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Cash Management


1. Introduction to Cash Management

Management of cash is one of the most important areas of overall work­ing capital management due to the fact that cash is the most liquid type of current assets. As such it is the responsibility of the finance function to see that the various functional areas of the business have sufficient cash when­ever they require the same. 

At the same time, it has also to be ensured that the funds are not blocked in the form of idle cash, as the cash remaining idle also involves cost in the form of interest cost and opportunity cost. As such the management of cash has to find a mean between these two ex­tremes of shortage of cash as well as idle cash. 

2. Nature of Cash

Cash is the medium of exchange for purchase of goods and services and for discharging liabilities.


In cash management, the term has been used in two senses:

(a) Narrow Sense – Under this cash covers currency and generally accepted equivalents of cash, viz., cheques, demand drafts and banks demand deposits.

(b) Broad Sense – Here, cash includes not only the above stated but also near cash assets. They are Bank time deposits and marketable securities. 

3. Objectives of Cash Management

The prime objective of cash management is to channelize the flow of cash from the surplus to deficit units to maintain the appropriate liquidity position of the organization. In addition, the objectives of cash management can be broadly subdivided into two heads – maintaining the inflow and outflow of cash and sustaining the cash position held by the organization to meet the current obligations.


Other important objectives of cash management are discussed as follows:

i. Planning of Cash Flows – Refers to scheduling the cash inflow and outflow of an organization over a period of time. The planning of cash flow helps in maintaining an adequate amount of capital to finance day-to-day- functions of the organization.

ii. Synchronizing Cash Flows – Refers to developing equilibrium between inflow and outflow of cash in the business. If the amount of cash receipts (inflow) is equal to the cash payment (outflow) then there would be no requirement of holding extra cash.

iii. Optimizing Cash Holding – Refers to determining the appropriate amount of cash to be kept in the business to meet the contingency needs. It is the duty of the finance manager to decide the optimal cash holding to avoid any excess or deficit of cash.


iv. Investing Idle Cash – Refers to utilizing the idle cash kept in the business for short-term investment purposes. An organization can invest the idle cash in marketable securities for a short duration to earn a reasonable rate of return. The marketable securities are highly liquid in nature and can be easily converted into cash at a short notice.

4. Importance of Cash Management

Cash management is one of the critical areas of working capital management and assumes greater significance because it is the most liquid asset used to satisfy the firm’s obligations but it is a sterile asset as it does not yield anything. Therefore, the finance manager has to manage cash so that the firm maintains its liquidity position without jeopardizing profitability.

Problem of prognosticating cash flows accurately and absence of perfect coincidence between the inflows and outflows of cash add to the significance of cash management. In view of the above, at one time a firm may experience dearth of cash because payments of taxes, dividends, seasonal inventory, etc., build up while at other times, it may have surfeit of cash stemming out of large cash sales and quick collections of receivables.

It is interesting to observe that in real life a finance manager spends considerable time managing cash which constitutes relatively a small proportion of a firm’s current assets. This is why in recent years a number of new techniques have been evolved to minimize cash holding of the firm.  

5. Scope of Cash Management

Cash management refers to a systematic way of handling cash inflows and outflows resulting from business operations. Understanding the basic concepts of cash management will help business enterprises to plan for the unforeseen eventualities that nearly every business faces.

1. Cash Planning:

Cash planning is a systematic way of forecasting the cash requirements for a given period with an objective to maintain adequate cash balance in hand, sufficient to meet the payments and obligations as and when they mature. Thus it includes forecasting of cash inflows and cash outflows. A business must generate a positive cash flow, meaning that long-term cash outflows must be less than long-term cash inflows.

2. Managing Cash Flows:

Cash planning is a systematic way of forecasting the cash requirements for a given period with an objective to maintain adequate cash balance in hand, sufficient to meet the payments and obligations as and when they mature. 


Thus it includes forecasting of cash inflows and cash outflows. Managing cash inflows is the task of implementing policies and procedures regarding inflow and outflow of cash. It includes short term investment plans when cash in surplus and borrowing programmes during the days of cash deficit.

