# Thus this model let the companies cash balance move

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Thus, this model let the companies’ cash balance move within the lower limit and upper limit.Formulae:Return Point:Return Point=Lower Limit×Spread3Downloaded by cielalOMoARcPSD|16786498
Thelower limitis set by management. It depends on the acceptable risk of cash fows gap,creditworthiness of a business, and expected needs in cash. However, the lower limit can be set as zero ifa business has sufcient investments in marketable securities or perfect creditworthiness and can raiseadditional short-term debt at any time.Spread:Spread=3×334F σ2iWhere:F = Fixed Transaction Cost (i.e. Brokerage Fees)σ2= Variance of daily cash balance/cash fowi = is the rate of interest during the period or opportunity cost for withdrawal frominvestment during the periodUpper Limit:Upper Limit=Lower Limit+SpreadAssumptions:The cash infows and cash outfows are stochastic. In other words, each day a business may haveboth diferent cash payments and diferent cash receipts.The daily cash balance is normally distributed, i.e., it occurs randomly.There is a possibility to invest idle cash in marketable securities.There is a transaction fee when marketable securities are bought or sold.A business maintains the minimum acceptable cash balance, which is called the lower limit.Graphical Illustration of the Application of Miller-Orr ModelExplanation:A is when the actual cash balance drops to the lower limit. A company’s management should replenish it toreach the return point, which can be done by selling investments in marketable securities.B is when the actual cash balance touches the upper limit. In such cases, it is necessary to buy marketablesecurities and restore the cash balance down to the return point. The amount to be invested is thediference between the upper limit and return point.Limitations:An increase in transaction cost results in an increase of spread and a higher return point.The higher the standard deviation (σ) of daily cash balance, the wider the spread and higher returnpoint. A higher volatility of the daily cash balance also means a higher probability of reaching thelower or upper limit.By contrast, an increase in the return on investment in marketable securities will lead to a narrowerspread and lower return point because the opportunity cost of holding cash is also growing, so abusiness will seek to decrease its cash holdings.MANAGEMENT OF RECEIPTS AND DISBURSEMENTSFloatFunds that have been sent by the payer but are not yet usable funds to the payeeFloat has three component parts:Mail FloatThe time delay between when payment is placed in the mail and when it isreceivedDownloaded by cielalOMoARcPSD|16786498
Processing FloatThe time between receipt of a payment and its deposit into the frm’s accountClearing FloatThe time between deposit of a payment and when spendable funds becomeavailable to the frmSpeeding Up CollectionsSpeeding up collections reduces customer collection foat time and thus reduces the frm’saverage collection period, which decreases the investment the frm must make in its cashconversion cycleOne technique for speeding up collections is a lockbox systemLockbox SystemA collection procedure in which customers mail payments to a post ofce box that isemptied regularly by the frm’s bank, which processes the payments and deposits

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Term
Winter
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