The cash management aspects can be examined under three heads, such as:
1. Cash inflows and outflows,
2. Cash flow within the firm, and
3. Cash balances held at the point of time.
Cash inflows (receipts) and outflows (payments) may not match, they may be excess or less over cash outflows. Surplus cash arises when the cash inflows are excess over cash outflows and the deficit will arise when the cash inflows are less than the cash outflows. The balance known as synchronisation firm should develop appropriate strategies for resolving the uncertainty involved in cash flow prediction and in the balance of cash receipts and payments. The firm has to come up with some cash management Aspects strategies regarding the following four facts of cash management.
1. Cash Planning: Cash planning is required to estimate the cash surplus or deficit for each planning period. Estimation of cash surplus or deficit can be arrived by preparation of cash budget.
2. Cash Flows Management: Cash flows means cash inflows and cash outflows. The cash flows should be properly managed that the cash inflows should be accelerated (collected as early as possible) and cash outflows should be decelerated (cash payments should be delayed without affecting firm name).
3. Determination of Optimum Cash Balance: Optimum cash balance is that balance at which the cost of excess cash and danger of cash deficiency will match. In other words, it is the cash balance at that the total cost (total cost equals to transaction cost and opportunity cost) is minimum. The firm has to determine optimum cash balance.
4. Investment of Surplus Cash:Whenever there is surplus cash it should be properly invested in marketable securities, to earn profits. Firms should not invest in long-term securities, they cannot be converted into cash within a short period. [ Cash Management Aspects ]
Factors Determining Cash Needs
From the above, we can say that a firm has to decide the cash balance based on their needs, which is determined after taking into consideration of the following factors:
1. Synchronisation of Cash Flows: Synchronisation of cash flows arises only when there is no balance between the expected cash inflows and cash outflows. There is no need to manage cash balance if there is the perfect match between cash inflows and cash outflows. Otherwise, there is a need to manage cash balance for managing synchronisation. This synchronisation is forecasted through the preparation of cash budget for a period of 12 months or the planning period. A well-prepared cash budget will definitely point out the months or periods when the firm will have surplus or deficit cash. [ Cash Management Aspects ]
2. Short Costs:This is another factor to be considered while determining the cash needs. Short costs are those costs that arise with a shortfall of cash for the firm requirements. Shortage of cash can be found through the preparation of cash budget. Cash shortage is not cost free, it involves cost whether it is expected or unexpected shortage. The expenses incurred as a result of the shortfall are called short costs. They include the following:
(a) The cost of Transaction: Whenever there is a shortage of cash it should be financed. Financing may be done through the borrowings from banks or sale of marketable securities (if the firm has). If the firm is planning to finance the deficit cash by the sale of marketable securities, then the firm is expected to spend some expenses for brokerage.
(b) The cost of Borrowing: If the firm does not have marketable securities with it, then it prefers borrowing as a source of financing, shortage of cash. It involves costs like interest on the loan, commitment charges and other expenses relating to the loan.
(c) The cost of Deterioration of the Credit Rating: Generally credit rating is given by credit rating agencies (CRISIL, ICRA and CARE). Low credit rating firms may have to go for bank loans with high-interest charges since they cannot raise the required amount from the public. Low credit rating may also lead to the stoppage of supplies, demands for cash payment refusal to sell, loss of image and the attendant decline in sales and profits.
(d) The cost of Loss of Cash Discount: Sufficient cash helps to get cash discount benefits, but a shortage of cash cannot help to obtain cash discounts.
(e) The cost of Penalty Rates: Whenever there is a shortage of cash firm may not be able to honour currently returned obligations, which in turn demand penalty.
3. Surplus Cash Balance Costs: It is self-explanatory. It means that the cost associated with excess or surplus cash balance. Cash is not an earning asset. Surplus cash funds are idle, an impact of idle cash is that the firm losses opportunities to invest those funds and thereby lose interest, which would otherwise have been earned.
4. Management Costs: Management costs are those costs involved with setting up and operating cash management staff. This cost is generally fixed over a period and are mainly include staff, salary, storage, handling the cost of security and so on. [ Cash Management Aspects ]