Cash Management

Sl. No Company

2014-Cash & Bank

(Cr) % of Total Liabilities

1 SBI 132550 8

2 Bank of India 61382 11

3 Canara Bank 44829 9

4 ICICI Bank 41530 7

5 HDFC Bank 39584 9

6 Reliance Ind 36624 13

7 Infosys 24100 57

8 NMDC 18657 62

9 IDBI Bank 16818 5

10 NTPC 15311 10

11 TCS 12566 28

12 BHEL 11873 33

13 Oil India 11544 38

14 ONGC 10799 8

15 MRPL 10672 67

16 Wipro 10555 31

17 Coal India 9818 60

18 HCL Tech 7911 50

19 HDFC 7716 5

20 Rajesh Exports 7088 124

Top 20 Indian Cash Rich Companies

Working Capital Status of Indian Companies INFOSYS 2014 2013 2012

Cash and Bank Balance 24100 20401 18057

Total Current Assets 31436 26766 23461

% of Cash to TA 0.77 0.76 0.77

Current Ratio 3.7 4.75 4.91

Quick Ratio 3.65 4.69 4.88

Inventory Turnover Ratio -- -- --

Debtors Turnover Ratio 6.47 6.25 6.5

TCS

Cash and Bank Balance 12566 4054.16 3280.07

Total Current Assets 27047 15262.82 12391.9

% of Cash to TA 0.46 0.26 0.26

Current Ratio 3.18 2.85 2.48

Quick Ratio 3.16 2.88 2.47

Inventory Turnover Ratio 7546.4 7638.19 9386.12

Debtors Turnover Ratio 5.04 4.77 5.59

RELIANCE INDUSTRY

Cash and Bank Balance 36624 49547 889

Total Current Assets 90220 104156 55268

% of Cash to TA 0.41 0.48 0.016

Current Ratio 1.11 1.43 1.44

Quick Ratio 1.03 1.12 1.17

Inventory Turnover Ratio 9.09 8.43 10.42

Debtors Turnover Ratio 34.61 23.78 18.4

Target Cash Balance Motives of Holding Cash: (a) Transaction (b) Precautions (c) Speculation

Determining the Target Cash Balance: 1. William Baumol Model (W.J.Baumol, The transactions demand for cash: An inventory theoretic approach, Quarterly journal of economics 66, Nov 1952, pp-545-556)

2. The Miller-Orr Model (Miller, M.H. and Orr, D., A model for demand for money by firms. Quarterly, journal of economics, no. 80, August 1966, pp-413-435)

Costs of Holding Cash

Opportunity

Costs

Trading costs

Total cost of holding cash

C*

Costs in holding

cash

Size of cash balance

The investment income

foregone when holding cash.

Trading costs increase when the firm

sell securities to meet cash needs.

The Baumol Model

F = The fixed cost of selling securities to raise cash

T = The total amount of new cash needed

R = The opportunity cost of holding

cash, the interest rate.

Time

C

1 2 3

C

2

If we start with $C,

spend at a constant rate

each period and replace

our cash with $C when

we run out of cash, our

average cash balance

will be . C

2

The opportunity cost

of holding is C

2 C

2 R

The Baumol Model

Time

C

As we transfer $C each

period we incur a

trading cost of F each

period.

1 2 3

C

2

The trading cost is F T C

T C

If we need $T in total

over the planning

period we will pay $F

times.

The Baumol Model

C* Size of cash balance

FT

RC

C2

cost Total

Opportunity

Costs

RC

2

FT

CTrading costs

The optimal cash balance is found

where the opportunity costs equals

the trading costs FR

TC

2*

The Baumol Model

Opportunity Costs = Trading Costs

FC

TR

C

2

The optimal cash balance is found where the opportunity

costs equals the trading costs.

R

TFC

2*

Multiply both sides by C

FTRC

2

2

R

FTC

22

Baumol Model Example

Total cash outflows = $500,000 per month.

Total cash inflows from operations = $400,000

per month.

Net cash needs = $500,000 - $400,000 =

$100,000 per month, or $1,200,000 each year.

Costs:

Transaction/order costs = $32 per transaction (F)

r = 7% = rate the firm can earn on its marketable securities

123,33$07.0

)1200000)(32(2C*

Optimal cash transfer size

The optimal "order size" is $33,123, so the firm will liquidate marketable securities, or borrow from the bank, in blocks of $33,123. This is approximately $1,200,000/33,123 = 36 times a year, or about every week and a half.

F, r C* $32, 7% $33,123 $50, 7% $41,404 $32, 5% $39,192 Higher order costs, lower carrying costs increase the optimal order size.

The Miller-Orr Model

The firm allows its cash balance to wander randomly between upper and lower control limits.

$

Time

U

Z

L

When the cash balance reaches the upper control limit U, cash

is invested elsewhere to get us to the target cash balance Z.

When the cash balance

reaches the lower

control limit, L,

investments are sold to

raise cash to get us up

to the target cash

balance.

The Miller-Orr Model Math

Given L, which is set by the firm, the Miller-Orr model solves for Z and U

LR

FZ 3

2*

4

3 LZU 23 **

where s2 is the variance of net daily cash flows.

The average cash balance in the Miller-Orr model is:

3

4balancecash Average

* LZ

Implications of the Miller-Orr Model

To use the Miller-Orr model, the manager must do four things:

1. Set the lower control limit for the cash balance.

2. Estimate the standard deviation of daily cash flows.

3. Determine the interest rate.

4. Estimate the trading costs of buying and selling securities.

Implications of the Miller-Orr Model

The model clarifies the issues of cash management: The best return point, Z, is positively related

to trading costs, F, and negatively related to the interest rate R.

