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CHAPTER 16 Current Asset Management CHAPTER ORIENTATION This chapter initiates our study of liquidity management. Here, we focus on the cash flow process and the reasons why a firm holds cash balances. The objectives of a sound cash management system are identified. The concept of float is defined. Several techniques that firms can use to favorably affect their cash receipts and disbursement patterns are examined. Finally, the composition of the firms marketable securities portfolio is discussed. Additionally, the risk-return tradeoff associated with the firms investment in accounts receivable is discussed. For accounts receivable, this tradeoff occurs as less creditworthy customers with a higher probability of bad debts are taken on to increase sales. The analysis is similar for sound inventory management. Here a larger investment in inventory leads to more efficient production and speedier delivery; this should result in increased sales. However, additional financing costs to support the increase in inventory and increased handling and carrying costs are required. CHAPTER OUTLINE I. Why a company holds cash A. The firms cash balance is constantly affected by a variety of influences. Sound cash management techniques are based on a thorough understanding of the cash flow process. 1. On an irregular basis, cash holdings are increased from several external sources, such as from the sale of securities. 2. In a similar fashion, irregular cash outflows reduce the firms cash balance. Typical examples include cash dividend payments and the interest requirements on debt agreements. 3. Other major sources of cash arising from internal operations occur on a rather regular basis. Accounts receivable collections are an example. 234 B. Three motives for holding cash balances have been identified by Keynes. 1 1. The transactions motive is the need for cash to meet payments that arise in the ordinary course of doing business. Holding cash to meet a payroll or to acquire raw materials characterizes this motive. 2. The precautionary motive describes the investment in liquid assets that are used to satisfy possible, but as yet indefinite, needs for cash. Precautionary balances are a buffer against all kinds of things that might happen to drain the firms cash resources. 3. The speculative motive describes holding cash to take advantage of hoped-for, profit-making situations. II. Variations in liquid asset holdings A. Considerable variation is present in the liquid asset holdings of major industry groups and individual firms. 1. This is because (l) not all of the factors noted above affect every firm and (2) the executives in different firms who are ultimately responsible for cash management tasks have different risk-bearing preferences.... View Full Document

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