Topic 4 - Cash Management & Marketable Securities

DPB50113 – BUSINES FINANCE
TOPIC 4: CASH MANAGEMENT AND MARKETABLE

SECURITIES
Cash or money itself are in the form of currency and current accounts. Current account is known
more formally as a demand in the bank. The bank pays money out of the current account to another
person when the owner of the account issues cheque.
Cash is considered the most liquid asset of a company, which is non-earning asset. It means thatby
holding cash we cannot earn any interest or return on it. But the company still need cash to pay
bills, purchase goods, make payment on interest, pay salaries/wages and so on. Even thoughcash it
self does not earn any return, a firm must have cash in hand to run the business efficiently.
Cash management is mainly concerned with maintaining liquidity of a firm so as to minimize the
risk of insolvency. A company becomes insolvent when it is unable to meet its maturing liabilities
on time because it lacks the necessary liquidity to make prompt payment on its current debt
obligations.
Objectives of Cash Management
1. Carrying minimum amount of cash: a company attempts to carry the minimum amount so that
it does not have a lot of cash in hand since it does not earn any return. So a firm must minimize
idle cash balances.
2. Have enough cash to make payment.: to make sure a company can make the payment duringthe
operation of the business without running out of cash.
Motives for holding cash by British economist John Maynard Keynes are:
1. The transaction motive: cash balances held are for the purpose of meeting cash need in
term of the ordinary course of doing business. Ex. buying inventories, pay bills etc.
2. The precautionary motive: Cash balances act as a buffer for unexpected needs that may
arise.
3. The speculative motive: Cash balances are held for potential profit-making situations such
as bargain purchase opportunities that might arise and attractive interest rates.
Cash planning
- Cash budget to forecast cash inflow and outflow. Also referred to as cash budget.
Management of cash receipts and payments

- Float
Refers to funds that have been paid for but are as yet not useable. 3 components – mail,
processing and clearing float
• Mail – length of time between the mailing of payments and its receipt
• Processing – time between receiving of a payment and its deposits into the firm’s
account
• Clearing float – time between the deposit of payment into the firm’s account
andwhen the fund can be used (time for cheque to clear)
Methods to speed up collection and slow down payments:
1. Reducing collection time – this will reduce customer float time which will shorten the average
collection period and cash conversion cycle.
2. Increasing payment time – delay payment to supplier, must be use carefully as longer
payments period may cause a strain in relationship with supplier.
3. Concentration of cash – transfer mechanism selected/choose by the firm to concentrate
deposits into one bank.
4. Zero-balance account – allows a firm to keep all its operating cash in an interest earning
account. It allows the firm to maximize the use of float on each cheque without altering the
float time of payment to its suppliers.
The Efficient Management of Cash
Since the objective of a company is to run the business effectively without running out of cash, a
company must keep the minimum cash balance. By keeping the minimum cash balance, it will
allow the company to invest in various alternatives and to repay debts when they are due.
Therefore, the efficient cash management requires the following steps:
1. Determine minimum operating Cash (MOC)

Most companies need to have minimum cash balance in operate their business. This amountof
cash is called Minimum Operating Cash (MOC). MOC balances and safety stock of cash are
influenced by the firm’s production and sales techniques and by its procedures for collecting
sales receipts and payment on purchase. In other hand, cash balance is influenceby the firm’s
operating cycle and cash cycle.
If a company can manage these cycles efficiently, then the financial manager of that company
can maintain a minimum level of cash investment and contribute toward maximization of share
value.
2. Defining Operating Cycle (OC)

Operating cycle is an average time period to acquire inventory, process it and sell the finished
product until to the point when cash is collected from the sale of it.
3. Defining Cash Cycle (CC)

