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Literature Review on Cash Management Concepts

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Published: 29th Sep 2021

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Tagged: Finance


This chapter discusses the theoretical framework, empirical review both covering early studies between 1980 to 1999 and the current studies covers 2000 to 2009. At the end the summary of whole discussion has been provided.

Theoretical framework

Concept of cash and cash management

Cash concepts

According to (Davidson et al, 1999), cash is any medium of exchange, which is immediately negotiable. It must be free of restriction for any business purpose. Cash has to meet the prime requirements of general acceptability and availability for instant use in purchasing and payment of debt. Acceptability to a bank for deposit is a common test applied to cash items. This is a process of Planning, controlling, and accounting for cash transactions and cash balances. It is channeling available cash into expenditures that enhance productivity, directly or indirectly.

In addition, Cash is ready money in the bank or in the business. It is not inventory, it is not accounts receivable (what you are owed), and it is not property. These might be converted to cash at some point in time, but it takes cash on hand or in the bank to pay suppliers, to pay the rent, and to meet the payroll. Profit growth does not necessarily mean more cash. (Davidson et al, 1999)

Cash is the important current asset for the operations of the business. Cash is the basic input needed to keep the business running on a continuous basis: it is also the ultimate output expected to be realized by selling the service or product manufactured by the firm. The firm should keep sufficient cash, neither more nor less. Cash shortage will disrupt the firm’s manufacturing operations while excessive cash will simply remain idle. Without contributing anything towards the tint’s profitability. Thus, a major function of the financial manager is to maintain a Sound cash position. (Pandey, 2007)

Cash is the money which a firm can disburse immediately without any restriction. The term cash includes coins, currency and cheques held by the firm, and balances in its bank accounts. Sometimes near-cash items, such as marketable securities or bank times deposits, are also included in cash. The basic characteristic of near-cash assets is that they can readily be converted into cash. Generally, when a firm has excess cash, it invests it in marketable securities. This kind of investment contributes some profit to the firm. (Hampton, 2001)

Cash management concepts

Waltson and Head (2007) explained Cash management as the concept which is concerned with optimizing the amount of cash available, maximizing the interest earned by spare funds not required immediately and reducing losses caused by delays in the transmission of funds.

According to Zimmerer et al (2008) cash management is the process of forecasting, collecting, disbursing, investing, and planning for cash a company needs to operate smoothly. They further added that cash management is a vital task because it is the most important yet least productive asset that a small business owns. A business must have enough cash to meet its obligations or it will be declared bankrupt. Creditors, employees and lenders expect to be paid on time and cash is the required medium of exchange.

However, some firm retain an excessive amount of cash to meet any unexpected circumstances that might arise. These dormant cash have an income-earning potential that owners are ignoring and this restricts a firm’s growth and lowers its profitability. Investing cash, even for a short time, can add to company’s earning. Proper cash management permits the owner to adequately meet cash demands of the business, avoid retaining unnecessarily large cash balances and stretch the profit generating power of each dollar the business owns (Zimmerer et al, 2008).

Cash management is particularly important for new and growing businesses. (Jeffrey P. Davidson et al, 1992) indicated in their book that cash flow can be a problem even when a small business has numerous clients, offers a superior product to its customers, and enjoys a sterling reputation in its industry.

Companies suffering from cash flow problems have no margin of safety in case of unanticipated expenses. They also may experience trouble in finding the funds for innovation or expansion. Finally, poor cash flow makes it difficult to hire and retain good employees.

Westerfield et al, 1999 noted that it is important to distinguish between true cash management and a more general subject of liquidity management. The distinction is a source of confusion because the word cash is used in practice in two different ways.

First, it has its literal meanings, actual cash on hand. However, financial managers frequently use the word to describe a firm’s holdings of cash along with its marketable securities, and marketable securities are sometimes called cash equivalents or near cash. In our distinction between liquidity management and cash management is straightforward, they added.

Liquidity management concerns the optima quantity for liquid asset management policies. Cash management is much more closely related to optimizing mechanisms for collecting and disbursing cash, and it’s this subject that we primarily focus on this chapter.