3. Optimum Cash Level:

Cash optimization here signifies to make as perfect or effective as possible. Most enterprises focus on cash flows but find them hard to control. The problem is not so much predicting investments and payments to creditors and owners but rather being able to optimize and control cash flows related to the day-to-day operation of the enterprise. Effective cashflow is essential for survival, profit and sound business.

4. Investing Idle Cash:


If the business has surplus cash balances available during certain periods of time, then it should consider investing in short-term marketable securities. On the other hand if business is consistently generating a cash surplus, then it should consider longer-term and higher yield investments. However a business need to be cautious and maintain a certain level of cash on hand to cover any unforeseen circumstances, or to take advantage of prompt payment discounts, as mentioned above. 

6. Factors Determining Level of Cash

Factors Determining Cash Needs and Level of Cash:

The factors affecting or determining the cash requirements of a business are as follows:

(1) Timing of Cash Flows:


The need for maintaining cash balance arises because cash inflows and cash outflows take place at different times. If cash inflows perfectly match cash outflows, i.e., if they take place at same time, there would be no need for keeping cash balance. Need for keeping cash balance arises when cash outflows exceed cash inflows. Therefore, the need for cash can be determined by forecasting cash inflows and cash outflows. Forecast is done through a cash budget.

(2) Cash Shortage Costs:

Cash budget would reveal the quantum as well as periods of cash shortages. Every shortage of cash involves a cost depending upon the quantum and duration of shortfall. Costs incurred as a result of shortfall of cash are called cash shortage costs.

Examples of cash shortage costs are:

(i) Transaction cost relating to raising cash to tide over the shortage such as brokerage etc. for sale of marketable securities.

(ii) Borrowing costs like interest etc. for borrowing to cover the shortage,


(iii) Penal interest charged by banks due to shortfall in compensating or minimum balances in the bank.

(iv) Costs due to deterioration of credit rating like shortage in the supply of raw-material, less favourable terms offered by suppliers and so on.

(v) Loss of cash discount because of non-payment in time due to shortage of cash.

Cash shortage costs should also be considered along with cash shortage itself in determining cash needs.

(3) Cash Excess Costs:

If a firm keeps cash balance in excess of its requirements, it will miss opportunities to invest it elsewhere. As a result it will lose interest which it would otherwise have earned by investing excess cash elsewhere. This factor should also be considered in determining the level of cash and therefore the level of cash should not be determined in excess.


(4) Cash Management Costs:

Cash management also involves some costs such as salary, clerical expenses etc. of cash management staff. Cash need should be determined after considering this factor also.

(5) Uncertainty:

Cash flows can never be predicted with complete accuracy and there is always some uncertainty in their forecast such as unexpected delay in collection from debtors. Firm must always keep some additional cash to meet these uncertainties.

(6) Firm’s Capacity to Borrow in Emergent Situations:

If a firm is able to borrow quickly in case of emergency, it can keep a low level of cash. Firm’s ability to borrow depends on many factors such as its credit standing, relation with the banks and so on.


(7) Attitude of Management:

The attitude of management towards liquidity and profitability affects the level of cash. If the management attaches more significance to liquidity than profitability, the level of cash will be high. On the contrary, if it gives more importance to profitability instead of liquidity, the level of cash will be low.

(8) Efficiency of Management:

If the management can accelerate the collection of cash from customers and slow down the disbursement of cash, it can keep a low level of cash. 

7. Motives for Holding Cash

A company may hold the cash with the various motives as stated below:

(1) Transaction Motive:


The company may be required to make vari­ous regular payments like purchases, wages/salaries, various expenses, inter­est, taxes, dividends etc. for which the company may hold the cash. Simi­larly, the company may receive the cash basically from its sales operations.

However, receipts of the cash and the payments by cash may not always match with each other. In such situations, the company will like to hold the cash to honour the commitments whenever they become due. This require­ment of cash balances to meet routine needs is known as transaction mo­tive.

(2) Precautionary Motive:

In addition to the requirement of cash for routine transactions, the company may also require the cash for such purchases which cannot be estimated or foreseen. E.g. There may be a sudden decline in the collection from the customers, there may be a sharp increase in the prices of the raw materials etc. The company may like to hold the cash balance to take care of such contingencies and unforeseen circumstances. This need of cash is known as precautionary motive.

