Optimal cash balances

NotesCBE

Optimal cash balances

In optimising cash balances there's a balance between liquidity and profitability

  • If you keep lots of cash in your current account:

    Good liquidity but poor profitability (lose interest from investing / deposit account)

  • If you keep very little cash in your cuurent account:

    Good profits (money kept in investments) but poor liquidity

Deviations from expected cash flows

Cash budgets are only estimates of cash flows. 

So we need to consider this uncertainty when the cash budget is prepared. 

So perhaps prepare additional cash budgets based on different estimates of sales levels, costs, bad debts.

A cash budget model could show how cashflows change according to changes in revenues estimates.

So management should be able to prepare measures in advance.

Float

The term float is sometimes used to describe the amount of money tied up between:

  1. The time when a payment is initiated (for example when a customer sends a cheque in payment, probably by post)

  2. The time when the funds become available for use in the recipient's bank account

Rasons why there might be a lengthy float:

  • Transmission delay 

    When payment is posted, it will take a day or longer for the payment to reach the payee.

  • Delay in banking the payments received (lodgement delay)

    The payee might delay taking the cheque or the cash to his/her bank, they may only bank once a week for example

  • The time needed for a bank to clear a cheque (clearance delay)

    A payment is not available for use in the payee's bank account until the cheque has been cleared. 

    This will usually take two or three days for cheques payable in the UK. 

    For cheques payable abroad, the delay is much longer.

NotesCBE