ADVANCED FINANCIAL MANAGEMENT

Module 6 (9 Hours)
Cash Management: Facets of Cash Management, Motive for holding cash, managing cash
collection and disbursement-investing surplus, cash in marketable securities, forecasting cash
flows, Cash budgets-long-term cash forecasting, optimal cash balances, Baumol model-
Miller-Orr Model-Strategies for managing surplus fund. (Theory and Problems) Recent
Developments in Advanced Financial Management-Crypto currency, Block chain
technology, Cloud funding, Digitization of financial transactions-Big data project finance,
Behavioural finance-Derivative markets in developing countries. (Theory only)
Dr UMA K
Assistant Professor

6.1. Cash Management: Cash management is a crucial aspect of financial management that
ensures a business maintains adequate cash balance to meet its short-term obligations while
maximizing profitability. Effective cash management helps businesses optimize liquidity,
minimize idle cash, and improve overall financial efficiency.
Meaning of Cash Management
 Cash management refers to the planning, monitoring, and controlling of cash flows
within a business.
 It involves maintaining an optimal cash balance, ensuring sufficient cash
availability, and managing cash inflows and outflows efficiently.
 Example: A company ensures it has enough cash to pay salaries, buy raw materials,
and cover operational expenses while also investing excess cash to earn interest.

6.2. Presentation: Facets of Cash Management
A. Cash Planning
 Involves forecasting cash inflows and outflows to ensure the company maintains
sufficient liquidity.
 Helps avoid cash shortages or idle cash accumulation.
 Example: A manufacturing firm prepares a monthly cash budget to ensure it can
pay suppliers and meet expenses.
B. Managing Cash Flows
 Involves monitoring cash receipts and payments to maintain a positive cash
balance.
 Requires efficient collection of receivables and timely payments to suppliers.
 Example: A retail store ensures customers make quick payments, while supplier
payments are scheduled strategically.
C. Optimal Cash Balance
 Maintaining neither too much nor too little cash to maximize efficiency.
 Excess cash should be invested, while shortage leads to liquidity issues.
 Example: A software company invests excess cash in short-term market funds
instead of letting it remain idle.
D. Investing Idle Cash
 Any excess cash should be invested in short-term instruments to generate returns.
 Options include money market funds, treasury bills, or fixed deposits.
 Example: A pharmaceutical company invests $1 million in Treasury Bills for short-
term profits.
E. Controlling Cash Disbursements
 Avoids unnecessary expenses and ensures payments are made on time.
  Techniques include delaying payments (within credit terms) to optimize cash
outflows.
 Example: A company schedules supplier payments on the last day of the credit
period to maximize available cash.
F. Speeding Up Cash Collections
 Implementing methods to ensure faster inflow of cash from customers and debtors.
 Techniques include early payment discounts, electronic transfers, and efficient
invoicing.
 Example: A wholesaler offers a 2% discount for payments made within 10 days to
encourage early settlements.
6.3. Motive for holding cash: According to John Maynard Keynes, businesses hold cash
for three main motives: Transaction, Precautionary, and Speculative. Additionally,
businesses may hold cash due to Compensating Balance Requirements.
A. Transaction Motive
 Businesses need cash to meet daily operational expenses like salaries, rent, and raw
materials.
 Ensures smooth business operations without cash shortages.
 Example: A restaurant keeps cash for daily food purchases and employee wages.
B. Precautionary Motive
 Cash is held as a safety reserve for unexpected expenses or emergencies.
 Protects against sudden economic downturns, supplier delays, or emergency
repairs.
 Example: A logistics company holds extra cash in case of unexpected fuel price
hikes.
C. Speculative Motive
 Companies keep extra cash to take advantage of investment opportunities or
discounted purchases.
 Helps businesses make quick decisions on profitable ventures.
 Example: A real estate firm keeps surplus cash ready to buy land at a discounted
price.
D. Compensating Balance Requirement
 Some banks require businesses to maintain a minimum cash balance in their
accounts as a condition for loans or services.
 Example: A company takes a $500,000 loan, and the bank requires it to maintain a
$50,000 balance in its account.
Conclusion: Effective cash management is essential for business survival and growth. By
planning cash flows, maintaining optimal balances, and investing excess funds wisely,
businesses can avoid liquidity issues and maximize financial efficiency.
6.4. Managing cash collection: Cash management is a critical function in financial
management that ensures businesses maintain a proper balance between cash inflows and
outflows. Efficient cash collection and disbursement help in improving liquidity, while
investing surplus cash ensures optimal returns.
1. Managing Cash Collection
Efficient cash collection ensures that businesses receive payments quickly and efficiently,
reducing the risk of liquidity issues. The following strategies can improve cash collections:
A. Accelerating Cash Inflows
 Businesses must reduce the time lag between making sales and receiving payments.
 Strategies include offering early payment discounts, electronic payments, and
efficient invoicing systems.
  Example: A wholesaler offers a 2% discount for payments made within 10 days to
encourage early settlements.
B. Lockbox System
 Customers send their payments to a special bank-operated P.O. box, where the bank
processes checks and deposits the amount into the company's account.
 Reduces collection time and improves cash availability.
 Example: A utility company uses a lockbox system to collect electricity bill
payments faster.
C. Electronic Funds Transfer (EFT) and Online Payments
 Encouraging customers to use EFT, UPI, credit cards, or mobile wallets for faster
transactions.
 Reduces delays caused by check clearing or manual banking.
 Example: An online retailer integrates PayPal, Google Pay, and credit card
payments to ensure instant fund transfers.
D. Factoring of Receivables
 Selling accounts receivable to a factoring company to receive immediate cash
instead of waiting for customer payments.
 Useful for businesses with long credit periods.
 Example: A textile manufacturer factors $500,000 worth of invoices to receive
instant funds for production needs.
E. Credit Control Policies
 Setting clear credit policies to avoid delays in receivables collection.
 Regularly reviewing customer creditworthiness and limiting high-risk credit sales.