(3) Speculative Motive:

The company may like to hold some reserve kind of cash balance to take the benefit of favourable market conditions of some specific nature. E.g. Purchases of raw material available at low prices on the immediate payment of cash, purchase of securities if interest rates are expected to increase etc. This need to hold the cash for such purposes is known as speculative motive. 

8. Compensating Balances

Compensating balances represent cash at Bank balances which are necessary to compensate for the services rendered by banks to the business concerns. For operating and maintaining a Current Account or- Savings Account in any bank, a minimum balance in the account has to be kept all the time. That is known as compensating balances to a business concern.

Ordinarily, the compensating balance is fixed by a bank after considering the income from an account and cost of operation of the same account. Bank offers a number of services to its clients for whom it compels its clients to leave a minimum balance in their accounts so that the banker may earn some interest and thus compensate to some extent its cost-free services to clients.

A.M. King has suggested a method for determining the compensating balance from the point of view of business concern- “Relate the cash balance to the amount needed to keep one’s banker happy. This brings to mind a simple procedure of trial and error to determine minimum cash level. Every three months reduce the average bank balance by 5 percent. Keep doing this until a bank officer calls to find out what has happened. At that point you know you have a working cash level which if not maintained, will cause you to be unpopular at the bank.” 

9. Cash Management Models

Let us discuss very briefly some of these models:

(i) Cash Cycle Model:

Cash cycle is a term which is used to signify the entire process of cash flow through an enterprise’s accounts. Cash is used to purchase raw materials which are used to produce goods. Production of these goods also involves the use of cash for paying wages and meeting other expenses. Goods produced are sold both for cash as well as on credit.

In the case of credit sales, the pending bills are realised at a later date. This cycle continues to be repeated in an accounting year several times. Thus, the flow of cash in a business passes through various channels. The magnitude of the flow in terms of time (days) may be depicted in the diagram ahead- 

Let us summarise the information reflecting from the above diagram:

(i) Raw materials reach the factory 10 days after placement of order.

(ii) Conversion period including inventory holding period (from B to E) is 15 + 2 + 20 = 37 days.

(iii) Payment to suppliers for raw materials purchase may be deferred to 17 days. (Time distance between B to D assuming it takes 2 days C to D for collection of cheques by supplier’s banks).

(iv) The amount of bill for goods sold is released after 36 days (from E to I, i.e., 30 + 2 + 2 + 2) after the sale of goods.

(v) The recovery of cash spent till point D is made after 56 days (20 + 30 + 2 + 2 + 2).

Cash cycle = Conversion period (Inventory holding period) + Average Collection period – Average Payment period

In the above case,

Cash cycle = 37 + 36 – 17 = 56 days

Another term used in cash cycle model is cash turnover. It signifies the number of times enterprise’s cash is used during each year.

It is determined by the formula:

Cash Turnover = 365 or 360/ Cash Cycle period in days

The amount of cash required shall be ascertained by applying the cash turnover to total cash operating expenses (annual). Thus,

Minimum cash requirement = Total Cash outlay p.a. / Cash Turnover

(ii) Baumol Model:

This model is based on the Economic Order Quantity (EOQ) model used in inventory control and therefore, also known as Inventory Model. Application of EOQ model to the determination of Optimum Cash Balance was suggested by William J. Baumol.

Working cash balance on the basis of this model is determined under the following assumptions:

(i) All cash flows are certain.

(ii) Cash inflows are periodic and instantaneous.

(iii) Cash outflows occur at a constant rate.

Under this model, efforts are made to balance two types of costs—cost of holding the cash (i.e., loss of interest by not investing the cash in marketable securities, a kind of opportunity cost) and transaction cost [i.e., brokerage and other charges payable on converting (selling) the marketable securities into cash].

This can be explained through the graphical figure given below: 

 It is assumed in the annexed figure that demand for cash in the concern during a definite period is steady. During this period the concern collects cash by selling the marketable securities. Let us assume that in the beginning the cash balance with the concern is Rs.C.

The moment cash balance is spent, the same time the concern sells marketable securities of the amount equal to C. As such, when cash amounts to zero, funds invested in marketable securities are converted or transferred into cash. However, the concern may sell securities even before the cash balance becomes zero.

