The Management Of Cash And Marketable Securities Introduction - Financial Management

Cash and Marketable Securities Management

Cash and marketable securities are the most liquid of a company’s assets. Cash is the sum of the currency a company has on hand and the funds on deposit in bank checking accounts. Cash is the medium of exchange that permits management to carry on the various functions of the business organization. In fact, the survival of a company can depend on the availability of cash to meet financial obligations on time. Marketable securities consist of short-term investments a firm makes with its temporarily idle cash. Marketable securities can be sold quickly and converted into cash when needed. Unlike cash, however, marketable securities provide a firm with interest income.

Effective cash and marketable securities management is important in contemporary companies, government agencies, and not-for-profit enterprises. Corporate treasurers continually seek ways to increase the yields on their liquid cash and marketable security reserves. Traditionally, these liquid reserves were invested almost exclusively in negotiable certificates of deposit, Treasury bills, commercial paper, and repurchase agreements (short-term loans backed by Treasury securities).However, in recent years many treasurers have shown a willingness to take some additional risks to increase the return on liquid assets. Financial managers constantly face these types of risk–return trade-offs.

Many firms hold significant cash and marketable securities balances. For example, at the end of 2003, Ford had a cash balance of nearly $26 billion. As we saw in the “Financial Challenge” at the beginning of the chapter, Microsoft’s cash balance was $56 billion and growing (i.e., free cash flow) at a rate of $1 billion per month. These cash balances give the firm a cushion to handle economic downturns and the ability to make investments in other firms when the price is attractive. Large cash balances can make firms attractive takeover targets for corporate raiders, who seek to redeploy these surplus funds in more productive ways. For example, Kirk Kerkorian, Chrysler’s largest stockholder, made an unsuccessful buyout offer for the company in 1995.He claimed that Chrysler’s $7.3 billion cash stockpile was more than the company needed for its operations and that some of this hoard should be paid out to stockholders—either in the form of cash dividends or share repurchases.

In addition to managing the cash and marketable securities already in the firm’s possession, financial managers also aggressively seek to speed up cash collections from customers and to slow down disbursements to suppliers. For example, when Alaska sold its oil leases for $900 million, the state was paid with checks that had to physically reach New York before the state could collect and invest the funds. The state chartered a plane to take the checks to New York, thus saving one day in transit over commercial carriers. The daily interest on these funds at the time was nearly $200,000, and the plane charter cost only $15,000, resulting in $185,000 of additional returns to the state. Cash managers continually look for ways to reduce the collection and clearing time for checks received by the firm so that the funds can be put to work earning a return.

Management of Cash and Marketable Securities

Cash management involves much more than simply paying bills and receiving payments for goods and services. The cash management function is concerned with determining

  • The optimal size of a firm’s liquid asset balance
  • The most efficient methods of controlling the collection and disbursement of cash
  • The appropriate types and amounts of short-term investments a firm should make

Cash management decisions require a firm’s managers to consider explicitly the risk versus expected return trade-offs from alternative policies. Because cash and marketable securities generally earn low rates of return relative to a firm’s other assets, a firm can increase its expected return on assets and common equity by minimizing its investment in cash and marketable securities. However, a firm that carries a bare minimum of liquid assets exposes itself to the risk that it will run out of cash needed to keep the business operating. Also, a firm with extremely low cash balances may not be able to take advantage of unique investment opportunities when they arise.

In this chapter, we review the various cash management decisions that must be made by financial managers. Our analysis considers the risk versus expected return trade-offs characteristic of these decisions.

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