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Cash Management

Cash Cycle

Factors that influence the desired level

of cash

Optimal cash inventories

Short-term investment strategies

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The Manager

Resource Decisions

Information

Decisions

FinancingDecisions

Investment Decisions

Human Resources

Decisions

Managing an entitys Resources

Cash ManagementInventory Management

Working Capital Management

Investment in Human Capital

Long-term Assets

Accounts Receivable

Economics of Information

Database Management

Data Modeling

IS Planning & Development

Debt vs. Tax Financing

Cost of

Capital

Discount Rate

Value

Creation

Financial

Markets

Cash Inflows

Operating

Decisions

Recruitment, Selection

Training, Productivity

Performance Appraisal

Compensation

Unions & Labor Relations

Life cycle effects,

Business cycle,

public events,

etc.

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Overview

ST finl planning = deals w/ short-lived assets and liabilities

(working capital management);

concerned w/ 1) size of investment in CA like cash, A/R,

Inventorya tool is cash budgetanalysis and 2) how to

finance ST assetsa tool is performing credit analysis

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Managing WC involves determing:

How much to invest in CA?

- CA vs. FA

- Nature of activities/programs

In each CA?

- Cash, A/R, Inventory

- Cash Mgt- A/R is Credit Mgt

- Inv = POM & Cash balance models

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Our objectives

Learn about the Cash Cycle

Understand the factors that influence the

desired level of cash Learn two models that calculate the optimal

level of cash

Gain an overview of what factors/areas areinputs to a cash budget and how they affectthe cash balance

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Objectives of Public Money

Managers

Bringing the entitys cash resourceswithin control

Achieving optimum conservation andutilization of the funds

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Key areas of Public Cash

ManagementOrganization

Collection and disbursement of funds

Netting of interagency paymentsInvestment of excess funds

Optimal level of cash balances

Cash planning and budgetingBank relations

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Treasury Management of

Cash Balances

Operate with smaller amount of cash

Supervision is centralized

Better service from banks

Proper allocation of funds

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How much cash should a

organization keep on hand? Enough cash to make payments when

needed. (transactions motive)

(Daily or Weekly Cash Budget helpful)

Additional cash may be held for unexpected

requirements. (precautionary motive)

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The size of the minimumcash

balance depends on:

How quickly and cheaply a organization can raisecash when needed.

How accurately managers can predict cashrequirements. (Cash Budget helpful)

How much precautionary cash the managers needfor emergencies.

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The organizations maximumcash

balance depends on:

Available (short-term) investment opportunities e.g. money market funds, CDs, commercial paper

Expected return on investment opportunities. e.g. If expected returns are high, organizations should

be quick to invest excess cash

Transaction cost of withdrawing cash and makingan investment

Demand for Cash for daily transactions (Cash Budget helpful)

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Consider Cash an Inventory

Grantsvil le has a daily demand for cash of $10,000.

Grantsvilles treasurer invests excess cash in the state investment pool

that earns .01% per day. I n order to transfer funds from the state pool,

Grantsvil le must pay a transaction cost of $20. How much cash should

it transfer when it runs out. (Grantsvil le can complete the cash transfer

electronical ly so it waits unti l the cash balance is zero).

An inventory approach to CashBalance decisions:

the trade-offs: -hold little cash = investremainder in M/S to earn interest

- if hold too little cash = incur transactionscosts to meet cash needs

- hold lots of cash = forgo investing in M/S

and earning interest

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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

Optimal Cash Balance via Baumol Model

Z*Z*= [(2M*TC)/r]

M = $10,000 r = .01% .0001 TC = $20

Z = $63,246

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Problems with the Baumol Model

Cash flows may not be very predictable, much less

constant

Treasurers may want a safety stock of cash

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The Miller - Orr Model

The Miller-Orr Model provides a formula fordetermining the optimum cash balance (Z), the

point at which to sell securities to raise cash

(lower limit L) and when to invest excess cash bybuying securities and lowering cash holdings(upper limit H).

Depends on:

transaction costs of buying or selling securities variability of daily cash (incorporates uncertainty)

return on short-term investments

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Days of the Month

The Miller - Orr Model

Lower L imit

Upper L imi t

Z

Sell Secur ities

Buy Secur ities

H

L

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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 buyingor selling securities

V = variance of daily cash flowsr = daily return on short-term

investmentsL = minimum cash requirement

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Example: Suppose that short-term securities yield5% per year and it costs the organization $50 eachtime it buys or sells securities (TC). The dailyvariance of cash flows is $1000 (V) and your bank

requires $1,000 minimum checking accountbalance (L).*

The Miller-Orr Model

- Target Cash Balance (Z)

3 x 50 x 10004 x .05/360Z = + $1,000

= $3,000 + $1,000 = $4,000

3

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The Miller-Orr Model

- Upper Limit The upper limit for the cash account (H) is

determined by the equation:

H = 3Z - 2Lwhere:

Z = Target cash balance

L = Lower limit In the previous example:

H = 3 ($4,000) - 2($1,000) = $10,000

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Days of the Month

The Miller - Orr Model

Lower L imit

Upper L imi t

$4000

Sell Secur ities

Buy Secur ities

$10,00

$1000

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Cash Pooling

Centralized cash management involves transfer

of an agencys cash in excess of minimal

operating requirements into a centrallymanaged

account also known as a cash pool.

Procedure

andBenefits

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Investment of excess funds

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The Collection & Disbursement of Public Funds

Controll ing Cash

Collection &

Disbursement

Dual responsibility

Receipts maintained in a

location separate from

cash & checks Certification of vouchers

Managing Cash Balances

Safety

Liquidity

Maximize pool of funds

available for investment

Concentration Accounts

Zero-balance accounts

Highest yield

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Collection of funds

Need for accelerating collections

How to accelerate collection of receivables

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Disbursement of fundsImportance of disbursement of funds

Review of disbursements

Payment instruments being used (checks,drafts, wire transfers, etc.)

Bank charges and internal costs

Techniques being used

Time involved for processing of instruments

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Payments Netting in PublicCash Management

Need for payments netting

Procedure involved

Only netted amount is transferred (bilateralnetting)

Netting center (multilateral netting)

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Our objectives

Learn about the Cash Cycle

Understand the factors that influence the

desired level of cash Learn two models that calculate the optimal

level of cash

Gain an overview of what factors/areas areinputs to a cash budget and how they affectthe cash balance

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Stop Here

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Payments netting in Public

Cash Management (contd.)

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Payments Netting in Public

Cash Management (contd.)

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Cash Planning and Budgeting

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Cash Planning and Budgeting

(contd.)