FREE online courses on How to Manage Cash Flow - Chapter 2
Cash Flow Planning
One of the objectives of
cash flow management is to hold the right amount of cash. If we hold too much
cash, we lose the opportunity to earn a return on idle cash. If we hold too
little cash, we run the risk of not making timely payments to suppliers, banks,
and other parties. We want to have an optimal cash balance that is neither
excessive nor deficient. The optimal cash balance is determined by looking at
the four reasons for holding cash:
- Transaction Amounts: We have to
hold enough cash to cover our outstanding payments or transactions. In addition
to transaction amounts, we should add any compensating balances required under
loan agreements. Therefore, the amount of cash on hand must be transaction
amounts + compensating balances.
- Precautionary Amounts: We need to
maintain cash for unexpected disbursements. This is the precautionary amount of
cash.
- Speculative Amounts: If we are
anticipating making an investment, we will hold a speculative amount to take
advantage of opportunities in the marketplace.
- Financial Amounts: In order to
acquire assets, retire debt, or meet some major event, we will accumulate and
hold a financial amount of cash.
Key Point? The minimal
cash balance is usually equal to the total transaction amount (includes
compensating balances) + total precautionary amount.
