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(^198) Financial Management
The Precautionary Motive
Precautionary balances are a buffer stock of liquid assets. This motive for holding cash
related to the maintenance of balance to be used to satisfy possible, but as yet indefinite,
needs.
In our discussion of transactions balances we saw that cash flow predictability could
affect a firmís cash holdings through synchronisation of receipts and disbursements.
Cash flow predictability also has a material influence on the firmís demand for cash
through the precautionary motive. The airline industry provides a typical illustration. Air
passenger carriers are plagued with a very high degree of cash flow uncertainty. The
weather, rising fuel costs, and continual strikes by operating personnel make cash
forecasting a most difficult activity for any airline company. The up short of this problem
is that because of all the things that might happen, the minimum cash balances desired
by the management of the air carriers tend to be large.
In addition to cash flow predictability the precautionary motive for holding cash is
affected by the firmís access to external funds. Especially important are those cash
sources that can be tapped on short on short notice. Book banding relationships
and established lines of credit can reduce the firmís need to keep cash on hand. This
unused borrowing power will obviate somewhat the need to invest in precautionary
balances.
In actual business practice the precautionary motive to a large extend by the holding of
a portfolio of liquid assets, not just cash. In large corporate organisation, funds may
flow either into or out of the marketable securities portfolio on a daily basis. Because
actual rate of return can be earned on the near-cash assets, compared with a zero rate
of return available on cash holding, it is logical that the precautionary motive will be met
in part by investment in marketable securities.
The Speculative Motive
Cash is held for speculative purposes in order to take advantage of hoped for, profit
making situations. Construction firms that erect private dwellings will at times accumulate
cash in anticipation of a significant drop in lumber costs. If the price of building supplies
does drop, the companies that build up their cash balances stand to profit by purchasing
materials in large quantities. This will reduce their cost of goods sold and increase their
net profit margin. Generally, the speculative motive is the least important component of
a firmís preference for liquidity. The transactions and precautionary motive account for
most of the reasons why a company holds cash balances.
Decisions that concern the amounts of liquid assets to hold rest with the financial officer
responsible for cash management. A number of factors that can be expected to influence
the financial officerís investment in cash and near cash have just been reviewed. Not