Management of Cash (Various Theoretical Model), Inventories, Receivables, Marketable Securities and Account Payables


The following points highlight the top two cash management models. They are:

  1. Baumol’s EOQ Model of Cash Management
  2. Miller-Orr Cash Management Model.

(1) Baumol’s EOQ Model of Cash Management

William J. Baumol (1952) suggested that cash may be managed in the same way as any other inventory and that the inventory model could reasonably reflect the cost – volume relationships as well as the cash flows. In this way, the economic order quantity (EOQ) model of inventory management could be applied to cash management. It provides a useful conceptual foundation for the cash management problem.

In the model, the carrying cost of holding cash-namely the interest forgone on marketable securities is balanced against the fixed cost of transferring marketable securities to cash, or vice- versa. The Baumol model finds a correct balance by combining holding cost and transaction costs, so as to minimize the total cost of holding cash.


The Baumol’s model holds good if the following assumptions are fulfilled:-

(a) The rate of cash usage is constant and known with certainty. The model has limited use in times of uncertainty and firms whose cash flows are discontinuous or bumpy.

(b) The surplus cash is invested into marketable securities and those securities are again disposed of to convert them again into cash. Such purchase and sale transactions involve certain costs like clerical, brokerage, registration and other costs. The cost to be incurred for each such transaction is assumed to be constant/fixed. In practice, it would be difficult to calculate the exact transaction cost.

(c) By holding cash balance, the firm is would incur the opportunity cost of interest forgone by not investing in marketable securities. Such holding cost per annum is assumed to be constant.

(d) The short-term marketable securities can be freely bought and sold. Existence of free market for marketable securities is a prerequisite of the Baumol model.


The important limitations in Baumol’s model are as follows:-

(i) The model can be applied only when the payments position can be reasonably assessed.

(ii) Degree of uncertainty is high in predicting the cash flow transactions.

(iii) The model merely suggests only the optimal balance under a set of assumptions. But in actual situation it may not hold good.

(2) Miller-Orr Cash Management Model

Miller and Orr model (1966) assumes that the cashflow of the firm is assumed to be stochastic, i.e. different amounts of cash payments are made on different points of time. It is assumed that the movements in cash balance occur randomly. Miller and Orr suggested a model with control limits, which sets control points for time and size of transfers between an Investment Account and Cash Account.

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The model asserts that transfer money into or out of the account to return the balance to a predetermined ‘normal point whenever the actual balance went outside a lower or upper limit.

The lower limit would be set by management, and the upper limit and return points by way of formulae which assume that cash inflows and outflows are random, their dispersion usually being assumed to repeat a pattern exhibited in the past.

The model specifies the following two control limits:

h = Upper control limit, beyond the cash balance should not be carried.

0 = Lower control limit, sets the lower limit of cash balance, i.e. the firm should maintain cash resources atleast to the extent of lower limit.

z = Return point for cash balance.

The Miller-Orr model, will work as follows:-

(i) When cash balance touched the upper control limit (h), securities are bought to the extent of Rs. (h-z).

(ii) Then the new cash balance is z.

(iii) When cash balance touches lower control limit (o), marketable securities to the extent of Rs. (z-o) will be sold.

(iv) Then the new cash balance again return to point z.


The basic assumptions of the model are:

(a) The major assumption with this model is that there is no underlying trend in cash balance over time.

(b) The optimal values of ‘h’ and ‘z’ depend not only on opportunity costs, but also on the degree of likely fluctuations in cash balances.


Inventory is the raw materials, work-in-process products and finished goods that are considered to be the portion of a business’s assets that are ready or will be ready for sale. Inventory represents one of the most important assets of a business because the turnover of inventory represents one of the primary sources of revenue generation and subsequent earnings for the company’s shareholders.

Types of Inventory

There are three components typically classified under the inventory account:

  • Raw materials
  • work in progress
  • finished goods.

Raw materials represent goods that are used in the production as a source material. Examples of raw materials are metal bought by car manufacturers, food ingredients held by food preparation companies and crude oil held by refineries.

Work in progress includes goods that are in the process of being transformed during manufacturing and are about to be converted into finished goods. For example, a half-assembled airliner or a ship that is being built would be work in process.

Finished goods are products that have gone through the production and ready for sale, such as completed airliners, ready-to-ship cars and electronics. Retailers who buy and resell goods typically call inventory “merchandise,” which includes finished goods bought from producers and can be resold immediately. Examples of merchandise include electronics, clothes and cars held by retailers.