Now the financial manager has to determine the amount of C. Obviously, the amount of C should be such as to involve possible minimum cost in terms of charges on the sale of securities (transaction costs) and also the cost of holding cash, i.e., loss of interest on securities to be sold.

These costs can be expressed as under:

Here ‘b’ stands for transaction costs, i.e., fixed charges in the transactions (purchase and sale) of securities, T stands for total demand for cash during a particular period and ‘I’ stands for rate of interest on securities for a definite period. Interest rate is assumed to be fixed.

T/C in the formula suggests how many times the securities would be sold during a definite period and when it is multiplied by ‘b’, i.e., transaction costs, we find cost of sale of securities during a particular period. C/2 indicates the average cash balance and when it is multiplied by the rate of interest, we find the amount of loss of interest by holding the cash.

It is thus clear that higher the amount of C, the more will be the loss of interest, but transaction costs will be less.

The optimum amount of C may be found by the following formula: 

(iii) Miller-Orr Model:

The basic assumptions of this model are:

(i) Firm has minimum required cash balance.

(ii) Cash flows are normally distributed.

(iii) Expected cash flow is zero.

(iv) There is no auto-correlation in cash flows.

(v) The standard deviation of cash flows does not change over time.

Based on the above assumptions, Miller-Orr Cash Model is basically an application of control limits theory to the cash decision/investment decision. In other words, this model is based on control principles. 

Two control limits (upper control limits and lower control limits) are determined.

When cash balance goes beyond (or outside) the upper control limit, some cash is invested in short-term securities just to bring the cash balance back to the return point. When the cash balance goes below the lower control limits, investments in short-term securities are being sold, so that cash balance may rise and reach a return point.

The formula developed by Miller and Or is: 

Here ‘V’ is the variance of daily cash flow; T is the daily interest rate on investments in Govt. securities; and ‘a’ is the transaction cost of investing or disinvesting. If the lower control limit is taken to be ‘L’, then the optimum return point is (R + L). The lower limit ‘L’ is set by the firm itself and is not determined within the model. It may be a zero cash balance (so that the firm does not go for overdraft) or it may be a minimum compensating balance. The optimum upper control limit is (3R + L).

Lower control limits, return point, upper control limits and the effects of cash flows for a hypothetical case are shown in the figure 4-

It may be observed that the firm has a policy of keeping Rs.1,00,000 as minimum balance and thus it is set as Lower Control Limit (LCL). Also assume that the firm on the basis of historical data has calculated the value of R to be Rs.75,000 and therefore, return point is 1,00,000 + 75,000 = Rs.1,75,000. Using (3R + L), Upper Control Limit (UCL) comes to Rs.3,25,000. 

The figure shows five days’ cash flows and their effects. It can be observed that on 2nd day the cash balance has reached below LCL necessitating the sale of securities as much as to bring cash balance equal to return point up to Rs.1,75,000.

On 3rd and 4th days cash balances are within control limits and hence no action is required. However, on the 5th day Cash balance exceeds UCL (Rs.3,25,000) and therefore, cash balance on this day over Return point (Rs.1,75,000) will be invested in securities leading 6th day to start with return point.

This model is intended to be used when the concern has no valid future information about day-to-day cash flows. However, concerns may have knowledge about part of their cash flows with considerable certainty (as in the case of cash disbursements) but may be uncertain about other parts of the cash flows.

Where the concerns have some knowledge of future cash flows (may not be error free), Miller-Orr Model may provide non-optimal results. Take for example; when the cash balance exceeds Upper Control Limit, the model suggests that the concern should invest in short-term securities.

But if the concern has knowledge that major cash outflows are imminent, the decision to investment may not be a fair strategy. It would be better for the concern to ignore the investment as signaled by the model, to keep the cash to cover the outflow and also to save transaction costs. This limiting aspect of Miller-Orr Model has been taken care for in another model, i.e., Stone model.  

(iv) Stone Model:

This model is based on the assumptions given below:

(i) Firm has a minimum required cash balance.

(ii) Firm has some knowledge of future cash flows, although this knowledge contains an error component.

In fact, the last point of assumption has rendered Miller-Orr Model un-practicable. This model attempts to improve the decisions regarding investment and disinvestment on the basis of expected future cash flows particularly the outflows. This model also involves control limits.

