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(^220) Financial Management
to use this ratio for comparison with an average for the industry, but probably not with
individual firms within the industry, since special factors might affect the balance held
by a particular firm at its year-end date (especially if the businesses were seasonal, or
if the firm under review were accumulating cash for a specific project).
A second ratio quite often found is that between the cash balance and the total current
assets:
Cash Assets
Proporation of cash held =Cash balance
A wide range of figures between different industries will be found. Based on transaction
analysis or past trends, the company could set a minimum proportion of cash holdings to
current assets with the objective not of using this as an absolute limit but as an opportunity
for reviewing the reasons for any deviation from the norm.
In general the use of simple ratios has a limited value in cash planning. There is no
adequate substitute for detailed cash forecasts, possibly linked with a financial model of
the business as a whole.
For an outside observer, and to some extent for the board of a company, useful information
can be derived from a trend of liquidity ratios incorporating not merely cash but also
those elements of working capital which are readily convertible into cash. This concept
of liquidity was built into the source and application of funds statement described above.
Investing Surplus Funds
If the cash forecast for a business shows surplus funds becoming available, then plans
should be made for putting them to use. However, the surpluses may be transitory,
either because they are being accumulated deliberately for some purpose such as the
purchase of plant or the payment of taxes, or because the business is seasonal and the
funds will eventually be required to finance off-peak activities.
It is important to schedule in detail, with frequent reviews, how much money will be
available for various period of times, so that it can be put to the best possible use. Small
amounts which are required to be kept liquid are probably best placed on deposit with a
clearing bank or other finance house. The rate of interest will be low, but only short
notice is required for withdrawal. When large sums are available there is a greater
range of investment alternatives.
Loans to local authorities or merchant banks or local authority bonds, have various
terms from days upto five years, so they can be matched to the availability of funds,
however, they are not readily negotiable. Negotiable certificates of deposit issued by
the commercial banks overcome this disadvantage, offer a higher rate of interest and
can cover a wide range of maturities from three months upwards.