19.3 Cash Management

Cash management is crucial for businesses to maintain liquidity and financial stability. It involves balancing transaction needs, precautionary reserves, and speculative opportunities. Companies use various techniques to optimize cash flow, including short-term investments and careful budgeting.

Effective cash management strategies help businesses make the most of their resources. This includes using tools like cash budgets to forecast and plan, as well as implementing techniques such as float management and electronic funds transfer to streamline cash flows and maximize efficiency.

Cash Management

Reasons for holding cash

• Transaction motive involves holding cash to meet day-to-day operating expenses such as paying suppliers (inventory purchases), employees (salaries and wages), and taxes (income or property taxes)
• Precautionary motive entails holding cash as a safety net for unexpected events (equipment breakdowns) or emergencies (natural disasters), providing a buffer against cash flow volatility and helping maintain liquidity during economic downturns (recessions) or industry-specific challenges (supply chain disruptions)
• Speculative motive refers to holding cash to take advantage of potential investment opportunities, allowing companies to quickly invest in projects (research and development), acquisitions (buying competitors), or other strategic initiatives (entering new markets), enabling firms to capitalize on favorable market conditions (low interest rates) or bargain prices (discounted assets)

Short-term investment options

• ###Treasury_bills_(T-bills)_0### are short-term government securities with maturities of one year or less, considered one of the safest investments due to government backing but offering lower returns compared to other short-term investments
• Commercial paper consists of unsecured, short-term debt instruments issued by corporations, typically having maturities ranging from a few days to a few months and higher yields than T-bills but also higher risk
• Certificates of deposit (CDs) are time deposits offered by banks, requiring funds to be held for a specific term with maturities ranging from a few months to several years and generally offering higher interest rates than savings accounts, with longer maturities providing higher yields
• Money market funds are mutual funds that invest in short-term, low-risk securities (government bonds, corporate bonds), providing liquidity and aiming to maintain a stable net asset value (NAV) while offering diversification and professional management of short-term investments

Cash budgets for planning

• Cash budgets are financial projections that estimate a company's future cash inflows (sales revenue, investments, financing) and outflows (operating expenses, capital expenditures, debt repayments) over a specific period
• Key components of a cash budget include:
  1. Beginning cash balance representing the company's cash position at the start of the budgeting period
  2. Projected cash inflows such as sales revenue (customer payments), investments (dividends, interest), and financing (loans, equity issuance)
  3. Projected cash outflows like operating expenses (rent, utilities), capital expenditures (equipment purchases), and debt repayments (loan installments)
  4. Ending cash balance calculated as the beginning cash balance plus projected inflows minus projected outflows
• Cash budgets serve several purposes:
  • Forecasting cash surpluses (excess cash) or deficits (cash shortfalls), enabling proactive management of cash positions
  • Identifying potential liquidity issues (inability to meet short-term obligations) and allowing time to arrange financing (bank loans) or adjust spending (cost-cutting measures)
  • Optimizing the timing of cash inflows and outflows to minimize idle cash (opportunity cost) and maximize returns (investing excess cash)
  • Facilitating decision-making related to investments (capital budgeting), financing (debt vs equity), and dividend policies (payout ratios)
• Cash budgets are typically prepared on a monthly or quarterly basis and can be updated regularly to reflect actual performance (variance analysis) and changes in assumptions (revised sales forecasts)
• Sensitivity analysis can be performed on cash budgets to assess the impact of different scenarios such as changes in sales (demand fluctuations), expenses (input costs), or interest rates (borrowing costs) on the company's cash position

Cash Management Techniques

• Float management involves optimizing the time between when a payment is made and when it clears the bank, allowing companies to maximize their available cash
• Lockbox systems streamline the collection process by having customers send payments directly to a post office box managed by the company's bank, reducing processing time and improving cash flow
• Zero-balance accounts help minimize idle cash by automatically transferring excess funds to a central account or investing them in short-term securities
• Cash concentration techniques consolidate funds from multiple accounts into a single master account, improving control and visibility of cash positions
• Electronic funds transfer (EFT) systems enable rapid movement of funds between accounts, reducing transaction costs and improving cash management efficiency
• Working capital management focuses on optimizing the balance between current assets and current liabilities to ensure sufficient liquidity while maximizing profitability