But these control limits are of two sets-inner control limits (UCL1 and LCL1) and outer control limits (UCL2 and LCL2). The concern performs no evaluation (i.e., investment or disinvestment) until its cash balance falls outside the outer control limit. 

But when such a situation comes, i.e., cash balance falls outside the outer limit the concern thinks ahead by adding the expected cash flows for the next few days to the current balance.

If the total sum falls outside the inner control limits, a transaction (investing or disinvesting) is made, otherwise the transaction is foregone. It is to be remembered that the transactions relating to investments and their volumes are the same as those in Miller-Orr model. 

In other words, investments are made to bring the cash balance back to the return point if the upper control limit is crossed; corresponding investments are to be sold if the lower control point is crossed.

The outer control limits in Stone Model could be set by the Miller-Orr’s formula. Of course, internal control limits can be set at an amount slightly less than outer control limits.

The Stone model is flexible. The parameters of the model may be changed over time to accommodate concern’s needs. However, the model does not specify the optimum levels of the parameters. 

10. Management of Cash Flows

In order to manage cash properly a finance manager has to ensure that cash is flowing in and flowing out as per the plan. 

This requires comparison of actual performance against predetermined plans and objectives, finding discrepancies, if any, analyzing their variations in order to pinpoint the underlying causes and finally, taking remedial steps to correct the anomaly. All this is possible with the help of a cash budget report.

Besides, efficient utilization of cash involves accelerating cash inflows and slowing disbursements. There are various methods of speeding cash collections and delaying payments.

We shall now discuss each of these methods below:

1. Methods of Accelerating the Cash Inflows:

(i) Quick Deposit of Customer’s Cheques:

One way of shortening the time lag between the date when a customer signs a cheque and the date when the funds are available for use is to make an arrangement for quick deposit of the cheques in the banks. Special attention should, therefore, be given to large remittances. For example, these may be deposited individually or air-mail service should be used for such remittances.

(ii) Establishing Collection Centres:

To accelerate the cash turnover a nationwide organisation may, instead of a single collection centre, establish collection centres in various marketing centres of the country. The customers are instructed to remit their payments to the collection centre of their region.

The collection centre deposits the cheques in the local bank. These cheques are collected quickly because many of them originate in the very city in which the bank is located. Surplus of money of the local bank can then be transferred to the company’s main bank.

Thus, with this decentralized system of collection the company stands to gain two main advantages. First, time required to mail bills of customers is reduced because bills are handed over to customers by the collection centre of the area.

Again, time the customer’s payments reach the company’s head office is also reduced because the collection centre will receive all the payments whether cash or cheques from the customers of its region.

Secondly, the decentralized system hastens the collection of cheques because most of the cheques deposited in the company’s regional bank are drawn on banks located in that area. Thus, the company can reduce the time a cheque takes to collect.

Thus, if a company could reduce, say for example, two days – One day in mailing bill and one day in collection of cheques by adopting the decentralized system and if the company’s average daily remittances amount to say Rs.20 lakhs, funds of about Rs.40 lakhs could be released for investment elsewhere.

This would increase the profits of the company. However, the company will have to incur additional cost to man these collection centres. An in depth cost- benefit analysis of each region, where the collection centre is to be set up, therefore, should be undertaken by the company.

(iii) Lock-Box Method:

Another device which has become popular in the recent past is lock-box method which will help reduce the time interval from the mailing of the cheque to the use of funds by the firm. Under this arrangement, the company rents lock-boxes from post offices through its service area.

The customers are instructed to mail cheques to the local box. The company’s bank branch picks up the mail from the lock several times a day and deposits them in the company’s account and on the same day sends the firm by airmail the deposit slip listing all the cheques deposited.

Thus, the company is free from the bother of receiving, processing, endorsing and depositing remittance cheques and accordingly, overhead cost of the company is reduced to that extent. It takes less time under the lock-box system in mailing cheques for deposit in banks and in their collection.

Instead of going to the regional collection office and then to the bank, cheques go directly to the company’s bank via the lock-box. Another advantage of this arrangement is that it reduces the exposure to credit losses by expediting the time at which data are posted to ledgers.

However, the basic limitation of the lock-box system lies in additional cost which the company’s bank will charge in lieu of additional services rendered. Since the cost for these services is directly in proportion to the number of cheques handled by the bank, obviously the lock-box arrangement will prove useful and economical too particularly when average remittance is large.