 Example: A car dealership performs credit checks before financing vehicle
purchases to reduce default risks.
Managing Cash Disbursement: Cash disbursement refers to outgoing payments made by
businesses, including expenses like salaries, supplier payments, and loan repayments.
Efficient management ensures that companies meet their obligations without cash shortages.
A. Delaying Payments Without Penalty
 Companies can maximize cash availability by paying creditors at the last possible
date within the credit terms.
 Avoids unnecessary cash outflows while maintaining good supplier relationships.
 Example: A retailer receives 30-day credit from suppliers and ensures payments are
made only on the 29th day.
B. Using Credit Terms Efficiently
 Negotiating favorable payment terms with suppliers, such as longer credit periods
or installment payments.
 Helps maintain liquidity while continuing operations.
 Example: A construction company negotiates 90-day credit for cement purchases,
reducing short-term cash burden.
C. Just-In-Time (JIT) Inventory Management
 Reduces unnecessary inventory storage costs by purchasing raw materials only
when needed.
 Helps in controlling cash outflows related to stock purchases.
 Example: An automobile manufacturer orders parts only when a vehicle is
scheduled for assembly, avoiding excess inventory costs.
D. Payroll Management
 Using automated payroll systems to ensure timely salary payments without
excessive cash reserves.
  Example: A large corporation schedules salary disbursements on the last working
day of the month to maximize interest on cash balances.
E. Electronic Bill Payments
 Paying vendors, suppliers, and service providers through EFT, RTGS, or online
banking to reduce processing time and transaction costs.
 Example: A corporate office automatically pays rent and utility bills via direct
debit on the due date.
Investing Surplus Cash: Businesses should not let excess cash sit idle, as it leads to
opportunity costs. Instead, they should invest surplus funds in short-term and low-risk
financial instruments to generate additional income.
A. Treasury Bills (T-Bills)
 Short-term government-backed securities with high liquidity and low risk.
 Typically issued for 91, 182, or 364 days.
 Example: A software company invests $2 million in 182-day Treasury Bills,
earning safe returns.
B. Fixed Deposits (FDs) and Certificates of Deposit (CDs)
 Banks offer fixed-term deposits with guaranteed interest rates.
 Suitable for businesses that do not need immediate liquidity.
 Example: A pharmaceutical company deposits $5 million in a 6-month FD to earn
interest.
C. Commercial Papers (CPs)
 Unsecured, short-term debt instruments issued by corporations to raise funds.
 Offer higher returns than FDs but have slightly higher risk.
 Example: A large retail company invests in AAA-rated CPs of a consumer goods
firm for better returns.
D. Money Market Mutual Funds
 Pools of highly liquid short-term investments, including T-Bills, CPs, and bonds.
 Provide better returns than savings accounts while maintaining liquidity.
 Example: A consulting firm invests excess funds in a money market mutual fund to
earn passive income.
E. Repurchase Agreements (Repo Agreements)
 A short-term borrowing method where securities are sold with an agreement to
repurchase later.
 Used by businesses needing very short-term investments (overnight to a few days).
 Example: A financial firm invests $10 million in repo agreements for overnight
interest gains.
F. Sweeping Accounts (Zero-Balance Accounts)
 Surplus funds are automatically transferred to interest-bearing accounts at the end
of the day.
 Ensures optimal cash utilization.
 Example: A multinational company sets up a sweep account, where extra funds
move to a high-interest savings account daily.
G. Corporate Bonds & Short-Term Mutual Funds
 Suitable for companies with higher risk tolerance and longer surplus periods.
 Example: A large manufacturing firm invests $50 million in 2-year corporate
bonds for better yields.
Conclusion: Effective cash collection and disbursement ensure a company maintains
financial stability, while investing surplus cash enhances profitability. By using techniques
like electronic payments, credit management, and strategic investments, businesses can
optimize liquidity and increase returns.
6.5. investing surplus: Surplus cash refers to extra funds a business has after covering all
operating expenses, debts, and planned investments. Holding excess cash without investing it
leads to opportunity costs, as the funds could be earning returns elsewhere. Efficient
investment of surplus cash helps businesses earn additional income, improve financial
stability, and prepare for future expansion.
1. Importance of Investing Surplus Cash
 Prevents cash from sitting idle in non-interest-bearing accounts.
 Helps in capital preservation while earning returns.
 Provides liquidity for unexpected expenses or future investments.
 Enhances shareholder value by increasing company profits.
 Protects against inflation, which erodes the value of money.
Example: A retail company has $10 million in extra cash. Instead of keeping it in a current
account, it invests in short-term Treasury Bills and earns 5% annual returns.
2. Factors to Consider Before Investing Surplus Cash
A. Risk Tolerance
 Businesses must evaluate how much risk they can take while investing.
 Low-risk investments are preferred for short-term funds, while moderate-risk
options suit long-term surplus.
 Example: A startup invests in government bonds (low risk), while an established
company invests in corporate bonds (moderate risk).
B. Liquidity Requirements
 The investment should allow easy withdrawal when needed.
 Companies needing frequent access to cash should prefer money market
instruments over fixed deposits.
 Example: A logistics firm invests in liquid mutual funds so it can withdraw cash
anytime.
C. Return on Investment (ROI)
 Businesses must compare different investment options based on their expected
returns.
 Example: A manufacturing company compares bank fixed deposits (6% interest)
with short-term commercial papers (8% interest) before investing.
D. Tax Efficiency
 Certain investments provide tax benefits that can improve net returns.
 Example: A business invests in tax-free bonds issued by the government to reduce
tax liabilities.
3. Investment Options for Surplus Cash
A. Treasury Bills (T-Bills) – Low Risk, High Liquidity
 Issued by governments for short-term borrowing (91, 182, or 364 days).
 Highly secure and easily convertible to cash.
 Example: A pharma company invests $2 million in 182-day Treasury Bills to earn
safe returns.
B. Fixed Deposits (FDs) & Certificates of Deposit (CDs) – Low Risk
 Banks offer FDs and CDs with fixed interest rates over a specific term.