Z and the average cash balance are positively related to the variability of cash flows.

Investing Idle Cash

A firm with surplus cash can park it in the money market.

Some large firms and many small ones use money market mutual funds.

Firms have surplus cash for three reasons:

Seasonal or Cyclical Activities

Planned Expenditures

Different Types of Money Market Securities

Seasonal Cash Demands

Long-term

financing

Short-term

financing

Time

Total Financing needs

J F M A M

Marketable

securities

Bank loans

Cash Budget: The Primary Cash Management Tool

Purpose: Uses forecasts of cash inflows, outflows, and ending cash balances to predict loan needs and funds available for temporary investment.

Timing: Daily, weekly, or monthly, depending upon budgets purpose. Monthly for annual planning, daily for actual cash management.

Data Required for Cash Budget

1. Sales forecast.

2. Information on collections delay.

3. Forecast of purchases and payment terms.

4. Forecast of cash expenses: wages, taxes, utilities, and so on.

5. Initial cash on hand.

6. Target cash balance

Cash Budget for January and February- An Example

Net Cash Inflows January February

Collections $67,651.95 $62,755.40

Purchases 44,603.75 36,472.65

Wages 6,690.56 5,470.90

Other Exps. 2,500.00 2,500.00

Total payments $53,794.31 $44,443.55

Net CF $13,857.64 $18,311.85

Cash at start if no borrowing $ 3,000.00 $16,857.64

Net CF 13,857.64 18,311.85

Cumulative cash $16,857.64 $35,169.49

Less: target cash 1,500.00 1,500.00

Surplus $15,357.64 $33,669.49

Forecasted cash budget indicates that the companys cash holdings will exceed the targeted cash balance every month..

Cash budget indicates the company probably is holding too much cash.

Company could improve the position either investing its excess cash in more productive assets or by paying it out to the firms shareholders.

What reasons might be for the company to maintaining a relatively high amount of cash?

If sales turn out to be considerably less than expected, the company could face a cash shortfall.

A company may choose to hold large amounts of cash if it does not have much faith in its sales forecast, or if it is very conservative.

The cash may be there to fund a planned fixed asset acquisition.

Ways to Minimize Cash Holdings

Use lockboxes. Insist on wire transfers from customers. Synchronize inflows and outflows. Use a remote disbursement account. Increase forecast accuracy to reduce the need

for a cash safety stock. Hold marketable securities instead of a cash

safety stock. Negotiate a line of credit (also reduces need for

a safety stock).

Marketable Securities

Considerations

Financial Risk - uncertainty of expected returns due to changes in issuers ability to pay.

Interest rate risk - uncertainty of expected returns due to changes in interest rates.

Liquidity - ability to transform securities into cash. Taxability - Taxability of interest income and capital

gains. Yield - Influenced by the previous 4 considerations.

A. Cash cycle policies and tactics B. Forecasting and review process C. Organizational design and incentives

Other Factors of cash management

A.Cash cycle policies and tactics

Managing cash cycle through active management of accounts payable, receivable and inventory.

Accounts payable management Pay first deliveries (cash on

delivery, COD) Initially pay bill on time Maintain perfect credit with

several suppliers Test suppliers terms Prioritize vendors Manage supplier base Pay early when possible

Inventory Management Off-load buffer inventory

levels Adjust production shifts

between peak and non-peak seasons

Add sales and inventory forecasting systems

Discount excess inventory Perform regular inventory

audit

Accounts receivable Create rigorous credit review

process Actively monitor aging reports Establish and enforce collections

policy Make noise Offer discounts for pre-payments Hire capable collection personnel Establish relation with customers Fire bad customers Review credit lines annually Know the customers business Factor receivables

B: Forecasting and review process- Anticipate cash requirements Prioritize use of cash Identify variances and reinforce

a culture of prudent cash management within the organizations.

C: Organizational design and incentives Assign overall cash management

responsibilities Assign collection responsibility Assign purchasing approval

responsibilities

Marketable Securities

Types

Treasury Bills - short term securities issued by the government.

Government Agency Securities - Debt issued by agencies of govt.

Bankers Acceptances - short term securities used in international trade. Sold on discount basis.

Negotiable CDs - short-term securities issued by banks

Commercial Paper - short-term unsecured instruments sold by large reputable firms to raise cash.

Repurchase Agreements - an investor acquires short-term securities subject to a commitment from a bank to repurchase the securities on a specific date.

Money Market Mutual Funds - a pool of money market securities, divided into shares, which are sold to investors.

Example: The annual cash requirement of Amul Ltd. is Rs10 lakhs. The company has marketable securities in lot sizes of Rs50000, Rs100000, Rs200000, Rs250000 and Rs500000. Cost of conversion of marketable securities per lot is Rs1000. The company can earn 5% annual yield on its securities. You are required to prepare a table indicating which lot size will have to be sold by the company. Also show that the economic lot size can be obtained by the Baumol Model.

annual requirement of cash 1000000 1000000 1000000 1000000 1000000

lot size of securities 50000 100000 200000 250000 500000

No. of lots 20 10 5 4 2

conversion cost per lot 1000 1000 1000 1000 1000 total coversion cost (20*1000) 20000 10000 5000 4000 2000 average lot size of securities 25000 50000 100000 125000 250000

interest charges= avg size *5% 5% 1250 2500 5000 6250 12500

total cost 21250 12500 10000 10250 14500

minimum cost at 200000 lot size. So it is the economical lot size

as per Baumol Model = c= sqr(2AO/Int) 4000,0000000

C= optimum transaction size 200,000 this is the optimum size

O= Fixed cost per transaction i.e. Rs1000 A= estimated annual requi. Of cash Rs10 lkakh

Int= 5%

Answer