Before deciding to adopt the lock-box system a finance manager must compare the added income on funds released as a consequence of speedy collection of remittances with the increased cost entailed in the system. If the benefits are more than the cost, obviously the company should use the lock-box system otherwise the idea of employing the system should be dropped.

(iv) Other Methods:

Cash balances lying idle in the company’s name in several banks could be minimized without any loss in banking service. The most important measure that can be used in this respect is to eliminate many such bank accounts as were originally opened and subsequently maintained just for building up a strong image in the market.

Thus, with a few accounts in bigger banks having their branches scattered all over the country the company can handle customer’s cheques as effectively as earlier with several unnecessary accounts. By closing the superfluous accounts the company can release fund for investment in profitable channels.

Another device of improving the efficiency of cash utilization in the company is to set a maximum limit which each bank of the company will maintain at one time. The banks may be given instruction that any balance in excess of the stipulated limit should be immediately transferred by wire to the company’s principal bank.

The principal bank, in turn, may be instructed to invest funds in excess of the limit set for it in highly liquid assets. Thus, without jeopardizing liquidity the company manages to increase its profits under the above arrangement.

The firm should also tighten control over transfer of cash between its various units so that excessive funds are not tied in some units.

2. Methods of Slowing Cash Outflows:

In order to optimize cash availability in the firm a finance manager must employ some devices that could slow down the speed of payments outward in addition to accelerating collections.

We shall now discuss some of the important methods that may delay disbursements:

(i) Delaying Outward Payment:

By delaying the payment on bills until the last date of the no-cost period, finance managers can save cash resources. If purchases are made on terms of 1/10, n/30, this method suggests that payment should be made on the 10th day. In this way the firm hot only avails the benefits of discount but also releases funds for eight days for investment in short-term channels.

(ii) Slowing Disbursement by Use of Drafts:

A company can delay disbursement by the use of drafts on funds located elsewhere. Payments could be made through cheques but for that drawer of the cheque must have the funds in the bank. Contrary to this, draft is payable only on its presentation to the issuer for collection.

Thus funds have to be provided to meet a draft only when it is presented by the bank for payment. This arrangement will delay the time the company is required to deposit money in its bank to cover draft. If the term of trade is 2/10, n/30, a company can mail the draft to the supplier on the 10th day. The supplier will present the draft to his bank for its presentation to the buying company’s bank.

It will take several days for the draft to be actually paid by the company. Finance managers can thus economies large amounts of cash resources for at least a fortnight, the funds so saved could be invested in highly liquid low risk assets such as treasury bills to earn income thereon.

(iii) Making Payroll Periods Less Frequent:

This can also help a company to economies cash. If the company is currently disbursing pay to its employees weekly, it can affect substantial cash savings in case it is disbursed only once in a month.

(iv) Where Payroll is Monthly:

A finance manager should predict as to when employees will present cheques to the company’s bank for collection. Supposing if pay day falls on Saturday, not all cheques will be presented on that day. The company need not deposit funds to cover its entire payroll.

Even on Monday, some employees may not present cheques for payment. Thus, on the basis of the past experience, the finance manager could estimate on an average, the cheques presented on the pay day on the subsequent day for payment. Accordingly, a finance manager can assess fund requirements to cover payroll cheques on different days.

(v) Using Float:

Float is the difference between the company’s cheque book balance and the balance shown in the bank’s books of account. When a firm writes a cheque, it will reduce the balance in its books of account by the amount of the cheque. But the bank will debit the amount of its customers only after a week or so when the cheque is collected.

Thus, there is no strange if the firm’s books show a negative balance while the bank’s books show positive balance. The firm can make use of the float if the magnitude of the float can be accurately estimated.

In all these methods of delaying payments, the company’s reputation is likely to be damaged. The cost that would thus result must be taken into account.

(vi) Inter-Bank Transfer:

Another method of making efficient use of cash resources is to transfer funds quickly from one bank to another bank where disbursements are to be made. This would prevent building up of excess cash balances in one bank. This procedure could be adopted by a company having accounts with several banks. 

