Cash management theory pdf

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The download link provided above is randomly linked to our ebook promotions or third-party advertisements and not to download the ebook that we reviewed. We recommend to buy the ebook to support the author. Thank you for reading. The Baumol model is a model for establishing the firm's target cash balance that closely resembles the EOQ model used for inventory.

The model assumes 1 that the firm uses cash at a steady, predictable rate, 2 that the firm's cash inflows from operations also occur at a steady, predictable rate, and 3 that its net cash outflows therefore also occur at a steady rate. The model balances the opportunity cost of holding cash against the transactions costs associated with replenishing the cash account. Carrying costs are the costs of carrying inventory. Ordering costs are the costs of ordering inventory.

Total inventory costs are the sum of ordering and carrying costs. The Economic Ordering Quantity EOQ is the order quantity that minimizes the costs of ordering and carrying inventories. The range around the optimal ordering quantity that may be ordered without significantly affecting total inventory costs is the EOQ range.

The reorder point is the inventory level at which a new order is placed. The red line method is a technique for inventory control, as is the two-bin method. Answers and Solutions: 28 - 1 Computerized inventory control systems are just what the name implies. In the red line method, a line is drawn around the inside of a bin at the level of the reorder point, and the inventory clerk places an order when the red line shows. The two-bin method is similar--when the first bin is exhausted, items are ordered.

With a computerized inventory control system, the computer starts with an inventory count in memory. As withdrawals are made, they are recorded by the computer, and the inventory balance is revised. When the reorder point is reached, the computer automatically places an order, and when the order is received, the recorded balance is increased.

Just-in-time systems refer to receiving inventories just as they are needed. Firms that employ such systems are attempting to minimize inventory carrying costs. Out-sourcing is the practice of purchasing components rather than making them inhouse. Our suppliers switch from delivering by train to air freight. We change from producing just in time to meet seasonal sales to steady, year-round production. Competition in the markets in which we sell increases.

The rate of general inflation increases. Interest rates rise; other things are constant. When money is tight, interest rates are generally high. This means that near-cash assets have high returns; hence, it is expensive to hold idle cash balances. Firms tend to economize on their cash balance holdings during tight-money periods. Answers and Solutions: 28 - 2 a. Better synchronization of cash inflows and outflows would allow the firm to keep its transactions balance at a minimum, and would therefore lower the target cash balance.

Improved sales forecasts would tend to lower the target cash balance. A reduction in the portfolio of U. An overdraft system will enable the firm to hold less cash. If the amount borrowed equals the increase in check-writing, the target cash balance will not change.

Otherwise, the target cash balance may rise or fall, depending on the relationship between the amount borrowed and the number of checks written. The firm will tend to hold more Treasury bills, and the target cash balance will tend to decline. The figure below shows the optimum cash balance. The annual cash requirement of A Ltd.

The company has marketable securities in lot sizes of Rs 50,, Rs 1, 00,, Rs 2, 00,, Rs 2, 50, and Rs 5, 00, Cost of conversion of marketable securities per lot is Rs 1, You are required to prepare a table indicating which lot size will have to be sold by the company.

Also show that the economic lot size can be obtained by the Baumol Model. This usually does not happen in practice. The cash flows of a firm are neither uniform nor certain.

The Miller and Orr model overcomes the shortcomings of Baumol model. Miller and Daniel Orr A Model of the Demand for Money expanded on the Baumol model and developed Stochastic Model for firms with uncertain cash inflows and cash outflows. The Miller and Orr MO model provides two control limits-the upper control limit and the lower control limit along-with a return point as shown in the figure below:. When the cash balance touches the upper control limit h , markable securities are purchased to the extent of hz to return back to the normal cash balance of z.

In the same manner when the cash balance touches lower control limit o , the firm will sell the marketable securities to the extent of oz to again return to the normal cash balance. The spread between the upper and lower cash balance limits called z can be computed using Miller-Orr model as below:. A company has a policy of maintaining a minimum cash balance of Rs 1, 00, The standard deviation in daily cash balances is Rs 10, The interest rate on a daily basis is 0. The transaction cost for each sale or purchase of securities is Rs Compute the upper control limit and the return point as per the Miller-Orr model.

A firm having an annual opportunity cost of 15 per cent is contemplating installation of a lock box system at an annual cost of Rs 3, 00, The system is expected to reduce mailing time by 4 days and reduce cheque clearing time by 3 days.

If the firm collects Rs 4, 00, per day, would you recommend the system? Beta Ltd. Menyah, K. Emerald Group Publishing Limited. Report bugs here. Please share your general feedback. You can join in the discussion by joining the community or logging in here. You can also find out more about Emerald Engage. Visit emeraldpublishing.