Page 114 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 7: Cash Management

Notes
Example: Transaction costs,Borrowing costs, Loss of cash discount, Cost associated with
deterioration of credit rating, and Penalty rates.
3. Excess cash balance: If a affirm is having large funds lying as idle, it shows that the firm has
missed opportunities to invest those funds and has thereby lost interest which it would
otherwise have earned. This loss of interest is primarily the excess cost.

Caselet Purple Software Solutions: Missed Opportunities

n Shahadara, Delhi, Mr Gulab Kohli starts a business in the name of Purple Software
Solutions by the capital he inherited after his father sold his toy manufacturing business
Iand died later in the year 1999. Since the money he invested initially was more than his
business needed, Mr Gulab Kohli spent it in maintaining his office lavishly and when questioned
about the same by his wife, he replied that it was all to attract customers. Obviously, he
concentrated more on office maintenance that was required. Also he had this a habit of
maintaining some 25 lac rupees in cash at home so that if and when required, he could spend
it. ON his also, his wife questioned him once, to which he said that they may require cash
anytime, and since he has a lot of it, there is no harm in keeping it safely at home.
Later on, when he needed funds for following up his prospective clients, he started falling
short of cash. Reason is for anybody to guess. He spent the money on wrong heads. And
sooner or later, the cash he kept at home had to deplete. As a result of this, he incurred
huge losses and to close his business.

4. Procurement and management: Procurement and management costs are associated with
establishing and operating cash management staff and activities. They are usually fixed
and are mainly accounted for by salary, storage, handling of securities, etc.
5. Uncertainty: Finally, the impact of uncertainty on cash management strategy is also
relevant as cash flows cannot be predicted with complete accuracy. The first requirement
is a precautionary cushion to cope with irregularities in cash flows, unexpected delays in
collection and disbursements, defaults and unexpected cash needs.

Task Think of the conditions/situations when the impact of uncertainty on cash
management can be mitigated and enlist such situation.

A firm has to maintain a minimum of cash for settling the dues in time. The cash is needed to
purchase raw materials, Creditor’s day to day expenses, dividend, etc. The test of liquidity of the
firm is that it is to meet various obligations in time.
Some cash will be needed for transaction needs and amount may be kept as a safety stock. An
appropriate amount of cash balance to be maintained should be determined on the basis of past
experience and future expectations. If a firm maintains less cash balance then its liquidity position
will be weak. If higher cash balance is maintained then an opportunity to earn is list. Thus a firm
should maintain an optimum cash balance neither a small nor a large cash balance. For this
purpose the transaction costs and risk of too small a balance should be matched with the
opportunity costs of too large a balance.

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