11. Advantages of Ample Cash

As we know that without cash we cannot run the business. Cash is the backbone of every business. Without cash no firm can survive. So the planning of cash is one of the primary responsibilities of a financial manager.

A firm having sufficient cash balance can drive the several advantage some of them are listed below:

1. Increase in Goodwill:

The goodwill or reputation of a business firm depends to a large extent on this fact that the firm retires all the obligations and meets the payments as and when they mature. It can be possible only when the firm maintains a good cash balance.

2. Cash Discount:

Cash discount is received when we pay in cash and only a firm having the adequate cash balance can avail cash discounts offered by the suppliers. It will lower down the cost of raw material and the cost of production. Hence by decrease in cost of production the profit margin will automatically increase.

3. Good Bank Relations:

Commercial banks like to maintain good relations with such firms having high liquidity in funds. Such firms can avail credit facility from the banks at a reasonable rate of interest.

4. Encouragement to Investors:

Generally the dividends are paid in cash. Investors like to have dividends in cash form only. To pay a high cash dividend a firm requires adequate cash balance also. A firm having a good cash position can maintain a sound cash dividend policy. This encourages the investors to invest in the shares of such firms because shareholders are attracted towards cash dividend.

5. Exploitation of Favorable Market Conditions:

Only concerns with adequate cash can exploit favourable market conditions such as purchasing its requirements in bulk when the prices are lower and by holding its inventories for higher prices.

6. Ability to Face Crisis:

Adequate cash enables a concern to face business crisis such as depression because during such periods, generally, there is much pressure on working capital. So a firm having sufficient working capital can easily face the adverse conditions of the business.

7. High Efficiency and Morale:

Unless there is an adequate supply of cash, production cannot be carried out smoothly. Uninterrupted production process increases labour efficiency. Adequacy of cash increases the morale also.

Adequate cash balance with the firm creates an environment of security, confidence, and high morale and creates overall efficiency in a business. As earlier mentioned with ample cash we can pay the salary and wages on time that will increase the morale of employees also.  

12. Cash Budget 

Cash budget is an extremely important tool available in the hands of a finance manager for planning fund requirements and for controlling cash position in the firm. As a planning device, a cash budget helps the finance manager to know in advance the cash position of the firm in different time periods.

The cash budget indicates in which months there will be cash surfeit and in which months the firm will experience cash drain and by how much.

With the help of this information finance manager can draw up a programme for financing cash requirements. There will be two advantages if the finance manager knows in advance as to when additional funds will be required. First, funds will be available in hand when needed and there will be no idle funds.

In the absence of the cash budget it may be difficult to determine cash requirements in different months. If cash required is not available in time it will land the firm in a precarious position. 

Importance of Cash Budget:

Cash budget is an important budget for any business concern.

The main advantages of preparing cash budget are as follows:

1. Estimate of Future Position of Cash:

It can be estimated with the help of a cash budget that how much cash will be needed and when and what will be the position of availability of cash during the budget period. If there is a position of shortage of cash, proper arrangement can be made by securing bank overdraft or short-term borrowings. On the contrary if there is a position of surpluses, a plan can be made for profitable investment of such funds.

2. Control over Cash Expenditure:

The cash expenses of various departments of an enterprise can easily be controlled with the help of a cash budget because it reveals the estimated expenditure of each department. These figures can be compared with reasonable expenditure and possible cash receipts and necessary corrective actions may be taken.

3. Formulation of Suitable Dividend Policy:

Cash budget enables the management to formulate a suitable dividend policy. If the business is not able to obtain sufficient inflow of cash then the business can restrict its cash dividends.

4. Helpful in Financial Planning:

Cash budget is extremely useful as a tool for financial planning because it may facilitate coordination between cash on the one hand and working capital, sales, investments or loan on the other hand.

5. Regulation of Other Budgets:

Cash budget regulates other budgets such as sales budget, capital budget, etc.

6. Helpful in Fulfillment of Seasonal Needs:

This budget is more helpful in those concerns where there are wide seasonal fluctuations.

7. Justification of Cash Requirements:

The system of preparing a cash budget helps to convince the bank and other financial institutions about the bona-fides of the cash requirement of the concern.Thus, it is clear that cash budget is an important tool of managerial control. In fact, it is like a mirror in which the pattern of future cash flow is reflected. 


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