1.1.           Why does a company hold cash?

Before analyzing the impact of cash on the net daily cash flow, we first need to understand the reason why a company needs cash. A company basically needs cash for three reasons:

a.  Transactions. All the transactions whether receipts or payments involve cash. So, we need cash for the transaction balances.

b.  Precautionary. Both cash inflows and outflows can be unpredictable, so we need cash as a precautionary measure for unexpected requirements.

c.  Speculative. A company can have unexpected opportunities to earn super-normal profits. Such opportunities may require investment in the form of cash. Thus, in order to capitalize on such lucrative investment opportunities a company needs speculative cash.

All the firms attempt to forecast cash flow to ensure that their net cash position is greater than zero, on a day-to-day basis.

1.2.           Managing Cash Positions

a.  In order to understand how to manage the cash flows, it is important to understand the sources of inflows and outflows to the company, and what pulls the levels of cash to a certain level, and what are the factors that make the cash fall below the minimum desired levels.

In the above figure, the sources of inflows and outflows are listed in the sequence of a period of maturity of the sources.

b.  Based on the terms of the sources of inflow and outflow of cash, as shown in the above figure, the management can go ahead with forecasting the cash on a daily/short-term/long-term basis. This will help in projecting and forecasting the levels of cash of the company, as to when it will fall below the minimum required balance and when it may be at the desired levels. This would help in taking the required action in advance, so that desired cash balance can be maintained throughout.

c.  The companies usually prefer to manage the cash positions with the help of short-term liquidity sources such as short-term investments and borrowings. This helps in countering the excesses and deficits that occur.

d.  In the process of managing the daily cash flows, the company needs to maintain a balance between various assets. They must maintain very liquid, short-term investments, that are necessary to maintain the liquidity position, and give up on the yield on longer-dated less liquid securities.

e.  On the liabilities side also, a balance needs to be maintained. The company might need to borrow short-term borrowings for a very short period of time, at the time of emergency, which usually carries a very high cost. Whereas, it may be more economical to borrow for a longer period of time.

f.  Some of the examples of typical short term investments and borrowings are: