced should be held in the company’s possession as the company’s capital would be locked up in these goods. Thus it is essential that the company sell all these finished goods as soon as possible so as to allow the company reacquires its capital employed in the operating cycle.

4.Receipt of sales:

The receipts of the money from the debtors as soon as possible so as to regain the money along with the profits.This is how the operating cycle operates along with how it can be improved so as to enable the company to regain the money invested in the production of the goods being produced.Marketable investments: - Marketable investments are those investments which are acquired by the company by the employing its surplus funds or cash temporarily. These investments are short term in nature. These investments can be disposed off by the company at its free will and thus convert it into cash as and when the need arises. Hence, these investments are considered as good as cash, and are often called ‘secondary cash resources’. such investments are grouped under “current assets”.

Factors Determining Cash Needs:

The working capital needs of a firm are influenced by numerous factors. The important ones are:

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Nature of business.

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Seasonality of operations.

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Production policy.

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Market conditions.

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Conditions of supply.

Nature of business:

The working capital requirement of a firm is closely related to the nature of its business. A service firm, like an electricity undertaking or a transport corporation which has a short operating cycle and which sells predominantly on cash basis, has a modest working capital requirement. On the other hand,a manufacturing concern likes a machine tools unit, which has a long operating cycle and which sells largely on credit, has a very substantial working capital requirement.

Seasonality of operations:

Firms which have marked seasonality in their operations usually have highly fluctuating working capital requirements. To illustrate, consider a firm manufacturing ceiling fans. The sale of ceiling fans reaches a peak during the summer months and drops sharply during the winter period. The working capital need of such firm is likely to increase considerably in summer months and decrease significantly during the winter period. On the other hand, a firm manufacturing product like lamps, which have even sales round the year,tends to have stable working capital needs.

Production policy:

A firm marked by pronounced seasonal fluctuation in its sales may pursue a production policy which may reduce the sharp variations in working capital requirements. For example, a manufacturer of ceiling fans may maintain a steady production throughout the year rather than intensify the production activity during the peak business season. Such a production policy may dampen the fluctuations in working capital requirements.

Market conditions:

The degree of competition prevailing in the market has an important bearing on working capital needs. When competition is keen, a larger inventory of finished is required to promptly serve customers who may not be inclined to wait because other manufacturers are ready to meet their needs.

Further, generous credit terms may have to be offered to attract customers in a highly competitive market. Thus, working capital needs tend to be high because of greater investment in finished goods inventory and accounts receivable.If the market is strong and competition weak, a firm can manage with a smaller inventory of finished goods because customers can be served with some delay. Further, in such a situation the firm can insist on cash payment and avoid lock-ups of funds in accounts receivable –it can even ask for advance payment, partial or total.

Conditions of supply:

The inventory of raw materials, spares, and stores on the conditions of supply.If the supply is prompt and adequate, the firm can manage with small inventory. However, if the supply is unpredictable and scant, then the firm, to

ensure continuity of production, would have to acquire stocks as and when they are available and carry large inventory on an average. A similar policy may have to be followed when the raw material is available only seasonally and production operations are carried out round the year.