Cash Management
Cash Cycle
Factors that influence the desired level
of cash
Optimal cash inventories
Short-term investment strategies
The Manager
Resource Decisions
Investment Decisions
Operating
Decisions
Human Resources
Decisions
Managing an entity’s Resources
Cash Management
Inventory Management
Working Capital Management
Investment in Human Capital
Long-term Assets
Accounts Receivable
Recruitment, Selection
Training, Productivity
Performance Appraisal
Compensation
Unions & Labor Relations
Information
Decisions
Economics of Information
Database Management
Data Modeling
IS Planning & Development
Financing Decisions
Debt vs. Tax Financing
Life cycle effects,
Business cycle,
public events,
etc.
Cash Inflows
Value
Creation
Discount Rate
Cost of
Capital
Financial
Markets
Overview
ST fin’l planning = deals w/ short-lived assets and liabilities
(working capital management);
concerned w/ 1) size of investment in CA like cash, A/R,
Inventory…a tool is cash budget analysis and 2) how to
finance ST assets…a tool is performing credit analysis
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
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 are
inputs to a cash budget and how they affect
the cash balance
Objectives of Public Money
Managers
Bringing the entity’s cash resources
within control
Achieving optimum conservation and
utilization of the funds
Key areas of Public Cash
Management
Organization
Collection and disbursement of funds
Netting of interagency payments
Investment of excess funds
Optimal level of cash balances
Cash planning and budgeting
Bank relations
Treasury Management of
Cash Balances
Operate with smaller amount of cash
Supervision is centralized
Better service from banks
Proper allocation of funds
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)
The size of the minimum cash
balance depends on:
• How quickly and cheaply a organization can raise
cash when needed.
• How accurately managers can predict cash
requirements.
– (Cash Budget helpful)
• How much precautionary cash the managers need
for emergencies.
The organization’s maximum cash
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 making
an investment
• Demand for Cash for daily transactions
– (Cash Budget helpful)
Consider Cash an ‘Inventory’
the
- holdapproach
little cash = invest
Antrade-offs:
inventory
to Cash
remainder
in M/S to earn
interest
Balance
decisions:
Grantsville has a daily demand for cash of $10,000.
Grantsville’s
treasurer
invests
excess
cash in the state investment pool
- if hold too
little cash
= incur
transactions
that earns
.01%
day.
In order to transfer funds from the state pool,
costs to
meetper
cash
needs
Grantsville must pay a transaction cost of $20. How much cash should
it transfer when it runs out. (Grantsville can complete the cash transfer
electronically so it waits- hold
until lots
the of
cash
cash
balance
= forgoisinvesting
zero). in M/S
and earning interest
Optimal Cash Balance via Baumol Model
50000000 1002 504 339.3333333 258 210
r = .01%  .0001
M = $10,000
TC = $20
Cost ($)
Z*=
Z*  [(2M*TC)/r]
Total Costs
Z = $63,246
Holding Costs:
(Z/2)*r
Order Costs:(M/Z)*TC
Z*
Order Quantity (Z)
Problems with the Baumol Model
•
Cash flows may not be very predictable, much less
constant
•
Treasurers may want a ‘safety stock’ of cash
The Miller - Orr Model
• The Miller-Orr Model provides a formula for
determining the optimum cash balance (Z), the
point at which to sell securities to raise cash
(lower limit L) and when to invest excess cash by
buying 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
The Miller - Orr Model
Upper Limit
Buy Securities
H
Z
L
Lower Limit
Sell Securities
Days of the Month
The Miller-Orr Model
- Target Cash Balance (Z)
3
Z=
3 x TC x V
+L
4xr
where: TC = transaction cost of buying
or selling securities
V = variance of daily cash flows
r = daily return on short-term
investments
L = minimum cash requirement
The Miller-Orr Model
- Target Cash Balance (Z)
• Example: Suppose that short-term securities yield
5% per year and it costs the organization $50 each
time it buys or sells securities (TC). The daily
variance of cash flows is $1000 (V) and your bank
requires $1,000 minimum checking account
balance (L).*
Z=
3
3 x 50 x 1000
4 x .05/360
+ $1,000
= $3,000 + $1,000 = $4,000
The Miller-Orr Model
- Upper Limit
• The upper limit for the cash account (H) is
determined by the equation:
H = 3Z - 2L
where:
Z = Target cash balance
L = Lower limit
• In the previous example:
H = 3 ($4,000) - 2($1,000) = $10,000
The Miller - Orr Model
Upper Limit
Buy Securities
$10,000
$4000
$1000
Lower Limit
Sell Securities
Days of the Month
Cash Pooling
Centralized cash management involves transfer
of an agency’s cash in excess of minimal
operating requirements into a centrally
managed
account also known as a cash pool.
Procedure
and
Benefits
Investment of excess funds
The Collection & Disbursement of Public Funds
Managing Cash Balances
• Safety
• Liquidity
• Maximize pool of funds
available for investment
– Concentration Accounts
– Zero-balance accounts
• Highest yield
Controlling Cash
Collection &
Disbursement
• Dual responsibility
• Receipts maintained in a
location separate from
cash & checks
• Certification of vouchers
Collection of funds
Need for accelerating collections
How to accelerate collection of receivables
Disbursement of funds
Importance 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
Payments Netting in Public
Cash Management
Need for payments netting
Procedure involved
Only netted amount is transferred (bilateral
netting)
Netting center (multilateral netting)
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 are
inputs to a cash budget and how they affect
the cash balance
Stop Here
Payments netting in Public
Cash Management (contd.)
Payments Netting in Public
Cash Management (contd.)
Cash Planning and Budgeting
Cash Planning and Budgeting
(contd.)