SlideShare a Scribd company logo
1 of 17
Download to read offline
Cash Management Model


           By
           Godfrey Ouseph
Cash Management Model
• A number of mathematical model have been
  to develop to determined the optimal cash
  balance.
• Two of such model are as follow;
   a) William J. Baumol's inventory model
   b) M. H. Miller and Daniel Orr’s Stochastic
      model
William J. Baumol's Inventory model
Baumol’s model of cash management-
• Trades off between opportunity cost or
  carrying cost or holding cost & the transaction
  cost. As such firm attempts to minimize the
  sum of the holding cash & the cost of
  converting marketable securities in to cash.
• Helps in determining a firm's optimum cash
  balance under certainty
William J. Baumol's Inventory model



                                                    Opportunity Cost
                                    Total Cost




                                       Transaction Cost


           Optimum Cash Balance
 (Baumol’s Model : Tradeoff Between Holding cost and transaction cost)
William J. Baumol's Inventory model

Assumptions
• Cash needs of the firm is known with certainty
• Cash Disbursement over a period of time is
  known with certainty
• Opportunity cost of holding cash is known and
  remains constant
• Transaction cost of converting securities into
  cash is known and remains constant
William J. Baumol's Inventory model
    Algebraic representation of William J.
          Baumol's Inventory model

                  C = 2A*F
                        o
C = Optimum Balance
A = Annual Cash Distribution
F = Fixed Cost Per Transaction
O = Opportunity Cost Of Holding
William J. Baumol's Inventory model
Uses
The Baumol’s model enables companies to find out
their desirable level of cash balance under certainty.
The Baumol’s model of cash management theory relies
on the tradeoff between the liquidity provided by
holding money (the ability to carry out transactions)
and the interest foregone by holding one's assets in the
form of non-interest bearing money. The key variables
of the demand for money are then the nominal interest
rate, the level of real income which corresponds to the
amount of desired transactions and to a fixed cost of
transferring one's wealth between liquid money and
interest bearing assets
William J. Baumol's Inventory model
Evaluation of the model
• Helpful in determining optimum level of Cash
  holding
• Facilitates the finance manager to minimize
  Carrying cost and Maintain Cash
• Indicates idle cash Balance Gainful
  employment
• Applicable only in a situation of certainty in
  other words this model is deterministic model
M. H. Miller and Daniel Orr’s
           Stochastic Model
Overview
• The Miller and Orr model of cash
  management is one of the various cash
  management models in operation. It is an
  important cash management model as well. It
  helps the present day companies to manage
  their cash while taking into consideration the
  fluctuations in daily cash flow.
M. H. Miller and Daniel Orr’s
          Stochastic Model
Description
• As per the Miller and Orr model of
  cash management the companies
  let their cash balance move within
  two limits
a) Upper Control limit
b) Lower Control Limit
M. H. Miller and Daniel Orr’s
                    Stochastic Model
Miller – Orr Cash Management Model
Cash
                               Upper Control Limit : Buy Security
       h
           Curve representing Cash                  Purchase Market Security
           Balance

                                                                                   Return
       Z
                                                                                   Point



                                                                       Sale of market
                                                                       security
       O
                               Lower Control Limit : Buy Security
M. H. Miller and Daniel Orr’s
           Stochastic Model
Explanation For the Diagram
• Along with a return point when the cash
  balance touches the upper Control limit (h),
  the marketable security is purchased to the
  extend till it reaches normal cash balance (Z)
• In the same manner when the cash balance
  touches lower limit (o), the firm Will Sell the
  Marketable security to the extent till it
  reaches normal cash Balance (Z)
M. H. Miller and Daniel Orr’s
              Stochastic Model
       Computation of Miller – Orr Model of Cash
                     Management

                                                                  1/3
Spread (Z)= (3/4 * Transaction cost *Variance of Cash Flow)
                                   Interest Rate
Return Point = Lower limit + Spread (Z)
                                        3
                                                     2        2
Variance of Cash Flow = (Standard Deviation) or (             )
M. H. Miller and Daniel Orr’s
           Stochastic Model
Benefits