Empirical Evidence

Early study 1980–1999

General overview

In late 1980s authors played a great contribution in the concept of cash management. Ross et al (1988:619) explained that cash management involves three steps;

  • Determining the appropriate target cash balance
  • Collecting and disbursing cash efficiently
  • Investing “ excess cash ‘ in marketable securities

Determining the appropriate cash target balance involves an assessment of the trade off between the benefits and cost of liquidity. The benefit of holding cash is the convenience it gives the firm. A firm should increase its holding cash until its present value from doing so is zero. The incremental liquid value of cash should decline as more of it is held.

After the optimal amount of liquidity is determined, the firm must establish procedures so that collections and disbursement of cash are done so efficiently as possible. This usually reduces the dictum, “collect early and pay late’

Firms must invest temporarily ideal cash in short-term marketable securities. These securities can be bought and sold in the ‘Money market’ Money market securities have very little default risk and are highly marketable.

Key indicators in cash management

Without adequate cash flow, a firm can become technically insolvent even though assets far out way the liabilities. To reduce the chances for a firm becoming technically insolvent, the following parameters have been recommended to be employed in evaluating the effectiveness of a cash management system. These includes:

Cash conversion cycle

Operation cash flows

Increase of decrease in cash

Liquidity flow index

Cash conversion cycle

This is the time interval between actual cash payment/expenditure for the purchase of productive/operational resources and the ultimate collection of cash from the sales of products/services. The cash conversion cycle provides a valid alternative for measuring company liquidity. The longer the time taken to get back the money paid out, the more the likely hood the organization is to face technical insolvency and vice versa.

Operational cash flows

Cash flows from operations are the amount of cash a firm generates in a measured time from its operation. Various methods are used to determine the amount of operating cash flow. The prevalent methods use the income statement and the balance sheet to prepare the cash flow statement (also called statement of sources and application of funds). (Kasilo, 1997)

Positive cash flows indicate how much cash the organization has generated from operations during the financial year. Negative cash flows indicate how much additional cash has been used to support the operations during the same period. Usually, a firm with negative cash flow from operations is unable to finance its operations. De facto, it is consuming cash flows rather than generating them. It becomes prone to technical insolvency problems and it may go bankruptcy. (Kasilo op cit: 30, Vause and Woodward op sit: 99)

Cash flow accounting involves the reporting of classified list of last year’s cash flows, and a set of forecast cash flows, with supporting analysis of the variances between last year’s actual and forecast cash flows. It therefore emphasizes the most fundamental events in business activities, cash flows into and out of the firm, and the segregation of past (cash) facts from future estimates, accounting time period allocation, based on estimates of consumption are avoided. (Vause and Woodward, 2001)

The result is a set of statements that is objective, understandable and simple, and which meets the needs of a variety of users concerned with stewardship, liquidity, performance appraisal and investment. In particular, cash flow accounting meets one of the fundamental accounting objectives, “to provide information useful to investors and creditors for predicting, comparing and evaluating potential cash flows to them in terms of amount, timing and related uncertainty.”

Cash flows provide data, which, because it is properly dated, can be discounted at a rate, selected by the user, and which does not required level adjustments, although comparisons over time require, and the data permit general price level adjustment to a base period.

Finally, the use of a cash flow statement integrates trading activities and investments, dividends and financing policies, unlike information presented in profit and loss account and balance sheet format.

However, critics of the cash flow system argue that cash flow reports can be distorted, for example, by delaying payments to creditors, and as they ignore non-cash changes in assets and liabilities, including holding gains and losses, so that no estimate is provided of the extent to which these flows were obtained by consumption of assets. Operating cash flows have also be found to be poor predictors of failure. (Arnold and wearing 1988:313)

Increase or decrease in cash

A corporation’s cash flow statement shows whether the firm has increase or decrease its cash during the period for which the statement refers. Cautiously a decrease can be indicative of how unsatisfactory the firms operations have been during the year and vice versa. Since profits are not cash, a firm may realize profits but still be technically insolvent (Kasilo, op cit: 31, Vause and Woodward, op cit: 95).

