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What are the reasons for holding cash?

 Transactions motive – to meet day to day expenses

 Precautionary motive – as a cushion against unplanned expenditure

 Investment/speculative motive – cash kept available to take advantage of market investment opportunities, such as the opportunity to buy a strategically useful piece of land once its current owners have taken it through the planning permission process and made it available for sale


What is a cash budget?

A cash budget is a commitment to a plan for cash receipts and payments for a future period after taking any action necessary to bring the forecast into line with the overall business plan.


What are cash budgets used for?

assess and integrate operating budgets
plan for cash shortages and surpluses
compare with actual spending.


what is a cash forecast

A cash forecast is an estimate of cash receipts and payments for a future period under existing conditions.


What can cash forecasts be based on?

Receipts and payments forecast. This is a forecast of cash receipts and payments based on predictions of sales and cost of sales and the timings of the cash flows relating to these items.

 Statement of financial position forecast. This is a forecast derived from predictions of future statements of financial positions. Predictions are made of all items except cash, which is then derived as a balancing figure.

Working capital ratios. Future cash and funding requirements can be determined from the working capital ratios seen in the chapter on working capital management.


..What are the steps to prepare a forecast using Receipts and payments forecast.

Step 1) Prepare a proforma
Step 2) Fill in the simple figures

• Wages and salaries
• Fixed overhead expenses
• Dividend payments
• Purchase of non current assets

Step 3) Work out the complex figures

The information on sales and purchases can be more time consuming to deal with, e.g.:
• timings for both sales and purchases must be found from credit periods
• variable overheads may require information about production levels
• purchase figures may require calculations based on production schedules and inventory balances.


What are the steps to prepare a forecast using statement of financial position to predict the cash balance as at the end of the given period?

This method will require forecasts of:

changes to non-current assets (acquisitions and disposals)
future inventory levels
future receivables levels
future payables levels
changes to share capital and other long-term funding (e.g. bank loans)
changes to retained profits.


What are the steps to prepare a forecast using working capital ratios?

The first stage is to use the ratios to work out the working capital requirement, as we have already seen in the working capital management chapter.

Operating profit
+ Depreciation
= Cash flow from operations

+ Cash from sale of non-current assets
+ Long term finance raised
- (Purchase of non current assets)
- (Redemption of long term funds)
- (Interest paid)
- (Tax paid)
- (Dividend paid)
- (Increase in working capital)

= Net cash flow


0.What are the two cash management models?

Baumol model
Miller-Orr Model


What is the baumol model and it's assumptions?

Baumol noted that cash balances are very similar to inventory levels, and developed a model based on the economic order quantity (EOQ).

 cash use is steady and predictable
 cash inflows are known and regular
 day-to-day cash needs are funded from current account
 buffer cash is held in short-term investments

Baumol assumed that many companies would hold an inventory of marketable securities, which could be
sold in order to replenish the cash balance


What does the formula for EOQ for baumol calculate and disadvantage of this model

The EOQ now gives the optimum amount of treasury bills to sell by value each time the cash balance needs replenishing.

he model suggests that when interest rates are high, the cash balance held in non-interest-bearing current accounts should be low.

However, its weakness is the unrealistic nature of the assumptions on which it is based.


What is the miller Orr Model and what is it used for?

The Miller-Orr model controls irregular movements of cash by the setting of upper and lower control limits on cash balances.

The Miller-Orr model is used for setting the target cash balance.

It tries to minimise the cost of cash


What is an advantage of the miller orr model?

It has the advantage (over the Baumol model) of incorporating uncertainty in the cash inflows and outflows.

The model sets higher and lower control limits, H and L, respectively, and a target cash balance, Z.

The lower limit, L is set by management depending upon how much risk of a cash shortfall the firm is willing to accept, and this, in turn, depends both on access to borrowings and on the consequences of a cash shortfall.


 When the cash balance reaches Higher balance, then (H-Z Return point) dollars are transferred from cash to marketable securities, i.e. the firm buys (H-Z) dollars of securities.

 Similarly, when the cash balance hits L, then (Z-L) dollars are transferred from marketable securities to cash.


What is the formula that's given in the sheet for miller?

3 x [ (3/4 x Trasaction cost x Variance of daily CF) / Interst rate ] ^1/3

Variance and interest rates should be expressed in daily terms. If the question provides you with the standard deviation of daily cash flows, you will need to square this number to obtain the variance.


What are the disadvantages of Miller?

The model has some fairly restrictive assumptions, e.g. normally distributed cash flows but, in tests, Miller and Orr found it to be fairly robust and claim significant potential cost savings for companies.


What are short term cash investments

Short-term cash investments are used for temporary cash surpluses.


What are the 3 objectives of short term cash investment?

• Liquidity – the cash must be available to use when needed

• Low risk – there must be no risk of loss taken

• Profitability – subject to the above the aim is to earn the highest level of profit possible


What is commen between two cash management models

Both models take into account the transaction costs of switching between current accounts and investment


how do you work out the variation

it is the standard deviation squared (^2)


what is the matching principle?

The matching principle suggests that long-term finance should be used for long-term assets. Under a matching working capital funding policy, therefore, long-term finance is used for both permanent current assets and non-current assets.

Short-term finance is used to cover the short-term changes in current assets represented by fluctuating current assets


what is a conservative working capital funding policy?

use long term finance for part of fluctuating and all of permanent

A conservative working capital funding policy will use a higher proportion of long-term finance than a matching policy, thereby financing some of the fluctuating current assets from a long-term source. This will be less risky and less profitable than a matching policy, and will give rise to occasional short-term cash surplus


what is an aggressive working capital funding policy?

Short Term finance for part of permeant and all of fluctuating

An aggressive working capital funding policy will use a higher proportion of short term finance (lower proportion of long-term finance) than a matching policy, financing some of the permanent current assets from a short-term source such as an overdraft. This will be more risky and more profitable than a matching policy.


what are other factors that influence working capital funding policy?

Other factors that influence a working capital funding policy include management attitudes to risk, previous funding decisions, and organization size.

Management attitudes to risk will determine whether there is a preference for a conservative, an aggressive or a matching approach.

Previous funding decisions will determine the current position being considered in policy formulation. The size of the organization will influence its ability to access different sources of finance.

A small company, for example, may be forced to adopt an aggressive working capital funding policy because it is unable to raise additional long-term finance, whether equity or debt.


what is cash forecast?

A cash forecast is an estimate of cash receipts and payments for a future period under existing conditions before taking account of possible actions to modify cash flows, raise new capital, or invest surplus funds.


what is cash budget?

cash budget is a commitment to a plan for cash receipts and payments for a future period after taking any action necessary to bring the preliminary cash forecast into conformity with the overall plan of the business


what's included in cash budget and NOT

Cash inflows and outflows

notional rent
notional interest


Why does a cash surplus arise

Profitable trading
uneven trade cycle
lack of long term investment opportunities
disposal of assets