Most of the time a company can purchase raw materials on credit. The time it takes topay for
these inputs is called the average payment period.
The ability to purchase raw materials on credits allows the firm to offset the length of time
resources that are tied up in the operating cycle. So, cash cycle refers to an average time
between ‘cash out’ for inventory and ‘cash in’ from collection on sales. In other words, cash
cycle is an average time the company is without cash.
MARKETABLE SECURITIES MANAGEMENT
Are assets that be converted into cash quickly. Ex. Treasury bills, commercial papers, negotiable
certificates of deposit and money market mutual fund.
Rationale for holding marketable securities
• As a substitute to cash - When cash outflow exceeds cash inflows at any point in time, a firm
will sell the marketable securities.
• As a temporary investment - held as temporary investment for the purpose of meeting the
known financial requirements. Ex: to pay tax.
Selection criteria for marketable securities
1. Financial risk/ default risk – this is the risk of the borrower not being able to pay interest/
principle on the security traded.
2. Interest rate risk – Financial instruments with longer terms to maturity are more sensitive to
changes in interest rate and therefore have higher interest rate risk
3. Inflation risk – inflation will reduce purchasing power and those financial instruments whose
returns rise with inflation will experience lower inflation risk, whereas those financial
instruments whose returns fall with inflation, will experienced higher inflation risk.
4. Marketable/ liquidity – financial instrument which can be sold immediately at a price close to
their market price are more marketable and liquid as compared to those that cannot be sold
immediately.
5. Rates of return/yield – the return on marketable securities are dependent on the four factors
described above. The higher the risk, the higher the return. However, it must be said that safety/
liquidity should not be sacrificed for higher returns.
Types of marketable securities
1. Malaysian Treasury Bills (MT-bills) - MTBills are short-term securities issued by the
Government of Malaysia to raise short-term funds for Government's working capital. Bills are
sold at discount through competitive auction, facilitated by Bank Negara Malaysia, with
original maturities of 3-month, 6- month, and 1-year. The redemption will
be made at par. MTB are issued on weekly basis and the auction will be held
one day before the issue date. The successful bidders will be determined according to the most
competitive yield offered. Normal auction day is Thursday, and the result of successful
bidders will be announced one day after. MTB are tradable on yield basis (discounted
rate) based on bands of remaining tenure (e.g., Band 4= 68 to 91 days to maturity). The standard
trading amount is RM5 million, and it is actively traded in the secondary market.
2. Malaysian Islamic Treasury Bills (MITB) – are issued to allow Islamic banks to hold liquid
papers that meet their statutory liquidity requirements.
3. Promissory Note – A promissory note is a financial instrument that contains a written promise
by one party (the note's issuer or maker) to pay another party (the note's payee) a definite sum
of money, either on demand or at a specified future date. It is an unconditional promise to pay a
specific amount to bearer or to the order of a named of person, on demand or on a specific date.
It is a written promise by a maker to pay money to the payee.
4. Bill of Exchange – A bill of exchange is a written order once used primarily in international
trade that binds one party to pay a fixed sum of money to another party on demand or at a
predetermined date. Bills of exchange are like checks and promissory notes—they can be drawn
by individuals or banks and are generally transferable by endorsements. A bill of exchange
transaction can involve up to three parties. The drawee is the party that pays the sum specified
by the bill of exchange. The payee is the one who receives that sum. The drawer is the party that
obliges the drawee to pay the payee. The drawer and the payee are the same entity unless the
drawer transfers the bill of exchange to a third-party payee.
5. Negotiable Instrument of Deposit (NID): also known as Negotiable Certificate of Deposit

(NCD) aredeposit certificates used in the wholesale money market that are regularly purchased
and traded by institutional investors and high-net-worth individuals in the stock market. A
negotiable CD is one that can be bought and sold on a secondary market. The bank that issues
the original certificate sets the face amount and interest to be paid. In general, the longer the
term, the higher the interest rate. Negotiable CDs mature over relatively short periods, from
two weeks up to a year. At maturity, the holder of the CD receives the face amount from the
issuer and the CD expires. If the bank restricts the CD so that it can't be transferred by the
holder and sets a penalty for the return of principal before maturity, then the CD is non-
negotiable.
6. Banker’s Acceptance: A banker’s acceptance (BA, aka bill of exchange) is a commercial
bank draft requiring the bank to pay the holder of the instrument a specified amount on a
specified date, which is typically 90 days from the date of issue but can range from 1 to 180
days. A banker's acceptance is an instrument representing a promised future payment by a bank.
The payment is accepted and guaranteed by the bank as a time draft to be drawn on a deposit.
The draft specifies the amount of funds, the date of the payment (or maturity), and he entity to
which the payment is owed.
7. Commercial Paper: Commercial paper, in the global financial market, is an unsecured

promissory note with a fixed maturity of rarely more than 270 days.
Commercial paper is a money-market security issued (sold) by large corporations to obtain
funds to meet short-term debt obligations (for example, payroll) and is backed only by an
issuing bank or company promise to pay the face amount on the maturity date specified on the
note. Since it is not backed by collateral, only firms with excellent credit ratings from a
recognized credit rating agency will be able to sell their commercial paper at a reasonable
price. Commercial paper is usually sold at a discount from face value and generally carries
lower interest repayment rates than bonds due to the shorter maturities of commercial paper.
Typically, the longer the maturity on a note, the higher the interest rate the issuing institution
pays. Interest rates fluctuate with market conditions but are typically lower than banks' rates.
8. Repurchase Agreement (Repo): A repurchase agreement (repo) is a form of short-term
borrowing for dealers in government securities. In the case of a repo, a dealer sells government
securities to investors, usually on an overnight basis, and buys them back the following day at
a slightly higher price.

Topic 4 - Cash Management & Marketable Securities

Uploaded by

Copyright:

Available Formats

Topic 4 - Cash Management & Marketable Securities

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Topic 4 - Cash Management & Marketable Securities

Uploaded by

Copyright:

Available Formats

DPB50113 – BUSINES FINANCE

TOPIC 4: CASH MANAGEMENT AND MARKETABLE

Objectives of Cash Management

Management of cash receipts and payments

The Efficient Management of Cash

Therefore, the efficient cash management requires the following steps:

1. Determine minimum operating Cash (MOC)

2. Defining Operating Cycle (OC)

3. Defining Cash Cycle (CC)

Rationale for holding marketable securities

Selection criteria for marketable securities

Types of marketable securities

5. Negotiable Instrument of Deposit (NID): also known as Negotiable Certificate of Deposit

7. Commercial Paper: Commercial paper, in the global financial market, is an unsecured

You might also like