If cash flows are generated a firm may remain in business for several years while still making losses. Usually, with meticulously handled double entry account system, the decrease or increase in cash is simply the difference between opening cash balance and the closing balance.

Liquidity flow index (LFI)

The LIF indicates the relationship between the amount of cash that will be available for meeting the obligations and the amount of cash required to meet such obligation during the same period. It is cash budget’s ratio of operating cash influence to the required cash outflows for a particular period.

Maintaining liquidity may add value to a firm. A firm that faces variable demand can add value by maintaining liquidity to permit it operating flexibly since changes in operating levels can be more expensive than changes in liquidity or working capital.

Thus liquidity can enhance firm value by reducing the systematic components of its risk as it reduces the firm’s susceptibility to economic fluctuations. In addition, the value of a firm may be enhanced by its liquidity because of its ability to act as a financial intermediary for its customers and suppliers. A firm may be able to add value by doing this because of imperfections in financial markets. Further, under asymmetric information, a liquid firm may be able to fund valuable projects that may be difficult or costly to fund in financial markets. (Soenen and Aggarwal, 1989:600)

In the case of firms operating in multinational settings, maintaining liquidity may additionally allow a firm opportunity for arbitrage between segmented national capital markets and institutional settings. Such firms also face additional opportunities and challenges in managing liquidity under currency and political risks. Thus, because of the wide spread segmentation of national financial markets, the ability to increase firm value by internalising the rates due to the market imperfections through liquidity managements apply even to a great extent to firms operating in multinational settings. (Ibid: 601)

To illustrate this difference between the domestics and the multinational settings, nations can be defined as regions whose residents have different purchasing power indexes. National group of investors, therefore delineated by deviations from purchasing power parity which causes them to use different price indexes and deflating the monetary returns from the same security. In practice, nations may further be separated by such manifestations of sovereignty as taxes, and exchange and border controls, which restrict access to local capital markets.

Cash management models

According to (Davidson et al, 1992) Cash management has four major functions; determination of minimum cash balances, effective borrowing, advantageous investment of excess cash, and acceleration of cash flow.

The minimum cash balance is established by taking into consideration the basic safety cushion needed, minimum bank balance requirements, and the rate of daily cash collections and disbursements. Cash balances should be maintained at the lowest practical minimum because excess cash earns nothing and loses purchasing power in period of rising prices (Davidson et al, 1992).

The minimum cash balance should be the basic liquidity cushion needed taking into consideration the rate of daily cash collections and disbursements. The average cash balance (size of demand deposit) tentatively determined can be tested against industry standard by use of the ration of the average cash balance to total operating expenditures for the year. (Davidson et al, 1992).

Cash management has four major functions; determination of minimum cash balances, effective borrowing, advantageous investment of excess cash, and acceleration of cash flow.

According to Davidson (1992:13-12), The minimum cash balance is established by taking into consideration the basic safety cushion needed, minimum bank balance requirements, and the rate of daily cash collections and disbursements. Cash balances should be maintained at the lowest practical minimum because excess cash earns nothing and loses purchasing power in period of rising prices.

The minimum cash balance should be the basic liquidity cushion needed taking into consideration the rate of daily cash collections and disbursements. The average cash balance (size of demand deposit) tentatively determined can be tested against industry standard by use of the ration of the average cash balance to total operating expenditures for the year. If the company’s business is seasonal, the desirable cash balance will vary with peaks and valleys of enterprise activities. Such companies will find the ration of average cash balance for each month to total expenditures for the moth at a better standard.

According to Gallagher and Andrew,(2003) financial theorists have developed mathematical models to help firms find an optimal “target” cash balance, between the minimum and maximum limits, that balances liquidity and profitability concerns. In the following sections the discussion will be on one of these models, the Miller-Orr model.

The Miller – Orr cash Management Model.