• Allows for net cash flow in a random fashion.
• transfer can take place at any time and are
  instantaneous with a fixed transfer cost.
• Produce control limit can be used as basis for
  balance management
M. H. Miller and Daniel Orr’s
          Stochastic Model
Limitations
• May prove difficult to calculate.
• Monitoring needs to be calculated for
  the organizations benefits becomes a
  tedious Work.
M. H. Miller and Daniel Orr’s
           Stochastic Model
Application
• Finding out the approximate prices at which
  the salable securities could be sold or bought
• Deciding the minimum possible levels of
  desired cash balance
• Checking the rate of interest
• Calculating the SD (Standard Deviation) of
  regular cash flows
M. H. Miller and Daniel Orr’s
           Stochastic Model
Evaluation of the Model
• This Stochastic model can be employed even
  in extreme uncertainty
• When the cash flow fluctuate violently in
  short period it will give optimal result
• Finance Manager can apply this model in
  highly unpredictable situation

More Related Content

What's hot

Cash management- Need, Motives, Models of Cash Management, Boumol Model, Mill...
Cash management- Need, Motives, Models of Cash Management, Boumol Model, Mill...Cash management- Need, Motives, Models of Cash Management, Boumol Model, Mill...
Cash management- Need, Motives, Models of Cash Management, Boumol Model, Mill...Dr. Toran Lal Verma
 
Financial management unit 4 working capital management
Financial management unit 4 working capital managementFinancial management unit 4 working capital management
Financial management unit 4 working capital managementGanesha Pandian
 
Working capital-management
Working capital-managementWorking capital-management
Working capital-managementketan53
 
Dividend policy ppt
Dividend policy  pptDividend policy  ppt
Dividend policy pptAayush Kumar
 
Lease finance
Lease   financeLease   finance
Lease financeSubin Raj
 
Cash forecasting
Cash forecastingCash forecasting
Cash forecastingFatima Khan
 
Working capital management ppt
Working capital management pptWorking capital management ppt
Working capital management pptShanu Aggarwal
 
Capital structure decisions
Capital structure decisionsCapital structure decisions
Capital structure decisionsAchla_Anoop
 
Traditional and MM approach in capital structure
Traditional and MM approach in capital structureTraditional and MM approach in capital structure
Traditional and MM approach in capital structureMERIN C
 
Funds flow statement
Funds flow statement Funds flow statement
Funds flow statement Suresh Vadde
 

What's hot (20)

Capital structure ppt
Capital structure pptCapital structure ppt
Capital structure ppt
 
Cash management- Need, Motives, Models of Cash Management, Boumol Model, Mill...
Cash management- Need, Motives, Models of Cash Management, Boumol Model, Mill...Cash management- Need, Motives, Models of Cash Management, Boumol Model, Mill...
Cash management- Need, Motives, Models of Cash Management, Boumol Model, Mill...
 
Cash management
Cash managementCash management
Cash management
 
Cash management
Cash managementCash management
Cash management
 
Swaps
SwapsSwaps
Swaps
 
Cash management
Cash managementCash management
Cash management
 
Financial management unit 4 working capital management
Financial management unit 4 working capital managementFinancial management unit 4 working capital management
Financial management unit 4 working capital management
 
B.Com-Cash Management
B.Com-Cash ManagementB.Com-Cash Management
B.Com-Cash Management
 
Working capital-management
Working capital-managementWorking capital-management
Working capital-management
 
Cost of capital ppt
Cost of capital pptCost of capital ppt
Cost of capital ppt
 
Working capital ppt
Working capital  pptWorking capital  ppt
Working capital ppt
 
Dividend policy ppt
Dividend policy  pptDividend policy  ppt
Dividend policy ppt
 
Lease finance
Lease   financeLease   finance
Lease finance
 
CASH MANAGEMENT
CASH MANAGEMENTCASH MANAGEMENT
CASH MANAGEMENT
 
Cash forecasting
Cash forecastingCash forecasting
Cash forecasting
 
Working capital management ppt
Working capital management pptWorking capital management ppt
Working capital management ppt
 
