Other business owners elect to hold large cash balances even if the company has no debt because having cash makes fund management less stressful than not having cash.Ĭonversely, some business owners, particularly if the company is growing rapidly and cash-hungry, try actively to manage cash to a minimum to reduce the funding needed to support the aggressive growth. The rationale is that it is easier to borrow when it is not necessary than when it is. Some business owners prefer to arrange a loan and then draw down the full amount even though no immediate need requires the funds. Risk preference in establishing minimum cash balanceįinally, your own risk preferences are important. Desire to have multiple suppliers of credit familiar with the company.Special accounts for payroll and other types of disbursements.Widespread geographical plant locations.A company may keep more than one bank account for a variety of reasons: The number of banks used and the types and quantity of bank services needed affect the size of the cash balances that must be carried with the banks. Factors affecting the level of minimum cash balanceĪnother factor affecting the level of the cash balance is a company’s banking relationships. A company whose customers are unreliable in paying their bills will require more operating cash on the average than a company such as a retailer whose customers generally pay cash or use credit cards. If a company’s business requires investments of large sums on short notice in raw materials, management might elect to maintain many times-one week’s typical disbursements in the checking account or as very short, risk-less investments such as fixed Treasury bills. A company located in a region where weather can block mail for several days, but which must pay local suppliers and employees despite the weather, might typically hold an additional week’s cash disbursements in its balance as a buffer “cash inventory”, How to set up a minimum cash operating balance?Īnother way of setting a minimum cash operating balance is to plan to maintain sufficient cash to cover disbursements during a period in which the company’s receipts might be interrupted for some reason. The minimum cash balance decision is one that requires skilled managerial interpretation of the figures. The forecasts cannot give an exact answer, however. One way of maintaining financial flexibility is to increase the cash balances above the minimum operating level shown by the forecasts. The less accurate these forecasts, the higher the level of financial flexibility needed for a given level of “sleep well.” Forecasting minimum cash balanceįorecasting techniques aid in resolving the conflict by helping determine your company’s cash needs or surpluses and the likely variation in these estimates. A large cash balance means less risk of financial embarrassment. A small cash balance means higher income. The conflict between these two objectives is another instance of an “eat well,sleep well” decision. Liquidity, in the form of a large cash balance (or, less certainly, a line of credit), provides the firm with the ability to handle unfavorable variances from projections. Besides the desire for potential profitability, there is need for liquidity. It is not easy to figure out the minimum cash needed at any one time because of a second, conflicting objective in managing cash. How to figure out minimum cash balance needed?
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