Cash Management and Marketable Securities^199
all of these factors affect every firm. Moreover, factors that do affect many companies
will do so in differing degrees. Since the executives responsible for the ultimate cash
management choices will have different risk-bearing preferences, we might expect
that liquid asset holding among firms would exhibit considerable variation.
Cash Management Objectives and Decisions
Risk Return Trade off
A company wide cash management must be concerned with minimising the firmís risk
of insolvency. In the context of cash management the term insolvency is used to describe
the situation where the firm is unable its maturing liabilities on time in case the company
is technically insolvent in that it lacks the necessary liquidity to make prompt payment
on its current debt obligations. This problem could be met quite easily by carrying large
cash balances to pay the bills that come due. Production, after all, would soon come to
halt should payments for raw material purchases be continually late or omitted entirely.
The firmís suppliers would cut off further shipments. In fact, the fear of irritating a key
supplier by being past due on the payment of a trade payable does cause some financial
managers to invest in too much liquidity.
The management of the companyís cash position, though, is one of those major problem
areas where you are criticized if you donít and criticized if you do. True, the production
process will eventually be halted should too little cash be available to pay bills. If excessive
cash balances are carried, however, the value of the enterprise in the financial
marketplace will be suppressed of the large cost of Income forgone. The explicit return
earned on idle cash balances is zero.
The financial manager must strike an acceptable balance between holding too much
cash and too little cash. This is the focal point of the risk-return tradeoff. A large cash
investment minimises the chances of insolvency but penalises company profitability. A
small cash investment frees excess balances for investment in both marketable securities
and longer-lived assets; this enhances company profitability and thereby the value of
the firmís common shares but increases the chances of running out of cash.
Objectives
The risk-return tradeoff can be reduced to two prime objectives for the firmís
management system:
- Enough cash must be on hand to dispense effectively with the disbursal needs
that arise in the course of doing business. - The firmís investment in idle cash balances must be reduced to a minimum.