Capital structure decisions
Capital structure decisionsCapital structure decisions
Capital structure decisions
 
Receivables management
Receivables managementReceivables management
Receivables management
 
Traditional and MM approach in capital structure
Traditional and MM approach in capital structureTraditional and MM approach in capital structure
Traditional and MM approach in capital structure
 
Funds flow statement
Funds flow statement Funds flow statement
Funds flow statement
 

Viewers also liked (20)

CASH MANAGEMENT
CASH MANAGEMENTCASH MANAGEMENT
CASH MANAGEMENT
 
Cash management ppt @ mba
Cash management ppt @ mbaCash management ppt @ mba
Cash management ppt @ mba
 
14685550 cash-management-presentation
14685550 cash-management-presentation14685550 cash-management-presentation
14685550 cash-management-presentation
 
Cash management
Cash managementCash management
Cash management
 
Management of receivables
Management of receivablesManagement of receivables
Management of receivables
 
Management of Receivables
Management of ReceivablesManagement of Receivables
Management of Receivables
 
Management Of Cash
Management Of  CashManagement Of  Cash
Management Of Cash
 
Cash flow management
Cash flow managementCash flow management
Cash flow management
 
Managing Cash Flow
Managing Cash FlowManaging Cash Flow
Managing Cash Flow
 
Cash budget
Cash budgetCash budget
Cash budget
 
Cash budget
Cash budgetCash budget
Cash budget
 
Cash flow management
Cash flow managementCash flow management
Cash flow management
 
Methods of accelerating cash inflow PPT
Methods of accelerating cash inflow   PPTMethods of accelerating cash inflow   PPT
Methods of accelerating cash inflow PPT
 
Accounts receivables management 1 copy - copy
Accounts receivables management 1   copy - copyAccounts receivables management 1   copy - copy
Accounts receivables management 1 copy - copy
 
Cash budget
Cash budgetCash budget
Cash budget
 
Receivable mgmt
Receivable mgmtReceivable mgmt
Receivable mgmt
 
Cash budgets
Cash budgetsCash budgets
Cash budgets
 
Cash budgets
Cash budgetsCash budgets
Cash budgets
 
Receivable management presentation1
Receivable management presentation1Receivable management presentation1
Receivable management presentation1
 
Inventory control & management
Inventory control & managementInventory control & management
Inventory control & management
 

Similar to Cash management model

cash mgt. model , baumols model , finance
cash mgt. model , baumols model , financecash mgt. model , baumols model , finance
cash mgt. model , baumols model , financeswidan 1455
 
Shikha's ppt of business finance
Shikha's ppt of business financeShikha's ppt of business finance
Shikha's ppt of business financeShikhaChaudhary67
 
Unit 5Cash Management 2.docx.pptx
Unit 5Cash Management 2.docx.pptxUnit 5Cash Management 2.docx.pptx
Unit 5Cash Management 2.docx.pptxAnshikaMaheshwari10
 
Chapter 16 Working Capital
Chapter 16 Working CapitalChapter 16 Working Capital
Chapter 16 Working CapitalMikee Bylss
 
Topic 5 tools techniques of managing of cash
Topic   5 tools   techniques of managing of cashTopic   5 tools   techniques of managing of cash
Topic 5 tools techniques of managing of cashRAJKAMAL282
 
RMIT Vietnam - Risk Management - Options
RMIT Vietnam - Risk Management - OptionsRMIT Vietnam - Risk Management - Options
RMIT Vietnam - Risk Management - OptionsTai Tran
 
Cash management (4)
Cash management (4)Cash management (4)
Cash management (4)PrachiRao4
 
