Cash Management

Cash management is one of the key areas of working capital management. Apart from the fact that it is the most liquid current asset, cash is the common denominator to which all current assets can be reduced because the other major liquid assets, that is, receivables and inventory get eventually converted into cash. This underlines the significance of cash management.


The term ‘cash’ with reference to cash management is used in two senses. In a narrow sense, it is used broadly to cover currency and generally accepted equivalents of cash, such as cheques, drafts and demand deposits in banks. The broad view of cash also includes near-cash assets, such as marketable securities and time deposits in banks. The main characteristics of these are that they can be readily sold and converted into cash. They serve as a reserve pool of liquidity that provides cash quickly when needed. They also provide a short term investment outlet for excess cash and are also useful for meeting planned outflow of funds. Here, the term cash management is employed in broader sense. Irrespective of the form in which it is held, a distinguishing feature of cash, as an asset, is that it has no earning power. There are four primary motives for maintaining cash balances –

1) Transaction motive

2) Precautionary motive

3) Speculative motive

4) Compensating motive

1) Transaction motive:

An important reason for maintaining cash balances is the transaction motive. This refers to the holding of cash to meet routine cash requirements to finance the transactions which a firm carries on in the ordinary course of business.

A firm enters into a variety of transactions to accomplish its objectives which have to be paid for in the form of cash. For example, cash payments have to be made for purchases, wages, operating expenses, financial charges like interest, taxes, dividends and so on. Similarly, there is a regular inflow of cash to the firm from sales operations, returns on outside investments and so on. These receipts and payments constitute a continuous two-way flow of cash. But the inflows (receipts) and outflows (disbursements) do not perfectly coincide or synchronise. At times, receipts exceed outflows while, at other times, payments exceed inflows. To ensure that the firm can meet its obligations when payments become due in a situation in which disbursements are in excess of the current receipts, it must have adequate cash balance. The requirements of cash balances to meet routine cash needs is known as the transaction motive and such motive refers to the holding of cash to meet anticipated obligations whose timing is not perfectly synchronized with cash receipts.

Of the receipts of cash and its disbursements could exactly coincide in the normal course of operations, a firm would not need cash for transaction purposes. Although a major part of transaction balances are held in cash, a part may also be in such marketable securities whose maturity conforms to the timing of the anticipated payments, such as payment of taxes, dividends and so on.