ADVERTIsem*nTS:
Let us make an in-depth study of the nature and motives for holding cash.
Nature of Cash:
For some persons, cash means only money in the form of currency (cash in hand). For other persons, cash means both cash in hand and cash at bank. Some even include near cash assets in it. They take marketable securities too as part of cash.
These are the securities which can easily be converted into cash. These viewpoints reflect the degree of freedom of the persons using the cash. Whether a person’s wants to use it immediately or can wait for a time to use it depends upon the needs of the concerned person.
ADVERTIsem*nTS:
Cash itself does not produce goods or services. It is used as a medium to acquire other assets. It is the other assets which are used in manufacturing goods or providing services. The idle cash can be deposited in bank to earn interest.
A business has to keep required cash for meeting various needs. The assets acquired by cash again help the business in producing cash. The goods manufactured or services produced are sold to acquire cash. A firm will have to maintain a critical level of cash. If at a time it does not have sufficient cash with it, it will have to borrow from the market for reaching the required level.
There remains a gap between cash inflows and cash outflows. Sometimes cash receipts are more than the payments or it may be vice-versa at another time. A financial manager tries to synchronize the cash inflows and cash outflows. But this situation is seldom found in the real world. Perfect synchronization of receipts and payments of cash is only an ideal situation.
Motives for Holding Cash:
The firm’s needs for cash may be attributed to the following needs: Transactions motive, Precautionary motive and Speculative motive. Some people are of the view that a business requires cash only for the first two motives while others feel that speculative motive also remains.
ADVERTIsem*nTS:
These motives are discussed as follows:
1. Transaction Motive:
A firm needs cash for making transactions in the day to day operations. The cash is needed to make purchases, pay expenses, taxes, dividend, etc. The cash needs arise due to the fact that there is no complete synchronization between cash receipts and payments. Sometimes cash receipts exceed cash payments or vice-versa.
The transaction needs of cash can be anticipated because the expected payments in near future can be estimated. The receipts in future may also be anticipated but the things do not happen as desired. If more cash is needed for payments than receipts, it may be raised through bank overdraft.
On the other hand if there are more cash receipts than payments, it may be spent on marketable securities. The maturity of securities may be adjusted to the payments in future such as interest payment, dividend payment, etc.
2. Precautionary Motive:
ADVERTIsem*nTS:
A firm is required to keep cash for meeting various contingencies. Though cash inflows and cash outflows are anticipated but there may be variations in these estimates. For example, a debtor who was to pay after 7 days may inform of his inability to pay; on the other hand a supplier who used to give credit for 15 days may not have the stock to supply or he may not be in a position to give credit at present.
In these situations cash receipts will be less than expected and cash payments will be more as purchases may have to be made for cash instead of credit. Such contingencies often arise in a business. A firm should keep some cash for such contingencies or it should be in a position to raise finances at a short period.
The cash maintained for contingency needs is not productive or it remains ideal. However, such cash may be invested in short-period or low-risk marketable securities which may provide cash as and when necessary.
3. Speculative Motive:
The speculative motive relates to holding of cash for investing in profitable opportunities as and when they arise. Such opportunities do not come in a regular manner. These opportunities cannot be scientifically predicted but only conjectures can be made about their occurrence.
ADVERTIsem*nTS:
For example, the prices of shares and securities may be low at a time with an expectation that these will go up shortly. The prices of raw materials may fall temporarily and a firm may like to make purchases at these prices.
Such opportunities can be availed of if a firm has cash balance with it. These transactions are speculative because prices may not move in a direction in which we suppose them to move. The primary motive of a firm is not to indulge in speculative transactions but such investments may be made at times.
