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(^210) Financial Management
The working balance is maintained for transaction purposes for paying bills and
collecting payments on accounts receivable. If the firm maintains too small a working
balance, it runs out of cash. It then must liquidate marketable securities if available, or
borrow.
Liquidating marketable securities and borrowing both involve transaction costs. If, on
the other hand, the firm maintains too high a working balance, it foregoes the opportunity
to earn interest on marketable securities, that is, it incurs what economists refer to as
an opportunity cost. Thus, the answer we seek is the optimal working balance, rather
than the minimum. Finding the optimum involves a tradeoff of transaction costs against
opportunity costs. If a firm tries to keep its working balances low, it will find itself
selling securities (and later repurchasing securities) more often than if it aims at a
higher level of working balances, that is, transaction costs fall as the working balance
level rises. Opportunity costs, on the other hand, rise as the level of working balances
rises. There is one point where the sum of the two costs is at a minimum. This is the
point efficient management should try to find.
Compensating Balance Requirements
If a firm uses bank credit as a source of financing, the question of the optimal current
account balance may have a simple answer: it may be dictated by its compensating
balance requirements to compensate for various services such as processing cheques
and standby commitments to lend.
In some cases, a firm may determine with very little analysis that it optimal
working balance is below the bankís compensating balance requirement. In such
cases, the latter figure becomes the firmís minimum current account balance. In
other cases, where the answer is not so clear or where compensating balances are
not required. We must put pencil to paper to determine the appropriate working
balance.
Finding the Optimal Working Balance
Having done all we can to improve our collection and disbursement procedures, let us
now take the pattern of receipts and disbursement as given. Over any time period, a
firmís beginning and ending cash balances are related as follows:
Ending balance = Beginning balance + Receipts ñ Disbursement
If receipts and disbursements we constant each day, we would know with certainty
what each would be each day and our problem would be simple. Since receipt always
would exceed disbursements by the same amount, we count withdraw the ending balance
each day and use it for other purposes. In practice, we have two problems: variability