By Dr Francis Okereke FCA,FCIB,FCILRMN MANAGING DIRECTOR FONTINI GROUP

1. MANAGING CASH LEVEL
INTRODUCTION
The need for effective cash management cannot be over-
emphasized at this time of inflation. Before an effective
cash management can be executed by any organization a
program which would carried it out on a daily basis must
be set up.

2.  There are three main reasons why cash management is more vital to all
companies today than it has been in the past. These are the cost money,
innovations in the banking environment, and an increase in the
complexity of business organizations.
 The scarcity of cash and its higher cost is universal. The worldwide
banking network is tied together more than it has ever been in the past.
Major international banks have developed state of the art cash
management systems.

3.  Executives who are forced to take on short-term financing at a
high rate of interest are hard-pressed to generate earnings high
enough to pay off the interest and still yield a profit. Every company
is forced to look for better ways to use the cash it has available.
Utilizing cash effectively as a resource makes a lot of sense. Higher
interest rates just make a good justification for doing it.

4. WHAT IS CASH
MANAGEMENT?
 A consultant defines cash management as: “The optimization of
cash as an asset”. Van Horne in 1974 said that “Cash Management
involves managing the monies of the firm in order to attain maximum
cash availability and maximum interest income on an idle funds. The
organization wants to minimize borrowing, maximize investments,
pay people appropriately but control the funding of the payment
process.

5.  Cash shortage will disrupt the company’s daily operations while
excessive cash will simply remain idle at a cost without contributing
anything towards the organizations profitability. An organization, thus,
needs to maintain a sound cash position.
 Cash is the money which a firm can disburse immediately without any
restriction. This includes coins, currency, bank credit balances, money
market instruments, time deposits, cheques, money orders, dividend
warrants, postal orders and of course cash

6.  It is worth nothing at this point that for effective cash management, an
organization needs a full-time Treasurer/ cash manager
 Effective cash management involves:
a) Cash policies
b) Cash planning
c) Optimum cash level
d) Managing the cash flows
e) Control of cash

7. OBJECTIVES OF CASH
MANAGEMENT
 LIQUIDITY
 To adequately forecast cash needs and cash flow:
- Take measures to avoid cash shortages;
- Plan company liquidity in relation to forecasts
 To oversee banking relations:
- Make sure adequate cash management services are available;
- Make provisions for the long-term credit needs of the firm.

8.  To transfer funds within the company:
- Track the funds requirements of divisions and operating locations and ensure
appropriate supply of cash.
 To arrange bank balances into the most efficient structure:
- Eliminate unneeded and idle accounts
 To adequately schedule investment maturities
 To manipulate the timing of cash receipts and disbursements:
- Avoid unnecessary borrowing by using float, controlled disbursements, etc.

9.  To advise management on the cash effects of operating plans and capital
investment programs.
- EARNINGS
 To reduce the length of the total payment cycle on receivables.
 To minimize collection float on checks deposited.
 To maximize disbursement float without jeopardizing vendor relations
- analyze-trade discounts to achieve maximum “return” on cash assets
 To speed concentration of cash into a central investable account

10. - To speed concentration of cash into a central investable account.
 To invest excess funds for the highest prudent return:
- Keep abreast of available money market investments;
- Move cash into interest- paying investments as quickly as possible
 To increase the efficiency and reduce the cost of in-house cash
management processing and administration.

11.  To keep bank costs to the minimum needed for optimal cash management
services.
- Negotiate with banks for available discounts;
- Review the structure of the cash management system to achieve economies.
 To achieve source and structures of corporate short-term debt that reduces
interest cost to a minimum
 To eliminate idle bank balances while meeting targeted goals for bank
compensation.

12. MOTIVES OF HOLDING
CASH
 Organizations hold cash Asset to satisfy three motives:-
1. TRANSACTIONS MOTIVE
An organization needs to hold cash to finance its business in the ordinary course. Cash is
needed to pay wages salaries operating expenses, taxes, dividend etc.
2. SPECULATIVE MOTIVE
An organization need hold cash to finance profitable investment opportunities as and
when they arise. A firm may take advantage of sudden fall in materials prices or purchase
more materials now if they prices are likely to rise. To exploit an innovation/research.

