Page 183 - DMGT409Basic Financial Management

Basic Financial Management

Notes Therefore, effective management of cash involves an effort to minimise investment in cash without
impairing to liquidity of the firm. It implies a proper balancing between the two confl icting

objectives of the liquidity and profi tability.

Notes Nature of Cash
Cash is the medium of exchange for purchase of goods and services, and for discharging
liabilities. In cash management the term cash has been used in two senses:
1. Narrow Sense: Under this cash covers currency and generally accepted equivalents
of cash, viz., cheques, demand drafts and banks demand deposits.
2. Broad Sense: Here, cash includes not only the above stated but also cash assets. There
are bank’s time deposits and marketable securities. The marketable security can
easily sold and converted into cash. Here, cash management is in broader sense.

11.2 Objectives of Cash Management

Following as the objectives of cash management:
1. To Meet Cash Payments: The prime objective of cash management is to meet various cash
payments needed to pay in business operations. The payments are like payment to supplier
of raw materials, payment of wages and salaries, payment of electricity bills, telephone bills
and so on. Firm should maintain cash balances to meet the payments; otherwise it will not
be able to run business. To quote Bollen, “Cash is an oil to lubricate the ever-turning wheels
of business: without it, the process grinds to a stop”. Hence, one of the cash management
objectives is to meet the payments with the maintenance of suffi cient cash.
2. To Maintain Minimum Cash Balance (Reserve): This is second important objective of cash
management. It means the firm should not maintain excess cash balances. Excess cash

balance may ensure prompt payment, but if the excess balance will remain idle, as cash is a
non-earning asset and the firm will have to forego profits. On the other hand, maintenance

of low level of cash balance may not help to pay the obligations. Hence, the aim of cash
management is to maintain optimum cash balance.

Notes Motives for Holding Cash
Cash is the most crucial component of the working capital of a fi rm, as every transaction

results either in an inflow or outflow of cash. Cash has no earning power, then why does

a fi rm need cash? John Maynard Keynes puts forth that there are three possible motives
for holding cash.
1. The Transaction Motive: This motive arises due to the necessity of having cash for
various disbursements like purchase of raw materials, payment of business expenses,
payment of tax, payment of dividend and so on. The need to hold cash would not
arise, if there is perfect synchronization between the cash receipts and the cash

payments. Hence, the firm must have an adequate cash balance particularly when
payments are in excess of receipts to meet its obligations. The requirement of cash to
meet routine cash needs is known as the transaction motive and such motive refers
to the holding of cash to meet anticipated obligations whose timing is not perfectly
synchronized with each receipts. The transaction motive, thus, refers to the holding
Contd....

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