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Cash Management and Marketable Securities^219

the company wants to minimise the cash it is holding. Their studies have shown that this
level is the optimum level.

Figure: The Miller-Orr Model

Other mathematical models, too, have been suggested by various authors, but they tend
to be mainly of academic interest only.

A simpler approach to the definition of the required cash balance is by the use of ratios.

One such measure is the ratio between the sales of a period and the opening cash
balance:

Initial cash balance

Cash turnover = Sales^ for period

This is sometimes called the cash velocity. (The resemblance to the stock turnover
ratio will be obvious.)

As with all management ratios one is looking for consistency period by period within
the company, or a trend of improvement which, in this case, would be higher sales per
unit of cash held. If, for example, the cash velocity last period was:

20 x

Rs. 9,0000

Cash turnover = Rs.^ 18,000=

Then an increase of sales to Rs.2,25,000 without a change in cash holding would increase
the velocity to 25x. In other words, the cash balance would have been kept to Rs.9,000
instead of rising to Rs.2,25,000/20 = Rs.11,250, so there would be saving of interest or
a gain at the opportunity cost rate into Rs.2,250.

Again, like other ratios this ratio cannot be used in isolation. An increase in sales without
an increase in cash balance might mean that the company had become less able to pay
its debts as they fell due, possibly signifying that it was over-trading. It might be possible

U* is the upper control limit. L is the lower control limit. The target cash balance is

C* [which is 1/3(U*-L) +L]. As long as cash is between L and U*, no transaction is

made.

Cash

Tim

X Y e

L

C*

U*