13. 3. PRECAUTION MOTIVE
An organization needs to hold cash to meet any contingencies in the
future. Contingent losses may arise from pending law suits against the company or
the dishonor or a bill of exchange that the company has accepted
To finance promotional schemes in order to match competitors actions.
To minimize risk in uncertain financial and trading periods.
A company therefore must maintain sufficient level of cash to satisfy the three
motives

14.  Clearly, the disposition of funds will vary between companies and certainly
between industries because of their special characteristics e.g. banks needs more
cash to meet customers demand than manufacturing firms.
 Organizations prefer to hold as little cash as possible without creating
transactions problems. Because cash does not generate income, excess cash holding
have a high opportunity cost represented by the interest/ income that could be
earned on an alternative investment. Cash shortage can also threaten the survival of
a company.

15. A. CASH POLICIES
 For effective cash management, the organization must have cash policies. Cash
policies can be grouped under two categories- normal and abnormal.
- Normal cash policies are concerned with the determination and procurement of
the correct level of cash to meet that which can be anticipated with a reasonable
degree of accuracy.
- Abnormal cash policies are concerned with unpredictable events or unforeseen
contingencies or act of God, and interruption of cash flows resulting from sudden
shifts in demand or economic recessions which cannot be predicted.

16.  The amount of cash needed for normal requirement is dependent upon a variety of
factors such as credit position of the receivable, inventory accounts, nature of business
and management attitude towards risk.
B. CASH PLANNING
cash in flows and out flows should be planned to project cash surplus or deficit for each
period of the planning period. The first step to good cash management is preparing a
budget or schedule of receipts and disbursement for the year, that is, the cash flow
budget. Cash budget enables an organization:

17. - To determine operating cash requirement
- To anticipate short-term financing/over draft.
- To manage investment of surplus cash
- To determine the timing and amount of cash in flows and out flows over the period.
C. OPTIMUM CASH LEVEL
The firm should decide about the appropriate level of cash balances. The cost of
excess cash and danger of cash deficiency should be matched to determine the optimum
level of cash balances. The optimum level of cash balance is also influenced by a trade-
off between risk and return as well as level of uncertainty in the system.

18. D. MANAGEING THE CASH FLOWS/INVESTMENT
The flow of cash should be properly managed. The cash inflows should be accelerating while,
as far as possible, decelerating the cash out flows. There should be daily routine for cash
management. Investment goals and guidelines should be established while appropriate
investment instruments determined.
An organization can invest its excess cash in many types of securities. In choosing an
investment outlet a manager should bear in mind:
a) Safety
b) Maturity
c) marketability

19. D. CONTROL OF CASH
Management of cash involves a strong system of internal control. The
system of internal control consists of all measures employed by a
business for the purposes of safe guarding its resources against waste,
fraud and inefficiency, promote accuracy and reliability in accounting and
operating data, encouraging and measuring compliance with the company
policy and efficiency of the management. Control of cash is crucial to the
success and survival of every business.

20.  Cash control measures include the following:
a. Detailed planning and budgeting of cash inflows and out flows.
b. Frequent cash report for internal managerial use.
c. Careful delegation of authority for handling cash payment and
receipt (segregation of duties)
d. Prescribes accounting flows for cash receipts and disbursement.
e. Maintaining a dual record of cash with the bank

21. SPECIALISED METHODS OF
CASH MANAGEMENT
 The specialized and more sophisticated methods of cash management are as follows:
1. Balance sheet Analysis
2. Bank Relationship/Minimum Balance method
3. Identifying the float.
4. Lox Box System
5. Electronic Transfer
6. Compensation Balances
7. Concentration Banking

22. 1. BALANCE SHEET
ANALYSIS
 This is the review and control of accounts payable. Once a cash budget has
been prepared, you should begin to look at the account receivable and payable
activities.
 Aggressive and more rigorous collection procedures are the best way to ensure
adequate cash flow on the receivable side. I also suggest monitoring of any letter of
credit and their relationship to the receipt of funds
 On the account payable, always delay payment or pay at the last minute. Also
ensure that all cash discounts are taken.

23. 2. BANK
RELATIONSHIP/MINIMUM
BALANCE
 Another effective method is to identify cash available for investment through
bank relationship. The type of relationship your business organization has with
bankers is probably the limiting factor on what is acceptable level of cash to be
maintained in your bank accounts. There is no fast rule or formula for coming up
with the proper balance to be maintained at the bank but certainly, minimum levels
are required to support the services they provide.
 It is pertinent to note that how much money you have with any bank is subject
to negotiation, recognizing that at same point the bank will refuse to service your
account if you do not leave enough money.