In 1966 Metron Miller and Daniel Orr developed a cash management model that solves for optimal target cash balance about which the cash balance fluctuates until it reaches an upper or lower limit. If the upper limit is reached investment securities are bought bringing the cash balance down to the target again. If the lower limit is reached investment securities are sold bringing the cash balance up to the target (Gallagher and Andrew, (2003)

The formula for the target cash balance Z is:

Z = 3 √ 3 x TC x V + L

4 x r

Where: TC = Transaction cost of buying or selling short-term

investment securities

V = Variance of net daily cash flows

r = Daily rate of return on short – term investment


L = Lower limit to be maintained in the cash account

Figure No:1 The Miller-Orr Model (Access on 03/11/2009)

The target cash balance is one-third of the way between the lower limit(L) and upper limit (H).The Miller-Orr formula for the upper limit is as follows: H = 3Z – 2L.In the Miller-Orr model the lower limit(L) is set by management according to the minimum cash balance.

The lower limit is set by the firm based on its desired minimum “safety stock” of cash in hand. The firm should also determine the following:

An interest rate for marketable securities.

A fixed transaction cost for buying and selling marketable


The standard deviation if its daily cash flows(S).

The upper control limits and return path calculated by the Miller –Orr Model as follows;

Distance between the upper limits and lower limits is 3Z

(Upper limit – Lower limit) = (3/4 C Transaction Cost C Cash Flow Variance/Interest Rate) 1/3

Z = (3/4 C cs2/i) 1/3

If the transaction cost is higher or cash flows show greater fluctuations, then the upper limit and lower limit will be far off each other. As the interest rate increases, the limits will come closer. There is an inverse relation between Z and the interest rate. The upper control limit is three times above the lower control limits and the return point lies between the upper and lower limits. Hence,

Upper Limit = Lower Limit + 3Z

Return Point = Lower Limit + Z

However, though these are commonly available models their practical efficacy is still questionable due to the number of assumptions involved in each model.

Recent study 2000 – 2009

General overview

Though in late 1990s some development and discussions had been advanced, yet contributions kept on increasing from that era then. This part addresses contribution collected covering 2000 tom 2009.

Facets of Cash Management

Pandey (2008) has provided in his book, that cash management is concered with managing of cash flows into and out the firm as well as cash flows within the firm, and also cash balances held by the firm at a point of time by financing deficit or investing surplus cash.

He added that in order to resolve the uncertainty about cash flow prediction and lack of synchronisation between cash receipts and payments, the firm should develop appropriate strategies for cash management. The firm should evolve strategies regarding the following four facets of cash management which includes:

Cash planning: Cash inflows and outflows should be planned to project cash surplus or deficit for each period of the planning period. Cash budget should be prepared for this purpose.

Managing the cash flow:s The flow of cash should be properly managed. The cash inflows should be accelerated while, as far as possible, the cash outflows should be decelerated. This is concerned with management of collections and disbursements.

Optimum cash level: The firm should decide about the appropriate level of cash balances. The cost of excess cash and danger of cash deficiency should be matched to determine the optimum level of cash balances. It appreciates the need to retain cash in business to meet various cash requirements that may arise at any time. Especially short term requirement of cash.

Investing surplus cash The surplus cash balances should be properly invested to earn profits. The firm should decide about the division of such cash balance between alternative short-term investment opportunities such as bank deposits, marketable securities, or inter-corporate lending.

The ideal cash management system will depend on the firm’s products, organisation structure, competition, culture and options available. The task is complex, and decisions taken can affect important areas of the firm. For example, to improve collections if the credit period is reduced, it may affect sales, Pandey added.

However, in certain cases, even without fundamental changes, it is possible to significantly reduce cost of cash management system by choosing a right bank and controlling the collections properly.

Fundamental Principles Involved In Managing the Big Three of Cash Management (Accounts Receivables, Account Payables and Inventory)

Zimmerer, 2008 provides that controlling accounts receivables requires business owners to establish clear, firm credit and collection policies and to screen customers before granting them credit. Sending invoices promptly and acting on past due accounts quickly also improve cash flow. The goal is to collect cash from receivables as quickly as possible.

