Cash Management and Marketable Securities^221
The purpose of this type of investment is to squeeze extra profit out of money which is
normally in use in the operations of the business. It does not give full scope for portfolio
planning, which is essential when funds are available for investment over a long
period.
The main principle involved in planning the investment of short-term cash surpluses
is to match investment maturities with cash needs. Before considering
investment, therefore, it is necessary to have reliable cash movements forecast, so that
one knows with reasonable certainty how much cash will be spare for what period of
time.
The second principle is to invest for as long as possible, because interest rates are
higher for long periods. Opposed to this principle is the need to have a margin of safety,
this may be a bank overdraft facility or may take the form of slightly more liquidity in
the investment portfolio than the forecast strictly requires.
The size of the fund available for investment will have an effect on how profitably it
can be used, both because large funds can bear the cost of a professional investment
manager and because such funds can be placed directly on the money market rather
than through the companyís bank.
Cost of Holding Cash
Trading costs are increased when the firm must sell securities to establish a
cash balance. Opportunity costs are increased when there is a cash balance
because there is no return to cash. The tradeoff between the two results in an optimum
point of holding cash, which becomes their target cash balance as depicted in
figure.
Figure: Cost of Holding Cash