Objectives of Cash Management

Principle & Practice of Management

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Objectives of Cash Management

Cash Management Objectives

One of the prime responsibilities of the financial manager is that managing cash to make the balance between profitability and liquidity. In other words, he/she has to maintain the optimum cash balance. Optimum cash means it should not be excess or inadequate. Maintenance of excess cash reserve to meet the challenges, the excess cash will remain idle, and idle cash earns nothing but involves cost. So it will reduce profit. On the other hand, having inadequate cash balance will affect the liquidity of the firm. Hence, there is need to maintain the balance between profitability and liquidity. In other words, there should not be excess cash or inadequate cash.
From the above, we can trace the following as the cash management objectives:
1. To meet cash payment needs, and
2. To maintain a minimum cash balance.

Cash Management Objectives

To Meet Cash Payments: Cash Management Objectives

The prime objective of cash management is to meet various cash payments needed to pay in business operations. The payments are like payment to the supplier of raw materials, payment of wages and salaries, payment of electricity bills, telephone bills and so on. The firm should maintain cash balances to meet the payments, otherwise, it will not be able to run a 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 sufficient cash.

To Maintain Minimum Cash Balance (Reserve): Cash Management Objectives

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

Motives for Holding Cash 

Cash is the most crucial component of the working capital of a firm, as every transaction results either in an inflow or outflow of cash. Cash has no earning power, then why does a firm need cash? John Maynard Keynes puts forth that there are three possible motives for holding cash.

Transaction Motive 

This motive arises due to the necessity of having cash for various disbursements like the 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 synchronisation 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 synchronised with each receipt. The transaction motive, thus, refers to the holding of cash to meet anticipated obligations whose timing is not perfectly synchronised with cash receipts.

Precautionary Motive

Apart from the non-synchronization of anticipated cash flows in the ordinary course of business, the firm may require cash for the payment of unexpected disbursements. The unexpected cash needs at short notice may be the result of floods, strikes and failure of important customers, bills may be presented for settlement earlier than expected, slow down in the collection of accounts receivables, a sharp increase in the cost of raw materials. It provides a cushion or buffer to withstand some unexpected emergency. The precautionary balance may be held in near-money assets like marketable securities. The amount set aside for precautionary motive is not expected to earn anything. As the matter of abundant caution, many companies had learnt the art of ‘cultivating the rich uncle’, by establishing and maintaining a good lasting link with progressive banking institutions. Ready borrowing power is the best antidote to emergency cash drains and facilities release available cash resources for remunerative applications.

Speculative Motive

It refers to the desire of a firm to take advantage of opportunities, which present themselves at unexpected moments and that are typically outside the normal course of business. In simple words, it is a motive of holding cash rebates for investing in profitable opportunities as and when they arise. In other words, this motive comes from a desire of holding cash to gain in speculative transactions such as purchase of raw materials at reduced price on payment of immediate cash, dealing in commodities in bulk purchasing and selling when rates are considered favourable. Hence firms, which have such speculative dealings, may carry additional liquidity.