Valuing Callable Bond
Valuing Callable BondValuing Callable Bond
Valuing Callable BondDmitryPopov47
 
Cash flow part_12_-_cash_models
Cash flow part_12_-_cash_modelsCash flow part_12_-_cash_models
Cash flow part_12_-_cash_modelsmannat01
 
Derivative_Presentation.pptx
Derivative_Presentation.pptxDerivative_Presentation.pptx
Derivative_Presentation.pptxatuldeepgupta
 
Portfolio Risk & Return Part 2.pdf
Portfolio Risk & Return Part 2.pdfPortfolio Risk & Return Part 2.pdf
Portfolio Risk & Return Part 2.pdfRahul das
 

Similar to Cash management model (20)

cash mgt. model , baumols model , finance
cash mgt. model , baumols model , financecash mgt. model , baumols model , finance
cash mgt. model , baumols model , finance
 
Cash management
Cash managementCash management
Cash management
 
Shikha's ppt of business finance
Shikha's ppt of business financeShikha's ppt of business finance
Shikha's ppt of business finance
 
Cash Management
Cash Management Cash Management
Cash Management
 
Derivatives
DerivativesDerivatives
Derivatives
 
cash management
cash management cash management
cash management
 
Unit 5Cash Management 2.docx.pptx
Unit 5Cash Management 2.docx.pptxUnit 5Cash Management 2.docx.pptx
Unit 5Cash Management 2.docx.pptx
 
The Miller- Orr Model.pptx
The Miller- Orr Model.pptxThe Miller- Orr Model.pptx
The Miller- Orr Model.pptx
 
Chapter 16 Working Capital
Chapter 16 Working CapitalChapter 16 Working Capital
Chapter 16 Working Capital
 
Topic 5 tools techniques of managing of cash
Topic   5 tools   techniques of managing of cashTopic   5 tools   techniques of managing of cash
Topic 5 tools techniques of managing of cash
 
RMIT Vietnam - Risk Management - Options
RMIT Vietnam - Risk Management - OptionsRMIT Vietnam - Risk Management - Options
RMIT Vietnam - Risk Management - Options
 
Cash management (4)
Cash management (4)Cash management (4)
Cash management (4)
 
3 cash management
3 cash management3 cash management
3 cash management
 
Valuing Callable Bond
Valuing Callable BondValuing Callable Bond
Valuing Callable Bond
 
Cash flow part_12_-_cash_models
Cash flow part_12_-_cash_modelsCash flow part_12_-_cash_models
Cash flow part_12_-_cash_models
 
Derivative_Presentation.pptx
Derivative_Presentation.pptxDerivative_Presentation.pptx
Derivative_Presentation.pptx
 
Working capital mgt
Working capital mgtWorking capital mgt
Working capital mgt
 
Cash bud
Cash budCash bud
Cash bud
 
Section 2 - Chapter 11,12 - Volume Analysis
Section 2 - Chapter 11,12 - Volume AnalysisSection 2 - Chapter 11,12 - Volume Analysis
Section 2 - Chapter 11,12 - Volume Analysis
 
Portfolio Risk & Return Part 2.pdf
Portfolio Risk & Return Part 2.pdfPortfolio Risk & Return Part 2.pdf
Portfolio Risk & Return Part 2.pdf
 