 Suitable for businesses that do not need immediate liquidity.
 Example: A hotel chain deposits $5 million in a 1-year FD at 6% interest.
C. Commercial Papers (CPs) – Moderate Risk, Short-Term
 Unsecured, short-term debt instruments issued by corporations.
 Higher returns than FDs, but slightly more risk.
 Example: A software firm invests in AAA-rated CPs of an FMCG company for
higher returns.
D. Money Market Mutual Funds – Low Risk, Flexible
 A diversified portfolio of Treasury Bills, CPs, and bonds.
 Provides higher returns than savings accounts while maintaining liquidity.
 Example: A real estate company invests in a money market mutual fund to earn 3-
4% annual returns.
E. Corporate Bonds – Moderate Risk, Medium-Term Investment
 Issued by private corporations with fixed interest rates.
 Suitable for companies that can hold investments for 2-5 years.
 Example: A steel company invests $10 million in 3-year corporate bonds at 7%
interest.
F. Equity Shares – High Risk, High Return
 Companies can invest in stock markets to earn capital appreciation and dividends.
 Riskier but can provide higher long-term growth.
 Example: A tech firm invests $3 million in blue-chip stocks for long-term growth.
G. Mutual Funds – Medium Risk, Diversified Portfolio
 Funds that invest in stocks, bonds, and money market instruments.
 Provide moderate returns with professional fund management.
 Example: A consulting firm invests in a balanced mutual fund for steady returns.
H. Real Estate Investment – Medium to High Risk, Long-Term Returns
 Companies invest in commercial or industrial properties for rental income and
appreciation.
 Suitable for firms with long-term surplus cash.
 Example: A retail chain purchases warehouse properties to expand its distribution
network.
I. Repurchase Agreements (Repo) – Short-Term, Low Risk
 A short-term borrowing tool where businesses lend money in exchange for
securities.
 Ideal for companies needing overnight or short-term investments.
 Example: A bank invests $20 million in overnight repo agreements for quick
returns.
J. Sweeping Accounts (Zero-Balance Accounts)
 Automatically transfers surplus cash into interest-bearing accounts daily.
 Ensures optimal cash utilization.
 Example: A multinational company uses a sweep account to transfer extra funds to a
high-interest savings account daily.
4. Example of Surplus Cash Investment Strategy
Case Study: A Manufacturing Company with Surplus Cash
A manufacturing company has $50 million in surplus cash. The CFO decides to diversify
investments based on liquidity needs and risk tolerance:
Amount
Investment Option Purpose Expected Return
Invested
Treasury Bills (T-Bills) $10 million Emergency liquidity 4.5%
Fixed Deposits (FDs) $15 million Safe returns for 1 year 6%
Commercial Papers
$5 million Short-term profit 7%
(CPs)
Money Market Funds $5 million Flexible investment 5%
Corporate Bonds $10 million Medium-term returns 7.5%
High-risk, high-reward
Equity Shares $5 million 12%
growth
This strategy ensures a balanced mix of liquidity, safety, and growth, optimizing cash
utilization.
Conclusion: Investing surplus cash wisely helps businesses maximize returns while
maintaining financial security. Companies should diversify investments based on their
risk tolerance, liquidity needs, and expected returns.
6.6. cash in marketable securities: Marketable securities are short-term, highly liquid
financial instruments that businesses invest in to earn returns on surplus cash while
ensuring quick convertibility into cash when needed.
1. Meaning of Marketable Securities
 Marketable securities are liquid financial assets that can be quickly converted into
cash at market value.
 They serve as a temporary investment option for businesses to earn interest or
capital gains on idle cash.
 Example: A company with excess cash invests in Treasury Bills instead of letting it
sit in a non-interest-bearing account.
2. Characteristics of Marketable Securities
 Short-term in nature (usually maturing within one year).
 Highly liquid, meaning they can be sold quickly without losing value.
 Low risk, as they are usually issued by governments or highly rated corporations.
 Easily tradable in the market.
 Used for cash management rather than long-term investment.
3. Importance of Investing in Marketable Securities
 Earns a return on idle cash instead of keeping it in non-interest-bearing accounts.
 Provides liquidity for businesses to meet short-term obligations.
 Helps in cash flow management, ensuring funds are available when needed.
 Minimizes risk compared to speculative investments like stocks.
 Example: A retail company invests in money market funds to maintain liquidity
while earning small interest.
4. Types of Marketable Securities
A. Treasury Bills (T-Bills) – Low Risk, High Liquidity
 Short-term debt instruments issued by the government.
 Usually issued for 91, 182, or 364 days.
 Highly secure and backed by the government.
 Example: A pharmaceutical company invests $5 million in 182-day T-Bills to earn
4.5% annual returns.
B. Commercial Papers (CPs) – Moderate Risk, Higher Return
 Unsecured, short-term promissory notes issued by corporations to raise working
capital.
 Typically issued for 90 to 270 days.
 Higher returns than T-Bills but involves slightly higher risk.
 Example: A large retail firm buys AAA-rated CPs of a consumer goods company
to earn 6.5% interest.
C. Certificates of Deposit (CDs) – Fixed Returns, Bank Issued
 Issued by banks as a fixed-term deposit with higher interest than savings accounts.
 Can be issued for 3 months to 1 year.
 Cannot be withdrawn before maturity without penalty.
 Example: A construction firm deposits $10 million in a 6-month CD at 5%
interest.
D. Money Market Mutual Funds – Low Risk, Diversified Portfolio
 Funds that invest in short-term securities like T-Bills, CPs, and CDs.
  Provides a safe and flexible option for cash management.
 Example: A software company invests $3 million in a money market fund, earning
3-4% annual returns.
E. Government Bonds – Safe and Steady Returns
 Long-term bonds issued by governments, but can be sold anytime in the market.
 Provide fixed interest payments.
 Example: A logistics company invests $2 million in 10-year government bonds,
which can be sold in case of urgent cash needs.
F. Repurchase Agreements (Repo) – Short-Term Investment for Overnight Liquidity
 A business buys securities from financial institutions with an agreement to sell
them back later.
