Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VII. Short−Term Financial

Planning and Management

20. Cash and Liquidity
    Management

(^700) © The McGraw−Hill
Companies, 2002

CHAPTER

20

Cash and Liquidity

Management

Most often, when news breaksabout a firm’s cash position, it’s because the

company is running low. That wasn’t the case for oil companies in 2001. The Royal

Dutch/Shell Group, for example, was pumping out $1.5 million in profit per hour

and had about $12 billion in the bank. ExxonMobil was sitting on $11 billion, and

the industry as a whole had a $40 billion (and growing fast) stockpile according

to analysts. These companies certainly had ample cash reserves; in fact, the word

enormousmight be more appropriate. Why would these firms hold such large

quantities of cash? We examine cash management in this chapter to find out.

his chapte ris about how fi rms manage cash. The basic objective in cash manage-

ment is to keep the investment in cash as low as possible while still keeping the

firm operating efficiently and effectively. This goal usually reduces to the dictum

“Collect early and pay late.” Accordingly, we discuss ways of accelerating col-

lections and managing disbursements.

In addition, firms must invest temporarily idle cash in short-term marketable securi-

ties. As we discuss in various places, these securities can be bought and sold in the fi-

nancial markets. As a group, they have very little default risk, and most are highly

marketable. There are different types of these so-called money market securities, and we

discuss a few of the most important ones.

REASONS FOR HOLDING CASH

John Maynard Keynes, in his great work The General Theory of Employment, Interest,

and Money,identified three motives for liquidity: the speculative motive, the precau-

tionary motive, and the transaction motive. We discuss these next.

The Speculative and Precautionary Motives

The speculative motiveis the need to hold cash in order to be able to take advantage of,

for example, bargain purchases that might arise, attractive interest rates, and (in the case

of international firms) favorable exchange rate fluctuations.

T

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20.1

speculative motive

The need to hold cash to

take advantage of

additional investment

opportunities, such as

bargain purchases.