Edited by Anamika Anand

It is correctly said, Money is the lifeline of the business and therefore, for this it is necessary to maintain a sound cash flow position. To ensure sound cash flow, cash management is the key.

What is cash management?
Cash Management refers to the collection, handling, control and investment of the organizational cash and cash equivalent, to ensure optimum liquidity position. It is making sure that the revenues are effectively controlled and utilized in the best possible manner.
Objectives for maintaining Cash Management

  • Provide adequate cash to each of its units.
  • No funds are blocked in idle cash
  • The surplus cash should be invested in order to maximize return for the business

The function of Cash Management

  • Inventory Management
  • Receivables Management
  • Payables Management


In recent years several types of mathematical models have been developed to determine the optimum cash balance to be carried by a business.Models of cash management, Baumol EOQ model, Miller-Orr model

According to this model, the optimum cash level is the level of cash where the carrying cost and transaction cost are the minimum. According to Baumol, the optimum amount of cash should be withdrawn at a time. The optimum amount of cash means the level of cash at which sum total of annual transaction and interest cost in minimum. Optimum cash balance, EOQ model of baumol's model

Optimum withdrawal size is as under:
EOQ = =√2AT/I
A=Annual Cash Requirement
 T=Transaction cost per transaction
I=Annual Interest Rate

ABC Ltd. has estimated that the use of $ 24 lakhs of cash during the next budgeted year. It intends to hold cash in a commercial bank which pays interest @ 10% p.a. For each withdrawal, the company incurs an expenditure of $ 150. What is the optimal size for each withdrawal?

Optimum level = √2*150*24,00,000/0.01 =$84,853 or approx.$85,000
Each time the firm will withdraw $85,000 from the bank deposit. After spending all the amount of $85,000, again the company will withdraw a similar amount and so on.


According to this model, the flow of cash is very uncertain, one should not decide the amount of cash withdrawn at a time instead should plan a minimum level, maximum level and return level. If the cash reaches the minimum level the amount of cash should be withdrawn by the sale of securities to as to reach return level. If the cash level touches maximum level, securities should be purchased so as to bring the cash level down to return level.
The spread between the maximum and minimum cash level is denoted by 3z and can be calculated as per the Miller –Orr model:
Spread = 3(3/4 x Transaction cost x Cashflow variance/rate)1/3
Return Level =Lower Limit + (1/3 ) SpreadMiller-Orr model, Return level, maximum level, minimum level

If a company must maintain a minimum cash balance of $8,000, and the variance of its daily cash flows is $4m (i.e. std deviation $2,000). The cost of buying/ selling securities is $50 & the daily interest rate is 0.025%.
Required: Calculate the spread, the upper limit (max amount of cash needed) & the return point (target level)

Lower limit = 8,000 (per question)
Spread = 3(3/4 x 50 x 4,000,000 / 0.00025)1/3 = 25,303
Upper limit = 8,000 + 25,303 = 33,303
Return point = 8,000 + (1/3 ) 25,303 = 16,434