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Chapter 18 - Managing Cash “I’ve never been poor but...

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508 Managing Cash “I’ve never been poor, but I’ve been broke. —Mike Todd The Importance of Cash Bear Stearns gets bought out at a bargain basement price by JP Morgan Chase as does Merrill Lynch by Bank of America. Lehman Brothers fails and is liquidated. AIG requires federal government funds to stay afloat. What do all these events have in common? The answer is that the troubled companies didn’t have enough cash. When you don’t have enough cash to pay your obligations you are out of business. What does cash do for a company? It buys time. For a startup company it allows the firm to stay in business until it can attract enough paying customers to turn a profit and generate positive cash flow. Cash is important for long- standing companies too. It allows companies to weather financial storms. Bear Stearns, Merrill Lynch, Lehman Brothers, and AIG are four financial firms that in 2008 found themselves in the position of not being able to pay their bills. Cash gives you a chance to make it to the time when you’ll be profitable and have more cash coming in than going out. Many college students have negative net income since their expenses exceed their revenues. As long as you have cash in your checking account, however, you can pay your bills and avoid eviction from your apartment and an empty refrigerator. This chapter will focus on the management of that most important asset, cash.
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1 In fact, because there would be no investment in earning assets, such a business would never accumulate more cash than was originally contributed by the founders. 509 www.morguefile.com (cohdragive1.jpg), courtesy [email protected] Learning Objectives After reading this chapter, you should be able to: 1. List the factors that affect a company’s desired minimum cash balance. 2. List the factors that affect a company’s desired maximum cash balance. 3. Apply the Miller–Orr model to establish a target optimal cash balance. 4. Prepare a cash budget. 5. Explain how firms manage their cash inflows and outflows to maximize value. Chapter Overview In this chapter we look at how firms manage cash. Cash flow management can even mean electronic cash, as shown in the chapter opening. Here we start by exploring factors that affect a company’s optimal cash balance and learn how to estimate the optimal balance. Then we examine how firms forecast their cash needs, develop a cash budget, and manage cash inflows and outflows. Cash Management Concepts Whether they work in a large multinational corporation or a small business, financial managers need to know how much cash to keep on hand. Cash management may sound simple. Shouldn’t businesses accumulate as much cash as possible? It’s not that easy. Recall from Chapter 17 that cash earns no return for the business owners. In fact, a business that accumulated as much cash as possible and did not invest in any assets would fail because it would earn no return for the stockholders.
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