(20).WORKING CAPITAL MANAGEMENT-CASH MANAGEMENT

The Need For Cash Management.

How much cash should a company keep on hand or "on short call" at a bank? the more cash which is on hand, the easier it will be for the company to meet its bills as they foll due and to take adventage of discounts. however, holding cash or near equivalents to cahs has a cost in terms of the loss of earning which otherwise have been obtained by using the funds in another way. The finacial manager must try of balance liquidity with profitability.

we have already introduced the operating cycle, which connects invest ment in working capital with cash flows. cash flow problems can arise in several ways.

• Making losses.-If a business is continually making losses,it will eventually have cash flow problums.Just how long it will take before a loss-making business runs in to cash flow trouble will depend on. (1). How big the losses are;& (2). Whether depreciation charge is big enough to create a loss dispeite a cash flow surplus.In such a situation, the cash flow troubles might only begin when the business needs to replace fixed assets.
• Inflation.-In a period of inflation, a business needs ever increasing amounts of cash just to replace used-up & worn-out assets. A business can be making a profit in historical cost accounting terms,but still not be receiving enough cash to by the replacement assets it needs.
• Growth.-When a business is growing , it needs to acquire, & to support higher amounts of stocks & debtors. These addition assets must be paid for somehow ( or financed by creditors).
• Seasonlal Business.-When a business seasonal or cyclical sales , it may have cash flow difficulties at certain times of the year, when (1). Cash inflows are low but (2). Cash out flows are high, perhaps because the business is building up its stocks for the next period of high sales.
• One-off Items of expenditure.-The made might occasionally be a single the non-recurring item of expenditure that corrects a cash flow problum, such as (1). The repayment of loan capital on maturity of the debt.Business often try to finance such long repayments by borrowing again. (2). The purchase of an exceptionally expensive item. For example -A small or medium -sized business maght decide to buy a free hold property which then stretches its cash resources for several months or even years.

Methods Of Easing Cash Shortages.

The steps that usually taken by a company when a need for cash arises & when it cannot obtain resources from any other source such as a loan or an increased overdraft are as follows.

• Postponing capital expenditure.-It might be imprudent to postpone expenditure on fixed assets which are needed for the development growth of the business.On the other hand , some capital expenditures are routine & might be postponable without serious consequences.The routine replacement of motor vehicles is an example.If a company's policy is to replace company cars every two years ,but the company is facing a cash shortage ,it might decide to replace cares every three years.


• Accelerating cash inflows which would otherwise be expected in a later period.-The most obvious way of bringing forward cash inflows would be to press debtors for earlier payment.Often , this policy will result in a loss of goodwill & problems with customers. There will also be very little scope for speeding up payments when the credit period currently allowed to debtors is no more than the norm for the industry. It might be possible to encourage debtors to pay more quickly by offering discounts for earlier payment.


• Reversing past investment decisions by selling assets previously acquired.-Some assets are less crucial to a business than others & so if cash flow problem are serve, the option of selling investments or property might have to be considered.
• Negotiating a reduction in cash outflows so as to postpone or even reduce payments.-There are several ways in which this could be done,

Longer credit might be taken from suppliers.However , if the credit period allowed is already generous, creditors might be very reluctant to extend credit even further & any such extension of credit would have to be negotiated carefully.There would be a serious risk of having further supplies refused.

1. Loan replacements could be rescheduled by agreement with a bank.
2. A diferral of the payment of corporation tax could be agreed with the inland revenue.Corporation tax is payble nine months after a company's year end.but it might be possible to arrange a postponement by a few months. When this happens , the inland revenue will charge interest on the outstanding amount of tax.
3. Dividend payments could be reduced.Dividend payments are discretionary cash outflows , although a company's directors might be constrained by shareholders expectations , so that they feel obliged to pay dividend even when there is a cash shortage.

The Miller-ORR Model.
In an attempt to produce a more realistic approach to cash management,various models more complicated than the inventory approach have been developed.One of these the Miller-ORR model manages to achive a reasonable degree of realism while not being too elaborate.


Advantages & Disadvantages of the Miller-ORR Model.
The usefullness of the Miller-ORR model is limited by the assumptions on which it is based. In practice cash flows & outflows are unlikely to be entirely unpredictable as the model assumes: For example: For a retailer, seasonal factors are likely to affect cash inflows for any company , dividend & tax payments will in advance. However ,the miller-ORR model may save management time which might otherwise be spent in responding to those cash inflows & outflows which cannot be predicted.