 Used for very short-term cash management (overnight to a few weeks).
 Example: A financial services firm invests $15 million in overnight repo
agreements to earn 0.5% short-term interest.
5. Factors to Consider Before Investing in Marketable Securities
A. Liquidity Needs
 Businesses should invest only in securities that match their cash flow needs.
 Example: A company expecting payments in 3 months should invest in 91-day
Treasury Bills.
B. Risk Tolerance
 Risk varies across securities; T-Bills are risk-free, while corporate bonds have
some risk.
 Example: A conservative business invests in government securities, while a risk-
taking firm buys commercial papers.
C. Expected Returns
 Returns depend on interest rates, credit ratings, and market conditions.
 Example: A company compares Treasury Bills (4.5%) vs. Corporate Bonds
(6.5%) before investing.
D. Investment Horizon
 Short-term funds should be invested in highly liquid securities.
 Example: A firm with 6-month idle cash chooses 180-day CDs instead of long-term
bonds.
6. Example of a Business Investment Strategy in Marketable Securities
Scenario: A multinational company has $50 million in surplus cash and wants to invest
wisely.
Investment Option Amount Invested Purpose Expected Return
Treasury Bills (T-Bills) $15 million Emergency liquidity 4.5%
Fixed Deposits (FDs) $10 million Safe returns for 6 months 5%
Commercial Papers (CPs) $5 million Short-term profit 7%
Money Market Funds $5 million Flexible investment 3.5%
Corporate Bonds $10 million Medium-term returns 6.5%
Repurchase Agreements $5 million Overnight cash parking 0.5%
This diversified investment ensures liquidity, security, and returns.
Conclusion: Investing in marketable securities is a smart way for businesses to optimize
cash utilization while maintaining liquidity and earning returns. By choosing the right mix
of low-risk, short-term, and flexible securities, companies can enhance their financial
stability.
6.7. forecasting cash flows: Cash flow forecasting is the process of estimating future cash
inflows and outflows over a specific period. It helps businesses ensure liquidity, manage
working capital, and make informed financial decisions.
1. Meaning of Cash Flow Forecasting
 It is a financial planning tool used to predict how much cash a business will have in
the future.
 Helps in determining cash shortages or surpluses before they occur.
 Used by businesses to ensure smooth operations and avoid financial crises.
 Example: A manufacturing company forecasts its cash flow for the next 6 months to
ensure it can pay suppliers and employees.
2. Importance of Cash Flow Forecasting
 Ensures Liquidity → Helps businesses avoid cash shortages and prepare for future
expenses.
 Improves Decision-Making → Helps management decide when to invest or borrow
funds.
 Manages Working Capital → Ensures timely payments to suppliers and
employees.
 Prepares for Uncertainty → Helps businesses anticipate risks and financial crises.
 Optimizes Investments → Helps companies invest surplus cash efficiently.
 Example: A hotel chain forecasts seasonal fluctuations in cash flows and arranges
short-term credit in advance for the off-season.
3. Steps in Forecasting Cash Flows
Step 1: Define the Forecasting Period
 Can be short-term (weekly/monthly) or long-term (annual/multi-year).
 Example: A retail store forecasts cash flow weekly to plan supplier payments.
Step 2: Identify Cash Inflows
 Cash receipts from sales (cash & credit).
 Income from investments, loans, or asset sales.
 Example: A software company expects $1 million in monthly subscription
payments from customers.
Step 3: Identify Cash Outflows
 Payments for suppliers, salaries, rent, and loan repayments.
 Unexpected costs like maintenance, taxes, or emergency expenses.
 Example: A factory pays $500,000 in raw material costs every month.
Step 4: Calculate Net Cash Flow
 Formula: Net Cash Flow=Total Cash Inflows−Total Cash Outflows\text{Net Cash
Flow} = \text{Total Cash Inflows} - \text{Total Cash Outflows}
 Example: If a business has $200,000 inflows and $150,000 outflows, net cash flow is
$50,000 positive.
Step 5: Analyze and Adjust Forecasts
 Adjust forecasts based on market trends, seasonality, and economic conditions.
 Example: A travel agency increases cash flow estimates before peak vacation
seasons.
4. Methods of Cash Flow Forecasting
A. Direct Method – Short-Term, Transaction-Based
 Tracks actual cash movements (cash in & out).
 Suitable for daily, weekly, or monthly forecasting.
 Used by businesses with high cash transactions.
 Formula:
Ending Cash Balance=Beginning Cash Balance+Cash Inflows−Cash Outflows\
 text{Ending Cash Balance} = \text{Beginning Cash Balance} + \text{Cash Inflows} -
\text{Cash Outflows}
 Example: A grocery store tracks daily cash sales and expenses to plan inventory
purchases.
B. Indirect Method – Long-Term, Based on Accounting Profits
 Adjusts net income from financial statements to estimate cash flow.
 Useful for strategic planning and investment decisions.
 Formula: Cash Flow=Net Income+Depreciation−Changes in Working Capital\
text{Cash Flow} = \text{Net Income} + \text{Depreciation} - \text{Changes in
Working Capital}
 Example: A manufacturing firm forecasts cash flow based on quarterly income
statements.
5. Types of Cash Flow Forecasting
A. Short-Term Cash Flow Forecasting
 Covers periods ranging from a few days to a few months.
 Helps businesses meet immediate cash needs.
 Example: A restaurant forecasts weekly cash flow to manage payroll and inventory.
B. Medium-Term Cash Flow Forecasting
 Covers 3 months to 1 year.
 Useful for budgeting and capital expenditure planning.
 Example: A construction company forecasts 6-month cash flow to manage project
costs.
C. Long-Term Cash Flow Forecasting
 Covers more than 1 year, used for strategic planning.
 Helps businesses plan major expansions or long-term loans.
 Example: A tech startup forecasts 3-year cash flows to attract investors.
6. Example of Cash Flow Forecasting
Scenario: A clothing brand wants to forecast cash flow for the next 3 months.
