MANAGEMENT CASH The basic objective in cash management is to keep the investment in cash as low as possible while still operatings the firm’s activities.

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1 MANAGEMENT CASH The basic objective in cash management is to keep the investment in cash as low as possible while still operatings the firm’s activities efficiently and effectively Determining the appropriate target cash balance Determining the appropriate target cash balance Collecting and disbursing cash efficiently Collecting and disbursing cash efficiently Investing excess cash in marketable securities Investing excess cash in marketable securities

2 REASONS FOR HOLDING CASH 1. Transactions motive 2. Compensating balances DETERMINING THE TARGET CASH BALANCE The target cash balance involves a trade-off between the oppurtunity costs of holding too much cash and the trading costs of holding too little.

3 THE BAUMOL MODEL The Baumol Model : Suppose : the Golden Socks Corporation began week 0 with a cash balance of C = $1.2 million, & outflows exceed inflows by $600,000 per week. Its cash balance will drop to zero at the end of week 2, & its average cash balance will be C/2 = $600,000 over the two- week period. At the end of week 2, Golden Socks must replace its cash either by selling marketable securities or by borrowing. The opportunity costs : equal to the average cash balance multiplied by interest rate

4 THE BAUMOL MODEL  The opportunity costs : equal to the average cash balance multiplied by interest rate = (C/2) x K  Trading costs ($) = (T/C) x F F = the fixed cost of selling securities to replenish cash T = the total amount of new cash needed for transactions purposes over the relevant planning period, say, one year. K = the oppurtunity cost of holding cash; this is the interest rate on marketable securities  Total Cost (TC) = (C/2) x K + (T/C) x F  (dTC/dC) = (K/2) – (TF/C 2 ) = 0  Cash Balance = C* = (2TF/K) 1/2

5 LIMITATIONS THE BAUMOL MODEL 1. The model assumes the firm has a constant disbursement rate 2. The model assumes there are no cash receipts during the projected period 3. No safety stock is allowed for. Example : The Baumol model, if F = $1,000, T = $31,200,000, and K = 0.10, then C* = $789,936.71. Given the value of C*, Oppurtunity costs are : (C*/2) x K = ($789,936.71/2)x0.10 = $39,496.84 Trading costs are : (T/C*) x F = ($31,200,000/$789,936.71)x$1,000 = $39,496.84 Total costs = $39,496.84 + $39,496.84 = $78,993.68.

6 THE MILLER-ORR MODEL This model to deal with cash inflows and outflows that fluctuate randomly (normal distributed) from day to day. The model operates in terms of upper (H) and lower (L) control limits, and a target cash balance (Z). Z* = (3Fσ 2 /4K) 1/3 + L H* = 3Z* - 2L where * denotes optimal value, and σ 2 /4K) 1/3 is the variance of net daily cash flows. The average cash balance in the Miller-Orr model is = (4Z – L)/3

7 continue Example : Suppose F = $1,000, the interest rate is 10 percent annually and the standard deviation of daily net cash flows is $2,000. The daily oppurtunity costs, K, is (1 + K) 365 – 1.0 = 0.10 1 + K = (1.10) 1/365 = 1.000261 K = 0.000261 The variance of daily net cash flows is, σ 2 = (2,000) 2 = 4,000,000 Let us assume that L = 0 Z* = [(3 x $1,000 x 4,000,000)/(4 x 0,000261)] 1/3 + 0 = $22,568 H* = 3 x $22,568 = $67,704 Average cash balance = (4 x $22,568)/3 = $30,091

8 MANAGING THE COLLECTION AND DISBURSEMENT OF CASH ► Example : Imagine that GMI currently has $100,000 on deposit with its bank. It purchases some raw materials, paying its vendor with a check written on July 8 for $100,000. The company’s book are changed to show the $100,000 reduction in the cash balance. But the firm’s bank will not find out about this check until it has been deposited at the vendor’s bank and has been presented to the firm’s bank for payment on, say, July 15. Until the check’s presentation, the firm’s bank cash is greater than its book cash, and it has positive float. ► Position Prior to July 8 : Float = Firm’s bank cash – Firm’s book cash = $100,000 - $1,00,000 = 0 = $100,000 - $1,00,000 = 0 ► Position from July 8 throughJuly 14 : Float = Firm’s bank cash – Firm’s book cash = $100,000 – 0 = $100,000 = $100,000 – 0 = $100,000

9 ACCELERATING COLLECTIONS  The basic parts of the cash collection process : customer mails payment  company receives payment  company deposits payment  cash received  Some of the tehniques used to accelerate collections and reduce collection time : a. Lockboxes : corporate customers  post office box 1  local bank collects funds from post office boxes  envelopes opened; separation of checks and receipts  etc. b. Concentration banking (cash manager analyzes bank balance and deposit information and revises cash allocation) ; (maintenance of cash reserves, disbursements, short-term investments of cash, maintenance of compensating balance at creditor bank) c. Wire transfer : the fastest and most expensive

10 CASH DISBURSEMENT Disbursement process : Firm prepares check to supplier  post office processing  delivery of check to supplier  deposit goes to supplier’s bank  bank collects funds INVESTING IDLE CASH - Short-term marketable securities (money market), the maturity is one year or less, low risk debt securities - US Treasury bills, certificates of deposit, commercial paper, etc

11 a) PT. HAR merencanakan untuk mempunyai kas sebesar Rp 12 Milyar untuk pengeluaran kas tahun depan. Perusahaan memperkirakan bahwa tingkat suku bunga yang berlaku sebesar 8% dan akan menanggung biaya sebesar Rp 12 juta setiap kali meminjam (menarik uang). Pengeluaran kas diharapkan stabil selama tahun depan. Dengan menggunakan model BAUMOL : Tentukan jumlah saldo kas yang optimal untuk perusahan tersebut dan berapa biaya total untuk penggunaan kas yang diperlukan untuk keperluan transaksi ?

12 b. PT. BAHSAR memperkirakan bahwa pola pengeluaran kasnya tidak bisa diperkirakan (distribusi normal). Berdasarkan pengalaman, untuk setiap kali mengubah kas menjadi surat berharga atau sebaliknya, diperlukan biaya sebesar Rp 20 juta. Variance pengeluaran kas bersih sebesar Rp 80 juta. Tingkat bunga yang bisa diperoleh dari investasi pada surat-surat berharga sebesar 24% per tahun. Satu tahun = 365 hari. Berdasarkan data tersebut, hitunglah berapa batas atas jumlah kas yang sebaiknya ?