Cash Management and Marketable Securities^213
we can integrate cash management into the financial planning process. The projected
current account balance goes into the pro forma balance sheet. Any excess cash over
that figure then may be invested in interest-bearing assets.
Investing Idle Cash
Cash in excess of requirements for working balances normally is invested in interestñ
bearing assets that can be converted readily to cash. A firm might hold excess cash for
two principal reasons; First, the firmís working capital requirement may very over the
year, perhaps in a fairly predictable manner if the variation is due to recurring seasonal
factors. From the pro forma balance sheet, it was apparent that excess cash would
build up during seasonal lows in accounts receivable and inventory, and would be needed
later to finance a re-expansion of receivables and inventory during the next seasonal
high. We can view the excess cash as a part of the firmís transaction balances. Even
though the cash is temporarily idle, there is a predictable requirement for it later.
Second, excess cash may be held to cover unpredictable financing requirements. In a
world of uncertainty, cash flows can never be predicted with complete accuracy.
Competitors act, technology changes, products fail, strikes occur, and economic conditions
vary. On the positive side, attractive investment opportunities may suddenly appear. A
firm may choose to hold excess cash to finance such needs if and when they occur. We
noted earlier that cash held for such purposes is referred to as a precautionary balance
and usually in invested in interest-bearing assets until needed.
An alternative exists to the holding of excess cash for either of the two purposes
described above. The firm can simply borrow short-term to finance variable requirements
as they arise. Under such a policy, the firm would never hold excess cash. A firmís
choice between short-term borrowing versus liquid assets as a means of financing
variable requirements will depend on policy decisions with respect to the firmís long-
term financial structure, particularly the mix of short-term and long-term funds. We will
discuss overall financial structure and the relationship between maturity structure and
liquidity later. Here, we take as given the long-term structure and the amount available
for investment in interest-bearing assets.
Investment Criteria
A firm might invest excess cash in many types of interest-bearing assets. To choose
among the alternatives, we must establish criteria based on our reasons for investing
excess cash in the first place. We are investing either temporary transaction balances
or precautionary balance or both. When we need the cash, we want to be able to obtain
it-all of it-quickly. Given these objectives, we can rule out equity share and other
investments with returns that are not contractual and with prices that often vary widely.