24. 3. IDENTIFYING THE
FLOAT
 Another method for effective cash management is the float. The
difference between the business recorded amount and the amount
credited to the business by the bank is referred to as the float and
takes place as result of the time lag between the time period a cheque
is written and the eventual clearing of the cheque against a corporate
bank account.

25. 4. LOX-BOX SYSTEM
 Effective cash management calls for improving collections and cheque clearing
through a number of strategies. A popular method is to utilize a variety of
collection centers throughout the business marketing area. For organizations who
wish to enjoy the benefits of expeditious cheque clearance at lower cost, a lox-box
system is recommended.
 Under this programme, customers are requested to forward their cheque to a
post office box in their geographical region and a local bank or representative picks
up the cheques and processes them to other banks in the locality for rapid
collection. Funds are then wired to the corporate home officer for immediate use.

26.  Te advantage is that the company retains many of the benefits of
regional collection centers, but with reduced corporate overhead. The
purpose of the lox-box banking is to reduce the float thus, the process get
cash faster to the control bank.
 Extending disbursements of slowing of disbursements is not an
uncommon practice in cash management. It has been given the title,
“extended disbursement float”

27. 5. ELECTRONIC
TRANSFER
 Effective cash management is also achieved through the
techniques of electronic funds transfer. This is a process in which
funds are moved between computer terminals without the use of a
cheque.
 In this method, plastic cards with magnetic coding are to obtain
cash, to transfer funds from one account to another, to pay debts, to
borrow and to do other things.

28. 6. COMPENSATING
BALANCES
 Effective cash management is also achieved by the use of
compensating balances and fees. In this method, cash Managers should
not maintain balances with minor banks. Cash manager often withdraw
balances as fast as possible from less important banks and pay the
resulting service charge. The business firm should also use one balance
for both credit and banking activity. Thus, cheque are written on the bank
with the compensating balance which is a good cash management.

29. 7. CONCENTRATION
BANKING
 This involves the setting up of multiple collection centre by the company in
strategic locations instead of a single collection centre at the Head office. The
location of a collection centre is dependent on geographical area served and the
volume of business available in the area. The firm will usually instruct their
customers to settle their bills through a particular collection centre’s local bank
account. Based on the pre-determined cash level for the area, surplus funds are
usually transferred to a concentration bank. A concentration bank is the bank where
the firm maintains its major account.

30. OPTIMAL CASH LEVEL
 Having estimated the cash needs of a firm, the next problem is to determine the
level of cash balance that a firm should hold. Any cash in excess of the transaction
and precautionary demand for cash, should be invested in short –term marketing
securities.
 A simple model for determining optimal amount of transaction cash is the
economic order quantity formula. The model was first applied by Baumol (1952).
The objective of the model is to balance the holding cost of carrying cash (interest
forgone on marketable securities) against the fixed cost of transferring marketable
securities to cash or vice versa.

31.  Interest forgone on marketable securities is simple the interest rate on
short-term money market instruments. The fixed cost of transferring
marketable securities to cash or cash marketable securities includes fixed
component of transaction costs; the time it takes the company officials to
place an order with an investment banker, the time consumed in recording
the transaction, the secretarial time needed to type the transaction in the
books, and the time needed to record the safekeeping notification (Van
Horne, 1989).

32.  The model assumes that the firm has a steady demand for cash over a period of time.
Let
 Z = total demand for cash over a period of time.
 F = fixed cost per transferring cash
marketable securities{or vice versa
 R= interest rate on marketable by securities for the period involved assumed to be
constant.
 C= optimal cash level
 Total costs (TC)=Fixed costs associated with transfers +interest earnings forgone by
holding cash fixed costs associated with transfers =Number of transactions during the
period x fixed cost per transaction

33.  Total cost (TC) = Fixed costs associated with transfers + Interest earnings forgone by holding cash
 Fixed costs associated with transfers = Number of transactions during the period X fixed cost per transaction
 Z x f
C
 Interest earnings forgone by holding cash = Average cash balance x interest rate on marketable securities.
 C x r
2
 T C = Z f + C r
C 2
 Just like the EOQ derivation, at the minimum total cost, the optimal level of cash is given by:
 C= 2Zf
r