When managing accounts payables, a manager’s goal is to stretch out payables as long as possible without damaging the company’s credit rating. Other techniques include verifying invoices before paying them, taking advantages of cash discounts, and negotiating the best possible credit terms.

Finally they further added inventory frequently causes cash headaches for small business managers. Excess inventory earn zero rate of return and ties up a company’s cash unnecessarily. Owners must watch for stale merchandise.

However, Pandey, 2008 on his side commended that Cash management is also important because it is difficult to predict cash flows accurately, particularly the inflows, and there is no perfect coincidence between the inflows and outflows of cash.

During some periods, cash outflows will exceed cash inflows, because payments for taxes, dividends, or seasonal inventory build up. At other times, cash inflow will be more than cash payments because there may be large cash sales and debtors may be realised in large sums promptly.

Further, it has been noted that cash management is significant because cash constitutes the smallest portion of the total current assets, yet management’s considerable time is devoted in managing it. In recent past, a number of innovations have been done in cash management techniques. An obvious aim of the firm these days is to manage its cash affairs in such a way as to keep cash balance at a minimum level and to invest the surplus cash in profitable investment opportunities.

As hinted above Pandey, 2008 had revealed the interconnectivity between cash budget and cash management. It has to be noted that once the cash budget has been prepared and appropriate net cash flow established, the financial manager should ensure that there does not exist a significant deviation between projected cash flows and actual cash flows. To achieve this, cash management efficiency will have to be improved through a proper control of cash collection and disbursement. The twin objectives in managing the cash flows should be to accelerate cash collections as much as possible and to decelerate or delay cash disbursements as much as possible.

Public Sector Cash Management and Audit of Public Authorities

Governments are accountable for the efficient, effective and ethical use and management of public resources. Good cash management is an important and integral component of this accountability function and is an established business practice in all successful, high performance organizations.

According to study conducted by Amani (2005) on the causes of collapse of Public Corporations in Tanzania, fact findings revealed that finance (cash) Management in Tanzania had been regulated through the Exchequer and Audit Ordnance of 1961 and provisions set out in Chapter 7 of the Constitution. The provisions outlined Financial Orders which form the basis for financial regulation and administrative procedures. Financial Orders had been issued by the Accountant General’s Office and Financial Procedures had been issued by the Central Ministries.

The Accountant Journal, issued by NBAA revealed that Governments expend large amounts of funds on various activities and programs, which are funded by all kinds of revenues, grants and borrowings. A large part of governments’ expenditures are not directly related to the source of revenue or funding. The sheer size of the cash flow itself, as well as the need to match in-flow to out-flow makes good cash management in governments a necessity.

The Controller and Auditor General (CAG) is therefore empowered to ensure adherence to the set laws and regulation that govern public financial management including auditing of all revenue and spending from Government Authorities, Ministries, Departments and Agencies, and subsequently report to the Parliament by presenting periodic audit reports through the Minister for Finance and Economic Affairs or through the Parliamentary Accounts Committee PAC) and Public Organisation Accounts Committee (POAC).

MUWSA is one of these public authorities which are subject to be Audited by CAG. The Public Finance Act No. 6 of 2001 (Ammended 2004) provides in Section 37 (1)(a) that;

any public authority or body-

established by a written law or other instrument which is in receipt of a contribution from, or the operations of which may, under the law or instrument relating thereto, impose or create a liability upon, public funds;

excuting a Government project in respect of which a foreign Government or institution or an international organisation provides, any money, goods or services, whether or not it is specifically provided in relevant agreement for the project that the accounts of the public authority or body are subject to audit by the Controller and Auditor-General;

whose accounts are, by or under a written law, required to be audited, or are open to inspection, by the Controller and Auditor-General.

With regard to the above provisions, the Authority is therefore to be audited by the CAG who actually is seeking to identify whether or not the financial management at the Authority has been maintained as required. The CAG is intending to ensure that all objectives of cash management in the public sector are being achieved.

