(c) The following factors should be considered in determining the optimum level of cash to be held by a company, for example,at the start of a month or other accounting control period.
The transactions need for cash The amount of cash needed for the next period can be forecast using a cash budget, which will net off expected receipts against expected payments. This will determine the transactions need for cash, which is one of the three reasons for holding cash.
The precautionary need for cash
Although a cash budget will provide an estimate of the transactions need for cash, it will be based on assumptions about the future and will therefore be subject to uncertainty. The actual need for cash may be greater than the forecast need for cash.
In order to provide for any unexpected need for cash, a company can include some spare cash (a cash buffer) in its cash balance. This is the precautionary need for cash. In determining the optimal level of cash to be held, a company will estimate the size of this cash buffer, for example from past experience, because it will be keen to minimise the opportunity cost of maintaining funds in cash form.
The speculative need for cash
There is always the possibility of an unexpected opportunity occurring in the business world and a company may wish to be prepared to take advantage of such a business opportunity if it arises. It may therefore wish to have some cash available for this purpose. This is the speculative need for cash. Building ‘a war chest’ for possible company acquisitions reflects this reason for holding cash.
The availability of finance
A company may choose to hold higher levels of cash if it has difficulty gaining access to cash when it needs it. For example,if a company’s bank makes it difficult to access overdraft finance, or if a company is refused an overdraft facility, its precautionary need for cash will increase and its optimum cash level will therefore also increase. |