Receivables is an asset designation applicable to all debts, unsettled transactions or other monetary obligations owed to a company by its debtors or customers. Receivables are recorded by a company’s accountants and reported on the balance sheet, and they include all debts owed to the company, even if the debts are not currently due. Long-term receivables, which do not come due for a significant length of time, are recorded as long-term assets on the balance sheet; most short-term receivables are considered part of a company’s current assets.

Receivables Example

If a company sells widgets and sells 30% of them on credit, it means 30% of the company’s receipts are receivables. That is, the cash has not been received but is still recorded on the books as revenue. Instead of an increase in cash, the company makes an increase to accounts receivable. They are both considered an asset, but accounts receivable is not considered cash until it gets paid off. If the customer pays the bill in six months, on the seventh month the receivable is turned into cash and the same amount of cash received is deducted from receivables.


Marketable securities are liquid financial instruments that can be quickly converted into cash at a reasonable price. The liquidity of marketable securities comes from the fact that the maturities tend to be less than one year, and that the rates at which they can be bought or sold have little effect on prices.

Marketable securities are defined as any unrestricted financial instrument that can be bought or sold on a public stock exchange or a public bond exchange. Therefore, marketable securities are classified as either a marketable equity security or a marketable debt security. Other requirements of marketable securities include having a strong secondary market that can facilitate quick buy and sell transactions, and having a secondary market that provides accurate price quotes for investors. The return on these types of securities is low, due to the fact that marketable securities are highly liquid and are considered safe investments.

Examples of marketable securities include common stock, commercial paper, banker’s acceptances, Treasury bills, and other money market instruments.

Using Marketable Securities in Fundamental Analysis

Marketable securities are evaluated by analysts when conducting liquidity ratio analysis on a company or sector. The liquidity ratio measures a company’s ability to meet its short-term financial obligations as they come due. In other words, this ratio assesses whether a company can pay its short-term debts using its most liquid assets. Liquidity ratios include:

  1. Cash ratio: The cash ratio is calculated as the sum of the market value of cash and marketable securities divided by a company’s current liabilities. Creditors prefer a ratio above 1 since this means that a firm will be able to cover all its short-term debt if they came due now. However, most companies have a low cash ratio since holding too much cash or investing heavily in marketable securities is not a highly profitable strategy.
  2. Current ratio: The current ratio measures a company’s ability to pay off its short-term debts using all its current assets, which includes marketable securities. It is calculated by dividing current assets by current liabilities.
  3. Quick ratio: The quick ratio factors in only quick assets into its evaluation of how liquid a company is. Quick assets are defined as securities that can be more easily converted into cash than current assets. Marketable securities are considered quick assets. The formula for the quick ratio is quick assets / current liabilities.


Accounts payable (AP) is an accounting entry that represents an entity’s obligation to pay off a short-term debt to its creditors. On many balance sheets, the accounts payable entry appears under the heading current liabilities. Another common usage of AP refers to a business department or division that is responsible for making payments owed by the company to suppliers and other creditors.

Accounts payable are debits that must be paid off within a given period to avoid default. For example, at the corporate level, AP refers to short-term debt payments to suppliers. The payable is essentially a short-term IOU from the business to the other business, who acts as a creditor.

How to Record Accounts Payable

To record accounts payable, accountants or bookkeepers credit accounts payable when they owe a bill, and they debit accounts payable when they pay the bill. For example, imagine a business incurs a $500 invoice for office supplies. When the AP department receives the invoice or incurs the bill, it records it as a debit in an accounts payable field. As a result, if anyone looks at the total debit in the accounts payable category, he can instantly see what the business owes all of its vendors and short-term lenders. When the bill is paid, the department enters a credit in its accounts payable column.

To balance these entries, the accountant must enter a debit in the relevant category, office supplies in this case, when the debt is incurred, and he must enter a credit in the cash column when he pays the invoice.

Accounts Payable vs. Trade Payables

While some people use the phrases accounts payable and trade payables interchangeably, the phrases refer to similar but slightly different things. Trade payables constitute all the money a company owes the vendors it buys business supplies and materials included in its inventory, while accounts payable include all other short-term debts. For example, if a restaurant owes money to a food or beverage company, the stock is part of its inventory and thus part of its trade payables, while money owed to the company that launders its chef’s whites falls into the accounts payable category. Some accounting methods roll both of these categories into the accounts payable category.

Accounts Payable vs. Accounts Receivables

Accounts receivables and accounts payable are essentially opposites. Accounts payable is the money a company owes its vendors, while accounts receivables is the money that is owed to a company. If a company has a bill in its accounts payable department, the company it owes the funds to categorizes the bill in its accounts receivables department.

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