Cash management model

  • 1. Cash Management Model By Godfrey Ouseph
  • 2. Cash Management Model • A number of mathematical model have been to develop to determined the optimal cash balance. • Two of such model are as follow; a) William J. Baumol's inventory model b) M. H. Miller and Daniel Orr’s Stochastic model
  • 3. William J. Baumol's Inventory model Baumol’s model of cash management- • Trades off between opportunity cost or carrying cost or holding cost & the transaction cost. As such firm attempts to minimize the sum of the holding cash & the cost of converting marketable securities in to cash. • Helps in determining a firm's optimum cash balance under certainty
  • 4. William J. Baumol's Inventory model Opportunity Cost Total Cost Transaction Cost Optimum Cash Balance (Baumol’s Model : Tradeoff Between Holding cost and transaction cost)
  • 5. William J. Baumol's Inventory model Assumptions • Cash needs of the firm is known with certainty • Cash Disbursement over a period of time is known with certainty • Opportunity cost of holding cash is known and remains constant • Transaction cost of converting securities into cash is known and remains constant
  • 6. William J. Baumol's Inventory model Algebraic representation of William J. Baumol's Inventory model C = 2A*F o C = Optimum Balance A = Annual Cash Distribution F = Fixed Cost Per Transaction O = Opportunity Cost Of Holding
  • 7. William J. Baumol's Inventory model Uses The Baumol’s model enables companies to find out their desirable level of cash balance under certainty. The Baumol’s model of cash management theory relies on the tradeoff between the liquidity provided by holding money (the ability to carry out transactions) and the interest foregone by holding one's assets in the form of non-interest bearing money. The key variables of the demand for money are then the nominal interest rate, the level of real income which corresponds to the amount of desired transactions and to a fixed cost of transferring one's wealth between liquid money and interest bearing assets
  • 8. William J. Baumol's Inventory model Evaluation of the model • Helpful in determining optimum level of Cash holding • Facilitates the finance manager to minimize Carrying cost and Maintain Cash • Indicates idle cash Balance Gainful employment • Applicable only in a situation of certainty in other words this model is deterministic model
  • 9. M. H. Miller and Daniel Orr’s Stochastic Model Overview • The Miller and Orr model of cash management is one of the various cash management models in operation. It is an important cash management model as well. It helps the present day companies to manage their cash while taking into consideration the fluctuations in daily cash flow.
  • 10. M. H. Miller and Daniel Orr’s Stochastic Model Description • As per the Miller and Orr model of cash management the companies let their cash balance move within two limits a) Upper Control limit b) Lower Control Limit
  • 11. M. H. Miller and Daniel Orr’s Stochastic Model Miller – Orr Cash Management Model Cash Upper Control Limit : Buy Security h Curve representing Cash Purchase Market Security Balance Return Z Point Sale of market security O Lower Control Limit : Buy Security
  • 12. M. H. Miller and Daniel Orr’s Stochastic Model Explanation For the Diagram • Along with a return point when the cash balance touches the upper Control limit (h), the marketable security is purchased to the extend till it reaches normal cash balance (Z) • In the same manner when the cash balance touches lower limit (o), the firm Will Sell the Marketable security to the extent till it reaches normal cash Balance (Z)
  • 13. M. H. Miller and Daniel Orr’s Stochastic Model Computation of Miller – Orr Model of Cash Management 1/3 Spread (Z)= (3/4 * Transaction cost *Variance of Cash Flow) Interest Rate Return Point = Lower limit + Spread (Z) 3 2 2 Variance of Cash Flow = (Standard Deviation) or ( )
  • 14. M. H. Miller and Daniel Orr’s Stochastic Model Benefits • Allows for net cash flow in a random fashion. • transfer can take place at any time and are instantaneous with a fixed transfer cost. • Produce control limit can be used as basis for balance management
  • 15. M. H. Miller and Daniel Orr’s Stochastic Model Limitations • May prove difficult to calculate. • Monitoring needs to be calculated for the organizations benefits becomes a tedious Work.
  • 16. M. H. Miller and Daniel Orr’s Stochastic Model Application • Finding out the approximate prices at which the salable securities could be sold or bought • Deciding the minimum possible levels of desired cash balance • Checking the rate of interest • Calculating the SD (Standard Deviation) of regular cash flows
  • 17. M. H. Miller and Daniel Orr’s Stochastic Model Evaluation of the Model • This Stochastic model can be employed even in extreme uncertainty • When the cash flow fluctuate violently in short period it will give optimal result • Finance Manager can apply this model in highly unpredictable situation