Net Cash Flow Ending Cash Balance
Month Cash Inflows ($) Cash Outflows ($)
($) ($)
January 50,000 30,000 20,000 20,000
February 60,000 35,000 25,000 45,000
March 55,000 40,000 15,000 60,000
Insights from Forecast:
 The company has a positive cash flow each month.
 It can invest excess cash ($60,000 in March) into short-term securities.
7. Challenges in Cash Flow Forecasting
A. Inaccurate Sales Predictions
 Overestimating or underestimating future sales affects cash flow forecasts.
 Solution: Use historical data and market trends for better accuracy.
B. Unexpected Expenses
 Emergency repairs, lawsuits, or tax penalties can disrupt cash flow.
 Solution: Keep a cash reserve for contingencies.
C. Late Payments from Customers
 Delays in accounts receivables affect cash inflows.
 Solution: Offer discounts for early payments and use factoring services.
D. Seasonal Variations
 Businesses in tourism, retail, and agriculture face seasonal cash flow fluctuations.
 Solution: Adjust cash flow forecasts for peak and off-seasons.
8. Best Practices for Effective Cash Flow Forecasting
 Use real-time data and update forecasts regularly.
 Maintain a cash buffer for unexpected expenses.
 Categorize cash inflows and outflows accurately.
 Automate forecasting with cash flow management software (e.g., QuickBooks,
Zoho).
 Compare forecasted vs. actual cash flow to improve accuracy.
Conclusion: Cash flow forecasting is essential for financial stability, liquidity
management, and strategic planning. By choosing the right forecasting method and
updating forecasts regularly, businesses can make better financial decisions and avoid
cash shortages.
6.8. Cash budgets-long-term cash forecasting: A cash budget is a financial plan that
estimates a business’s cash inflows and outflows over a specific period, helping to ensure
liquidity and financial stability. Long-term cash forecasting extends this approach to
multiple years, aiding strategic decision-making.
1. Meaning of Cash Budget
 A cash budget is a detailed estimate of future cash flows, covering both cash
receipts (inflows) and cash payments (outflows).
 Helps in identifying cash shortages or surpluses in advance.
 Used for working capital management, investment planning, and financial
control.
 Example: A company prepares a 6-month cash budget to ensure it can meet payroll
and supplier payments.
2. Importance of Cash Budgets
 Ensures Liquidity → Prevents cash shortages and overdrafts.
 Aids in Decision-Making → Helps determine when to borrow or invest surplus
cash.
 Controls Expenses → Helps monitor and reduce unnecessary spending.
 Supports Growth Planning → Provides financial insights for business expansion.
 Example: A startup uses a cash budget to plan funding rounds and avoid running
out of capital.
3. Components of a Cash Budget
A. Opening Cash Balance
 The amount of cash available at the start of the budget period.
 Example: A company starts January with $50,000 in cash reserves.
B. Cash Inflows (Receipts)
 Sales Revenue: Cash from product sales, services, or subscriptions.
 Loan Proceeds: Cash received from bank loans or investors.
 Interest & Dividends: Income from investments in securities.
 Asset Sales: Cash from selling equipment, land, or other assets.
 Example: A retailer expects $100,000 in sales revenue and $10,000 from a loan in
February.
C. Cash Outflows (Payments)
 Operating Expenses: Rent, salaries, utility bills, and supplies.
 Loan Repayments: Monthly principal and interest payments.
 Tax Payments: Corporate taxes, GST, and other obligations.
 Capital Expenditures: Investments in machinery, vehicles, or infrastructure.
 Example: A company pays $40,000 in salaries, $20,000 in rent, and $15,000 for
raw materials in March.
D. Closing Cash Balance
  The amount of cash left at the end of the period.
 Formula:
Closing Cash Balance=Opening Cash Balance+Total Cash Inflows−Total Cash Outflo
ws\text{Closing Cash Balance} = \text{Opening Cash Balance} + \text{Total Cash
Inflows} - \text{Total Cash Outflows}
 Example: If a company starts with $50,000, has $100,000 inflows, and $75,000
outflows, the closing balance is $75,000.
4. Types of Cash Budgets
A. Short-Term Cash Budget (1 Month - 1 Year)
 Helps manage daily and monthly cash flow.
 Used for payroll, supplier payments, and operational expenses.
 Example: A manufacturing company prepares a quarterly cash budget to ensure
smooth operations.
B. Long-Term Cash Budget (1 Year - 5 Years)
 Helps in capital investment planning and debt management.
 Useful for business expansion, mergers, or infrastructure projects.
 Example: A tech company forecasts cash needs for the next 3 years to plan product
launches.
5. Steps to Prepare a Cash Budget
Step 1: Define the Budget Period
 Choose a time frame (monthly, quarterly, or yearly).
 Example: A business creates a 12-month cash budget for 2025.
Step 2: Estimate Cash Inflows
 Forecast sales revenue, loan proceeds, and other receipts.
 Use historical data, market trends, and customer payment patterns.
 Example: A construction firm estimates $500,000 from project payments over the
next 6 months.
Step 3: Estimate Cash Outflows
 List expected expenses, loan repayments, and investments.
 Example: A factory estimates $200,000 in raw material purchases for the next
quarter.
Step 4: Calculate Net Cash Flow
 Use the formula: Net Cash Flow=Total Cash Inflows−Total Cash Outflows\text{Net
Cash Flow} = \text{Total Cash Inflows} - \text{Total Cash Outflows}
 Example: A business expects $300,000 in inflows and $250,000 in outflows, leading
to a positive cash flow of $50,000.
Step 5: Adjust for Cash Surpluses or Deficits
 If there’s a cash surplus, plan investments.
 If there’s a cash deficit, arrange short-term loans or credit.
 Example: A retail business with a $100,000 surplus invests in short-term
government bonds.
6. Long-Term Cash Forecasting
A. Meaning of Long-Term Cash Forecasting
 Estimates cash inflows and outflows beyond one year.
 Helps in strategic decision-making, investments, and financial risk management.
