Cash ‘consists of cash in hand and deposits repayable upon demand less overdrafts.’ ‘This includes cash held in foreign currency.’
Cash equivalents are ‘short-term highly liquid investments that are readily convertible to known amounts of cash and are subject to an insignificant risk of change in value.’
Cash flows are ‘inflows and outflows of cash and cash equivalents’
As individuals and corporate entities, cash which is needed daily, should be managed in such a way that there shall not be cash problems or impending cash problems could be foreseen and remedied.
Individuals just like well planned corporate entities, should prepare and use personal cash budgets.
Cash management involves a lot of techniques and every individual and organization should always institute measures to manage its scarce cash and cash equivalents.
Organizations that do not manage their cash might end up overtrading, i.e. carry on too many activities more than it can bear financially or they might end up overcapitalizing, i.e. their cash is excessive for their business requirements.
As individuals, sometimes, we have some cash that we do not really know immediately what to do with. That means, we did not plan for it, and that would be overcapitalization for the individual.
Sometimes, we can also buy more than we can pay. These should not normally happen if we institute cash management measures in place.
Cash should be managed taking into consideration the interrelationship among profit, taxation, dividend payment, (if any), recurrent and capital expenditure and working capital levels.
Individuals and corporate entities could have many types of income such as earned, portfolio or passive income and all these come into play when managing cash, because the various incomes constitute part or all the cash one has available for management.
Cash could be managed by:
• Preparing and using cash budgets
• Disposing of idle assets
• Having an investment plan for cash available on hand to maximize its earning potential
• Having a credit facility arrangement with your bank before you need it.
• Managing loans and overdrafts
• Managing cash short term investment
• Controlling credit efficiently
• Invoice customers quickly when goods or services are delivered and have convenient collection arrangement with them
• Asking for advance payment before credit facility agreement is established
• Not granting till all credit rating requirements are fully met
• Buying things only when you really need them, keep expense at a minimum
• Evaluating whether to use a centralized treasury for your organization
• Utilizing credit finance facilities but repay in good time
• Reducing stocks and increase stock turnover
• Minimizing production lead times, possibly using sub-contractor
The following cash monitoring and management models developed by the experts could also be used
“The Baumol Model is similar to the Economic Order Quantity (EOQ) Model. Mathematically it is:
where C = the optimal amount of cash to be acquired when reaching a threshold balance,
F = the fixed cost of acquiring the cash C amount,
S = the amount of cash spent during a time interval,
i = the interest rate expressed in the same time interval as S
One shortcoming of this model is that it accommodates only a net cash outflow situation as opposed to both inflows and outflows. Also, the cash outflow is at a constant rate, with no variation.
The Miller-Orr Model rectifies some of the deficiencies of the Baumol Model by accommodating a fluctuating cash flow stream that can be either inflow or outflow. The Miller-Orr Model has an upper limit U and lower limit L
When there is too much cash and U is reached, cash is taken out (to buy short-term securities to earn interest) such that the cash balance goes to a return (R) point. Otherwise, if there is too little cash and L is reached, cash is deposited (from the short-term investments) to replenish the balance to R. The equations of the Miller-Orr Model are:
where R = the return point,
f = the fixed cost for each transaction to withdraw or deposit cash,
s 2 = the variance of the cash flows,
i = the interest rate per same time period as s 2 ,
U = the upper limit
L is determined by other means, for example, compensating balance requirement, minimum balance to avoid bank service charges on checking account, or zero.
The Stone Model is somewhat similar to the Miller-Orr Model insofar as it uses control limits. It incorporates, however, a look-ahead forecast of cash flows when an upper or lower limit is hit to take into account the possibility that the surplus or deficit of cash may naturally correct itself. If the upper control limit is reached, but is to be followed by cash outflow days that would bring the cash balance down to an acceptable level, then nothing is done. If instead the surplus cash would substantially remain that way, then cash is withdrawn to get the cash balance to a predetermined return point. Of course, if cash were in short supply and the lower control limit was reached, the opposite would apply. In this way the Stone Model takes into consideration the cash flow forecast.
The goals of these models are to ensure adequate amounts of cash on hand for bill payments, to minimize transaction costs in acquiring cash when deficiencies exist, and to dispose of cash when a surplus arises. These models assume some cash flow pattern as a given, leaving the task of cash collection, concentration, and disbursement to other methods”
© 2010, Godwin-Xavier Ayeebo