cash cycle factors that influence the desired level of cash optimal cash inventories

Cash ManagementCash Cycle Factors that influence the desired level of cash Optimal cash inventories Short-term investment strategies... ST fin’l planning = deals w/ short-lived assets a

Cash Management

Cash Cycle Factors that influence the desired level

of cash Optimal cash inventories Short-term investment strategies

Investment in Human Capital Long-term Assets

Accounts Receivable

Economics of Information Database Management Data Modeling

IS Planning & Development

Debt vs Tax Financing Cost of

Capital

Discount Rate

Value Creation

Financial Markets

Cash Inflows

Operating

Decisions

Recruitment, Selection Training, Productivity Performance Appraisal Compensation

Unions & Labor Relations

Life cycle effects, Business cycle, public events, etc.

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?

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 fundsNetting of interagency payments

Investment of excess funds

Optimal level of cash balances

Cash planning and budgeting

Bank relations

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’

Grantsville has a daily demand for cash of $10,000.

Grantsville’s treasurer invests excess cash in the state investment pool that earns 01% per day In order to transfer funds from the state pool, 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 until the cash balance is zero)

An inventory approach to Cash

Balance decisions:

the trade-offs: - hold little cash = invest

remainder in M/S to earn interest

the trade-offs: - hold little cash = invest

remainder in M/S to earn interest

- if hold too little cash = incur transactions

costs to meet cash needs

- if hold too little cash = incur transactions

costs to meet cash needs

- hold lots of cash = forgo investing in M/S and earning interest

- hold lots of cash = forgo investing in M/S and earning interest

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

Days of the Month

The Miller-Orr Model

- Target Cash Balance (Z)

V = variance of daily cash flows

r = daily return on short-term

investments

L = minimum cash requirement

• 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).*

The Miller-Orr Model

- Target Cash Balance (Z)

The Miller-Orr Model

Days of the Month

account also known as a cash pool.

Procedure

and

Benefits

Investment of excess

funds

The Collection & Disbursement of Public Funds

Controlling Cash Collection &

Disbursement

• Dual responsibility

• Receipts maintained in a location separate from cash & checks

• Certification of vouchers

Managing Cash Balances

• Safety

• Liquidity

• Maximize pool of funds

available for investment

– Concentration Accounts

– Zero-balance accounts

• Highest yield

Collection of funds

Need for accelerating collectionsHow to accelerate collection of receivables

Payments Netting in

Public Cash Management

Need for payments 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.)