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Cash Management Models

Cash Management Models

Cash management models analyse methods which provide certain framework as to how the cash management is conducted in the firm. Cash management models are the development of the theoretical concepts into analytical approaches with the mathematical applications. There are three cash management models which are very popular in the field of finance.

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1. Baumol model

The basic objective of the Baumol model is to determine the minimum cost amount of cash conversion and the lost opportunity cost. It is a model that provides for cost efficient transactional balances and assumes that the demand for cash can be predicated with certainty and determines the optimal conversion size. Total conversion cost per period can be calculated with the help of the following formula:

t = Tb/C

where,

T = Total transaction cash needs for the period

b = Cost per conversion

C = Value of marketable securities

Opportunity cost can be calculated with the help of the following formula;

i = C/2

where,

i = interest rate earned

C/2 = Average cash balance

Optimal cash conversion can be calculated with the help of the following formula;

C = V2bT/i

where,

C = Optimal conversion amount

b = Cost of conversion into cash per lot or transaction

T = Projected cash requirement

i = interest rate earned

2. Miller-Orr model

This model was suggested by Miller Orr. This model is to determine the optimum cash balance level which minimises the cost of management of cash. Miller-Orr Model can be calculated with the help of the following formula;

C = [bE (N)/t] + [iE (M)]

where,

C = Total cost of cash management

b = fixed cost per conversion

E(M) = expected average daily cash balance

E(N) = expected number of conversion

t = Number of days in the period

i = lost opportunity cost

3. Orgler’s model

Orgler model provides for integration of cash management with production and other aspects of the business concern. Multiple linear programming is used to determine the optimal cash management. Orgler’s model is formulated, based on the set of objectives of the firm and specifing the set of constrains of the firm.

Cash Management Models Cash Management Models Reviewed by Ikpokolo Francis on Tuesday, August 22, 2017 Rating: 5

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