 Example: A real estate company forecasts cash flow for 5 years to plan land
acquisitions.
B. Importance of Long-Term Forecasting
 Supports Business Growth → Ensures funds for expansion.
 Improves Debt Management → Helps plan loan repayments.
  Prepares for Economic Uncertainty → Allows businesses to adjust for inflation
and interest rate changes.
 Example: A telecom company forecasts cash flow for 3 years to determine funding
for network expansion.
C. Methods of Long-Term Cash Forecasting
1. Percentage of Sales Method
 Assumes cash inflows grow at a fixed percentage of sales.
 Example: If sales are expected to grow 10% annually, cash inflows increase
proportionally.
2. Regression Analysis
 Uses historical data and statistical models to predict future cash flows.
 Example: A pharmaceutical company uses past cash flow trends to forecast 5-year
revenues.
3. Adjusted Profit Method
 Starts with net income and adjusts for non-cash expenses like depreciation.
 Example: A software firm estimates future cash flow based on net profit trends.
7. Example of a Cash Budget (Quarterly Forecast)
Opening Cash Cash Cash Net Cash Closing Cash
Quarter
Balance ($) Inflows ($) Outflows ($) Flow ($) Balance ($)
Q1 50,000 200,000 180,000 20,000 70,000
Q2 70,000 220,000 190,000 30,000 100,000
Q3 100,000 250,000 210,000 40,000 140,000
Q4 140,000 270,000 230,000 40,000 180,000
 Insights:
o The business has a positive cash flow each quarter.
o The cash surplus can be invested in marketable securities.
Conclusion: A cash budget and long-term cash forecasting are essential tools for effective
financial planning. They help businesses manage liquidity, avoid financial crises, and
plan for future investments.
6.9. optimal cash balances: Efficient cash management ensures that a business maintains
an optimal level of cash—enough to meet obligations while minimizing excess cash that
could be invested for higher returns.
Meaning of Optimal Cash Balance
 The minimum amount of cash a business should hold to meet daily expenses
without holding excessive idle cash.
 Balances liquidity needs and opportunity costs (missed investment returns).
 Considerations include cash inflows, cash outflows, marketable securities, and
borrowing capacity.
B. Factors Affecting Optimal Cash Balance
1. Transaction Needs: Daily payments like salaries, rent, and utilities.
2. Precautionary Motive: Cash reserves for unexpected expenses.
3. Speculative Motive: Holding cash to take advantage of investment opportunities.
4. Cost of Borrowing: If borrowing is expensive, businesses may hold more cash.
5. Market Conditions: Interest rates and inflation influence cash balance decisions.
C. Example of Optimal Cash Balance
 A retail store estimates monthly cash expenses at $50,000.
 It holds $60,000 in cash reserves to cover routine payments and emergencies.
 Any excess is invested in short-term securities for better returns.
6.10. Baumol Model of Cash Management
A. Meaning of Baumol Model: Developed by William Baumol (1952), this model applies
Economic Order Quantity (EOQ) principles to cash management.
 It helps businesses determine how much cash to withdraw from marketable
securities to minimize transaction and holding costs.
B. Assumptions of Baumol Model
1. Cash is spent at a constant rate over time.
2. Cash inflows occur periodically (e.g., from sales or investments).
3. Firms replenish cash by selling marketable securities or borrowing.
4. No buffer cash is maintained for contingencies.
C. Baumol Model Formula
C∗=2bTrC^* = \sqrt{\frac{2bT}{r}}
Where:
 C∗C^* = Optimal cash balance per transaction
 bb = Fixed transaction cost per withdrawal
 TT = Total cash requirement for a period
 rr = Opportunity cost of holding cash (interest rate)
D. Example of Baumol Model
 A company needs $1,000,000 in cash per year.
 The cost of converting securities to cash is $50 per transaction.
 The interest rate is 5% per year.
Using the Baumol formula:
C∗=2×50×1,000,0000.05C^* = \sqrt{\frac{2 \times 50 \times 1,000,000}{0.05}}
C∗=100,000,0000.05=2,000,000,000=44,721C^* = \sqrt{\frac{100,000,000}{0.05}} = \
sqrt{2,000,000,000} = 44,721
 The company should withdraw $44,721 from investments per transaction.
 It will make 1,000,000 / 44,721 = 22.4 ≈ 22 transactions per year.
E. Limitations of Baumol Model
 Assumes constant cash outflows, which may not be realistic.
 Does not account for uncertainties or emergency cash needs.
 Relies on accurate interest rate and transaction cost estimation.
6.11. Miller-Orr Model of Cash Management
A. Meaning of Miller-Orr Model
 Developed by Merton Miller and Daniel Orr (1966), this model is an extension of
the Baumol model that accommodates uncertainty in cash flows.
 It sets upper and lower cash balance limits and allows for random cash movements.
B. Assumptions of Miller-Orr Model
1. Cash balances fluctuate unpredictably.
2. A lower limit (L) is set to avoid cash shortages.
3. An upper limit (H) is set to avoid excess idle cash.
4. When the upper limit is reached, excess cash is invested.
5. When the lower limit is reached, cash is replenished.
C. Formula for the Optimal Return Point (Z)
Z = L + \frac{(3/4) \times (\text{Upper Limit} - \text{Lower Limit})}
Where:
 ZZ = Optimal cash balance (return point)
 LL = Lower cash limit
 HH = Upper cash limit
D. Example of Miller-Orr Model
 A company sets a lower cash limit of $10,000.
 The upper limit is $50,000.
Using the formula:
Z=10,000+34×(50,000−10,000)Z = 10,000 + \frac{3}{4} \times (50,000 - 10,000)
Z=10,000+34×40,000Z = 10,000 + \frac{3}{4} \times 40,000 Z=10,000+30,000=40,000Z =
10,000 + 30,000 = 40,000
 When cash reaches $50,000, the firm invests the excess $10,000 in securities.
 When cash falls below $10,000, it withdraws cash to reach $40,000$.
