Components of Cash and Bank Balances
The firms hold cash and bank balances in three major forms, i.e., cash and cheques in hand, balances with banks, and investment in liquid securities:
1. Cash and Cheques in hand
This is the most liquid and readily accessible component of cash. The cash is held to meet day-to-day payments of small amounts. It is generated from counter cash receipts of the firm if any, and from cash withdrawals from the bank. The volume of cash in hand maintained by the firm again depends upon the nature of operations of the firm. In case of a major portion of the sales being in cash, the firm is left with large amounts of cash at the end of the day which needs to be taken care of safely. This entails security and custody arrangements for the cash before it is deposited in the bank. Moreover, since receipt and payment of cash is a primary level transaction that is culminated with the handing over of the cash, special care is required while handling cash.
Cheques in hand are clubbed with cash in a categorization because a cheque is a secondary form of cash and is equivalent to holding cash. The care and precaution required for holding cheques are much less than required for cash because almost all the cheques are “account payee cheques” which can be credited to the account of the firm only. The cheques in hand need to be deposited carefully and expeditiously into the bank in order to get credit to the correct account well in time. Attention also needs to be paid to those cheques which are dishonored at the time of presentation to the payee banks since the drawer of the cheques has to be contacted for obtaining rectified cheques.
2. Bank Balances
Bank balances represent the amount held with banks in savings, current, or deposit accounts. In the case of firms, balances are not held in savings accounts. A firm has at least one main current account with a bank through which the transactions are carried out. All the excess cash is deposited into this account together with the cheques. Payments to employees, creditors, and suppliers are made by way of cheques drawn on this account. Being a current account, no interest is payable to the firm on the balance maintained in this account. Therefore, the firm seeks to keep just sufficient balance in the current account for meeting immediate payment liabilities. After accounting for these liabilities, the surplus is transferred either to an interest-bearing deposit account or invested in short-term liquid instruments. In case the firm has borrowed funds for working capital, the surplus cash and cheques are credited to those accounts, thereby reducing the liability of the company.
William J. Baumal Model for Optimal Cash Balance Management
The cash management model of William J. Baumal assumes that the concerned company keeps all its cash on interest yielding deposits from which it withdraws as and when required. It also assumes that cash usage is linear over time. The amount of money is withdrawn from deposits in such a way that the cost of withdrawal is optimally balanced with those of interest foregone by holding cash. The model is almost the same as the economic stock order quantity model.