The underlying objectives of cash management in government can be summarized to include the following:

  • To ensure that sufficient cash is available as and when needed to meet commitments to make payments
  • To minimize the cost of borrowing, particularly short-term borrowings, net of the returns on any surplus funds
  • To control aggregate cash flows within fiscal, monetary and legal limits

In the year 2006, the country (Tanzania) witnessed great reforms in the financial sector in Tanzania where Exchequer and Audit Ordnance of 1961was repealed and two new Acts were enacted by the Parliament of United Republic of Tanzania. The Acts are Public Finance Act No. 6 and Public Procurement Act No. 3 where the later was repealed in 2004 and another Act to regulate public procurement came into operation. The regulations to amplify these Laws were also developed.

Noela (2007) added that efficient cash management requires certain set of principles to be implemented in all government authorities or bodies. Her study on “An analysis of financial Performance of Professional Bodies in Tanzania” revealed that in order for public institutions to be efficient in the areas of finance and cash in general at minimum have to adhere to the following pillars/principles of cash management:

  • Timely collection, banking and accounting of all revenues, grants and loans
  • Better timing of decisions involving major expenditures
  • Establishing favorable banking arrangements and rationalizing the number of bank accounts
  • Managing cash proactively and having cash “just in time” through accurate forecasting and monitoring of needs by coordinating the activities of all entities that collect revenue and expend funds

The primary objective of governments is efficient program delivery or implementation resulting in the advancement of desired outcomes. From this perspective, cash management is an important support function, but not an end in itself.

Cash Management at MUWSA

The Authority has developed financial regulations, different manuals such as Accounting Manuals, Procurement Manual etc which are intended to regulate the cash management operations hence to achieve Value for Money in any commitment of cash.

Accounting for cash and other revenues

All income realized by the MUWAS in cash and cheques must immediately be deposited to the MUWAS’s bank account and an official receipt to be issued. (Sec 9.1 of MUWAS Financial Regulations). All receipts will be numbered consecutively and recorded in unused counterfoil registers. All receipts issued by the cashier will be written by him/her in their chronological order of the serial numbers as per section 57 – 61 of Public finance Act.

Accounting for payments

Generally cash collected by the Authority shall be used to facilitate various payments at the discretion of responsible authorities. Payments shall be approved by the Managing Director and the Finance Manager. The fund shall be under the custodian of a Cashier who shall maintain the records of cash receipts and payment in the separate Cash Book. The details of receipt and payment procedures shall be included in the Accounting Manual.

Payment Vouchers

All payments of whatever nature shall be made on payment vouchers consecutively numbered. These payments shall be charged against the appropriate expenditure sub-head, and the amount shall be within the allocation approved by the Board OF Directors of MUWAS.

All withdrawals out of a bank account except payment of salary, allowance, and/or honorarium shall be made by crossed cheques. However, under exceptional circumstances and at the discretion of the Accounting Officer, a payment cheque may be opened. For control purposes all payment Vouchers shall be authorized by four persons – the person preparing the payment and two other people’s one of whom shall be the manager Finance Department or his appointee and Internal auditor.

Accounting for Imprests

The financial regulations of MUWAS provides that for the sake of enhancing operations of the Authority, there will be two types of imprests to be advanced to the officials to enable them carry out their responsibilities.

Special Imprests

For the smooth running of activities, the Accounting Officer may at his/her discretion issue special imprests to employees for specific approved purposes and these imprests shall be retired in full immediately after the purpose for which the imprests were issued is completed, but not later than two weeks thereafter. (Sec 9.5 of MUWAS Financial Regulations)

Safari imprest

In order to enable an officer of the Authority or any other person authorized by the Accounting Officer, defray expenses in connection with an official duty assigned to him/her by the board outside his/her station, a sum of money can be advanced to him/her.

The basis for the amount issued shall be the approved rate of subsistence allowance, as will be reviewed from time to time, including any other expenses as will be approved by the Accounting Officer after she/he convinced that such expenses are appropriate and reasonable.

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