Brief Discussion on Management of Cash

The Cash Management is concerned with the collection, disbursement and the management of cash in such a way that firm’s liquidity is maintained. In other words, it is concerned with managing the cash flows within and outside the firm and making decisions with respect to the investment of surplus cash or raising the cash from outside for financing the deficit.

The objective of cash management is to have adequate control over the cash position, so as to avoid the risk of insolvency and use the excessive cash in some profitable way. The cash is the most significant and highly liquid asset the firm holds. It is significant as it is used to pay the firm’s obligations and helps in the expansion of business operations.

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The concept of cash management can be further understood in terms of the cash management cycle. The sales generate cash, and this has to be disbursed out. The firm invests the surplus cash or borrows cash in case of deficit. Thus, it tries to achieve this cycle at a minimum cost along with the liquidity and control.

An optimum cash management system is one that not only prevents the insolvency but also reduces the days in account receivables, increases the collection rates, chooses the suitable investment vehicles that improves the overall financial position of the firm.

The importance of the cash management can be understood in terms of the uncertainty involved in the cash flows. Sometimes the cash inflows are more than the outflows, or sometimes the cash outflows are more. Thus, a firm has to manage cash affairs in a way, such that the cash balance is maintained at its minimum level while the surplus cash is invested in the profitable opportunities.

Reasons For Holding Cash

There are practically two main reasons why modern businesses hold money in the form of cash. The first is to meet transactional requirements. The transactional motive of holding money comes from periodic disbursement and collection activities of a going concern. The disbarment of cash may include things like payment of: wages and salaries, taxes, dividends, rent, business related debt, etc. On the other hand, cash is collected from: normal business operations, sale of company asset, and other sources of finance. It all boils down to collecting cash as quick as possible and paying cash as slow as possible. A company that does not understand this simple yet, powerful cash flow trick will always struggle to remain liquid.

Another reason for holding cash is to meet minimum requirement balances. Banks require that you keep certain balance with them to compensate for the free financial services that they render to you. It is a costly mistake for a company to see the transaction cash and compensatory balances when attempting to get the cash flow outlook of the firm as different. The cash can be used to conveniently satisfy both cash requirements.

Basic economics tells us that the cost of holding cash include the opportunity cost of lost income in the form of interest. Similarly, the cost of running out of cash can mark an end to the existence of a company. This is why it is important to determine the optimal cash level or target cash that a company needs to keep at all given time. To get the target cash, a company must weigh the cost of holding cash against the benefits of holding cash.

Estimating Target Cash Balance

Target cash balance or optimum cash level is all about trading-off between what the economist call opportunity costs of holding too much cash and trading implication of holding too little. There are basically two main methods of estimating target cash. These are: the Baumol Model and the Miller-Orr Model. William Baumol was the first to develop a cash management formula that takes both opportunity cost and trading cost into consideration. After a few observations were made by finance scholars regarding the inability of the Baumol model to account for the random movements in cash flows, Merton Miller and Daniel Orr developed a cash management model which dealt with the cash-flow flaw. You can do a search on these topics for detailed work on them.

Float in Cash Management

There is always a difference between the amount of cash shown on a company’s statement of financial position (balance sheet) and that shown on the bank statement of the company. The difference between cash in bank and that on the books of account is called float (notice the contextual difference in usage of the term float here and imprest accounting system/petty cashbook). The primary cause for this (float) net difference is the presence of cheque in collection process.

Cash Collection and cash Disbursement Strategies

The various collection and disbursement strategies that a company can use to improve its cash management is a two way game. The first phase of the game involves acceleration of collections which has to do with reducing the delay between when a customer pays us by cheque and when the money drops in our bank account. A number of techniques are used to reduce this cycle and they include; (a) encouraging our customers to speed up the cheque mailing method- we can offer to bear the extra cost of using an overnight delivery for instance, (b) reducing the time it takes to bank cheques received from our customers, and (c) speeding up the movement of funds to disbursement bank.

It is important to state that the simple act of encouraging your customers to set up a direct debit with you is a more efficient way of managing cash by completely avoiding the use of cheques. The only drawback here is that one condition must be met for a direct debit to be used: – the customer must be a regular customer that buys periodically.


  1. Use of wire transfer
  2. Use of lockboxes
  3. Adopting concentration banking


  1. Draw a cheque in a bank that is far from the customer
  2. Hold payment for some days after postmarked in office
  3. Add a layer of bureaucracy to the process by calling your customer to verify large sums

In as much as it is tempting to employ the above techniques of delaying cash disbursement, there are however some business ethics and legal issues that the financial manager of a company must have to consider before making decision on whether to use them or not.

Whatever you are doing as a financial manager attempting to get the best cash management mix for your organization, do not forget the fact that technology has improved so much that leveraging on some bye product of technology will make the whole process of cash management seem easy and simple.

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