Page 258 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 11: Management of Cash

Notes
Figure 11.1: Several Kinds of Float
Cheque mailed

Mail float

Cheque received
Recipient sees delays Payee sees delays
as collection float Processing float as payment float

Cheque deposited

Availability float Presentation float

Cash available to recipient Cheque charged to payers account

Self Assessment

Fill in the blanks:
7. The financial manager's concern is with the available balance and not with the company's
……………… balance.
8. One can increase the available cash balance by increasing the ……………... .

11.5 Cash Management Models

In recent years, several types of mathematics models have been developed that help to determine
optimum cash balance to be carried by a business organization. All these models can be put into
two categories – inventory type models and stochastic models. Inventory type models have
been constructed to aid the finance manager to determine optimum cash balance of the firm.
However, in a situation where EOQ Model is not applicable, the stochastic model of cash
management helps in determining optimum level of cash balance. It happens when the demand
for cash is stochastic and is not known in advance.
11.5.1 William J Baumol's Economic Order Quantity Model

According to this model, optimum cash level is that level of cash where the carrying costs and
transaction costs are the maximum. The carrying costs refer to the cost of holding cash, namely
the interest foregone in marketable securities. The transaction costs refer to the cost involved in
setting the marketable securities converted into cash. This happens when the firm falls short of
cash and has to sell the securities resulting in clerical, brokerage, registration and other costs.
The optimum cash balance will be that point where these two costs are equal. The formula for
determining optimum cash balance is:

C =

Where, C = Optimum cash balance
U = Annual (or monthly) cash disbursement

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