E. Advantages of Miller-Orr Model
 Better for unpredictable cash flows.
 Provides a cash buffer for emergencies.
 More realistic than the Baumol model.
F. Limitations of Miller-Orr Model
 Requires accurate data on cash flow variations.
 Does not consider borrowing options for cash shortages.
 Assumes a fixed interest rate, which may change over time.
4. Comparison of Baumol and Miller-Orr Models
Feature Baumol Model Miller-Orr Model
Assumption Predictable cash flows Unpredictable cash flows
Cash Limits No limits (fixed amount) Upper & lower limits set
Small businesses, stable cash Large firms, fluctuating cash
Suitability
flow needs
Action Trigger Withdraws fixed cash amounts Adjusts cash when limits are hit
Mathematical
Simple formula More complex
Complexity
Conclusion
 Optimal cash balance is crucial for liquidity and profitability.
 Baumol Model helps firms with stable and predictable cash flows.
 Miller-Orr Model is better for businesses with uncertain cash inflows and
outflows.
 Businesses should choose a model based on cash flow variability and operational
needs.

6.12. Strategies for managing surplus fund. (Theory and Problems)

Strategies for Managing the Surplus Fund: Effective management of surplus funds
ensures that excess cash is invested wisely to generate returns while maintaining liquidity for
operational needs. Below are the key strategies for managing surplus funds in a business or
organization.
1. Meaning of Surplus Fund: Surplus funds refer to excess cash that is not immediately
required for business operations. Proper management ensures optimal returns while
minimizing risks.
Example:
 A company earns $500,000 per month but only requires $400,000 for expenses.
 The surplus $100,000 should be invested smartly instead of sitting idle in a bank
account.
2. Strategies for Managing Surplus Funds
A. Short-Term Investment Strategies: Used for funds required in the near future (3 months
to 1 year).
i. Investing in Marketable Securities
  Marketable securities include Treasury bills, commercial papers, and money
market funds.
 Provides liquidity and safety while generating moderate returns.
Example: A company with a $500,000 surplus invests in Treasury bills at a 5% annual
return, earning $25,000 per year.
ii. Fixed Deposits (FDs) and Certificate of Deposits (CDs)
 Bank FDs offer guaranteed returns with low risk.
 CDs are short-term deposits issued by banks with higher interest rates.
Example: A company parks $200,000 in a 6-month FD at a 6% annual interest rate,
earning $6,000.
iii. Liquid Mutual Funds
 Mutual funds with high liquidity and low risk, ideal for short-term investments.
 Offers higher returns than savings accounts while maintaining accessibility.
Example: A business invests $100,000 in a liquid fund offering 4% annual returns,
earning $4,000 per year.
B. Long-Term Investment Strategies: Used when surplus funds are not required for at least
1-3 years.
i. Investing in Bonds and Debentures
 Bonds provide fixed interest payments and are low-risk investments.
 Debentures are similar but may have higher risk and higher returns.
Example: A company buys corporate bonds worth $1 million at a 7% annual interest
rate, earning $70,000 annually.
ii. Equity Investments (Stocks & Mutual Funds)
 Investing in shares of well-established companies for capital appreciation.
 Equity mutual funds diversify risk across multiple stocks.
Example: A company invests $500,000 in blue-chip stocks and earns a 10% return,
gaining $50,000 annually.
iii. Real Estate Investments: Investing in commercial or rental properties provides long-
term value appreciation and rental income.
Example: A firm buys an office space for $1 million, generating $60,000 in annual rent.
C. Strategic Business Investments
Instead of external investments, businesses can use surplus funds to enhance operations.
i. Expansion and Diversification: Using surplus cash to enter new markets, launch new
products, or expand existing operations.
Example: A manufacturing firm invests $2 million in a new production line, increasing
revenue by $500,000 annually.
ii. Debt Repayment: Paying off high-interest loans reduces financial burdens and improves
profitability.
Example: A company uses $1 million in surplus cash to pay off a 10% interest loan,
saving $100,000 in interest annually.
iii. Research and Development (R&D): Investing in new product development,
technology upgrades, or process improvements.
Example: A tech firm invests $500,000 in R&D, leading to a new software product that
generates $1 million in revenue.
D. Dividend Payments and Share Buybacks: When a company has surplus funds, it can
reward shareholders.
i. Dividend Distribution: Paying extra dividends to shareholders increases their returns and
boosts investor confidence.
Example: A company with a $5 million surplus declares a special dividend of $2 per
share.
ii. Share Buybacks: The company repurchases its shares, reducing the number of
outstanding shares and increasing earnings per share (EPS).
Example: A firm uses $10 million to buy back 200,000 shares at $50 each, increasing
shareholder value.
3. Factors to Consider in Surplus Fund Management
A. Liquidity vs. Return Trade-Off
 Higher returns usually mean lower liquidity.
 A company should balance liquidity needs and investment opportunities.
B. Risk Tolerance
 Low-risk options: Fixed deposits, government bonds, liquid funds.
 Moderate-risk options: Corporate bonds, debt mutual funds.
 High-risk options: Equity stocks, real estate.
C. Tax Considerations: Investments should be tax-efficient to maximize after-tax returns.
D. Economic and Market Conditions: Interest rates, inflation, and market trends affect
investment decisions.
Conclusion
 Effective surplus fund management ensures businesses maximize returns,
minimize risks, and maintain liquidity.
 The right strategy depends on time horizon, risk appetite, and financial goals.
 Diversification across various instruments helps optimize returns and secure
financial stability.
6.13. Recent Developments in Advanced Financial Management
1. Cryptocurrency
1.1 Meaning and Definition
 Cryptocurrency is a digital or virtual currency that uses cryptography for secure
transactions.
 It operates decentrally on blockchain technology without control from a central
authority (e.g., banks or governments).
 The first cryptocurrency, Bitcoin (BTC), was introduced in 2009 by Satoshi
Nakamoto.
1.2 Features of Cryptocurrency
 Decentralization: No central bank or authority controls transactions.
 Security: Uses cryptographic techniques to prevent fraud and counterfeiting.
 Anonymity: Users can make transactions without revealing personal identities.
 Global Transactions: No geographical restrictions in trading and payments.
1.3 Examples of Cryptocurrencies
 Bitcoin (BTC): The first and most widely recognized cryptocurrency.
 Ethereum (ETH): A blockchain platform supporting smart contracts and
decentralized applications.
 Ripple (XRP): Focused on fast cross-border payments for financial institutions.
1.4 Applications of Cryptocurrency
 Investment and Trading: Many people buy and sell cryptocurrencies as an
alternative investment.
 Cross-border Transactions: Eliminates banking fees and delays in international
payments.
 Smart Contracts: Automated contracts that execute themselves on meeting specific
conditions.
2. Blockchain Technology
2.1 Meaning and Definition
  Blockchain is a distributed digital ledger that records transactions across multiple
computers.
 Once recorded, data cannot be altered, ensuring transparency and security.
 It operates on a peer-to-peer (P2P) network, eliminating intermediaries.
2.2 Features of Blockchain Technology
 Transparency: Every transaction is visible to participants in the network.
 Security: Data is stored in blocks and encrypted, preventing hacking.
 Immutability: Once a transaction is recorded, it cannot be altered.
 Decentralization: No central authority controls the database.
2.3 Examples of Blockchain Applications
 Cryptocurrency Transactions: Used in Bitcoin and Ethereum transactions.
 Supply Chain Management: Companies like Walmart use blockchain to track
goods.
 Smart Contracts: Automates contract execution without third-party involvement.
 Healthcare: Secure storage and sharing of medical records.
3. Crowdfunding
3.1 Meaning and Definition
 Crowdfunding is a fundraising method where businesses, startups, or individuals
raise small amounts of money from a large number of people, typically through
online platforms.
3.2 Types of Crowdfunding
1. Reward-Based Crowdfunding: Backers receive a product or service in return.
o Example: Kickstarter campaigns for new gadgets.
2. Equity Crowdfunding: Investors receive company shares in exchange for funding.
o Example: Startups raising capital on platforms like SeedInvest.
3. Donation-Based Crowdfunding: People contribute money without expecting
returns.
o Example: GoFundMe campaigns for medical treatments.
4. Debt Crowdfunding (P2P Lending): Investors lend money and earn interest.
o Example: Funding Circle, LendingClub.
3.3 Advantages of Crowdfunding
 Easy access to capital for startups and individuals.
 Engages customers and builds community support.
 No need for traditional financial intermediaries like banks.
4. Digitization of Financial Transactions
4.1 Meaning and Definition
 The digitization of financial transactions refers to using electronic methods instead
of cash and physical documents for conducting financial activities.
 This includes online banking, mobile payments, and digital wallets.
4.2 Examples of Digital Transactions
 UPI (Unified Payments Interface): Real-time payments in India.
 PayPal, Google Pay, Apple Pay: Digital wallets for seamless transactions.
 Internet Banking and Mobile Banking: Provided by banks for online fund transfers.
4.3 Benefits of Financial Digitization
 Faster transactions with minimal human intervention.
 Lower costs compared to traditional banking.
 Enhanced security through encryption and authentication.
5. Big Data in Project Finance
5.1 Meaning and Definition
  Big Data refers to large volumes of structured and unstructured financial data
analyzed to improve decision-making.
 In project finance, Big Data helps in risk assessment, fraud detection, and
investment planning.
5.2 Applications of Big Data in Finance
 Credit Risk Analysis: Banks use Big Data to evaluate borrower creditworthiness.
 Stock Market Predictions: AI-powered tools analyze historical data to forecast
trends.
 Fraud Detection: Financial institutions use machine learning to detect fraudulent
transactions.
5.3 Example of Big Data in Finance
 JPMorgan Chase uses AI-driven COiN (Contract Intelligence) to analyze legal
documents and reduce processing time.
6. Behavioural Finance
6.1 Meaning and Definition
 Behavioral finance studies how psychological factors affect financial decision-
making.
 Investors often make irrational decisions due to biases, emotions, and cognitive
errors.
6.2 Common Biases in Behavioral Finance
1. Herd Mentality: Investors follow market trends without independent analysis.
o Example: Bitcoin price surge due to mass adoption.
2. Overconfidence Bias: Investors overestimate their knowledge and take excessive
risks.
o Example: Stock traders ignoring market signals.
3. Loss Aversion: Fear of losing money leads to avoiding investments.
o Example: Selling stocks too early to prevent small losses.
6.3 Importance of Behavioral Finance
 Helps in understanding market anomalies and investor behavior.
 Encourages investors to make rational and informed decisions.
7. Derivative Markets in Developing Countries
7.1 Meaning and Definition
 Derivatives are financial instruments whose value is derived from an underlying
asset (stocks, bonds, commodities, or currencies).
 Includes futures, options, forwards, and swaps.
7.2 Role of Derivatives in Developing Economies
 Risk Management: Helps businesses hedge against currency fluctuations.
 Market Stability: Encourages liquidity and reduces volatility.
 Encourages Investment: Attracts foreign institutional investors.
7.3 Example of Derivative Usage
 Commodity Hedging: Farmers in India use commodity futures contracts to lock in
crop prices, reducing price uncertainty.
 Currency Hedging: Indian exporters use currency derivatives to protect against
rupee depreciation.
7.4 Challenges in Developing Countries
 Lack of Awareness: Many businesses do not understand derivative products.
 Regulatory Barriers: Governments impose restrictions on derivative trading.
 Market Volatility: Risk of speculative trading causing price fluctuations.
Conclusion
 Financial technology is rapidly evolving, impacting the way transactions are
conducted, investments are made, and financial decisions are approached.
 Cryptocurrency, blockchain, crowdfunding, and digital transactions are
revolutionizing traditional finance.
 Big Data, behavioral finance, and derivative markets play a crucial role in risk
assessment and investment strategies.
 Developing countries must adopt these financial innovations while managing
associated risks.