Factors Affecting the Level of Cash

Factors Affecting the Level of Cash. There are a number of things that affect how much cash is needed, such as:

1) Credit Position of the Firm:

The cash balance depends upon the credit position in the following two ways:

i) If a firm’s credit position is strong, only a reasonable amount of cash balances should be kept, as the rest can be borrowed in an emergency.

ii) If the inventory is financed with borrowed funds, the cash required is considerably less as the credit terms between the account receivables and the payables can be matched.

2) Status of Firm’s Receivable:

The time required for debts to realize is also a factor in determining cash needs. If the conversion period is minimum then the working capital requirement also will be minimum and vice versa. When the outflow does not match the turnover, a high volume of cash balance is required than normal.

3) Inventory Account Status:

The level of a firm’s inventory also influences cash requirements. The higher the inventory level, the higher the volume of cash locked in. Firm A, for example, keeps two months’ worth of inventory, whereas Firm B keeps one month’s worth of inventory. So, firm B will require a lower amount of cash for inventory as compared to firm A.

4) Nature of Business Enterprise: ( Factors Affecting the Level of Cash )

Another factor that affects the cash requirement of the business is its nature. For example, if the product in which a firm deal has a variable demand, then the cash required is also high as compared to a firm that deals in a product having constant demand. Consumer goods experience stable demands and similarly, less cash is required, whereas products that are based on current trends and fashion, experience blockage of funds.

5) Management’s Attitude towards Risk:

Conservative management and the cash levels are directly proportional to each other, i.e., high conservatism level, high will requirement of cash, and vice versa. It has been observed that the conservative management will opt for a more liquid position and hence the cash levels will go up. An assumption exists that a firm that constantly reviews its working capital, requires less cash as compared to a firm that is far from planning. The reason is that planning allows knowing the optimum cash balance that is to be maintained.

6) Amount of Sales in Relation to Assets:

Firms that experience large turnover of fixed assets are also required to maintain large cash balances. The basic reason is that those assets which are sold need to be bought again for further operations and obviously will require a larger outflow as compared to the inflow realized on account of the sale.

7) Cash Inflows and Cash Outflows: ( Factors Affecting the Level of Cash )

It is a very rare situation that the cash inflows and the outflows follow a matching pattern. In most cases, it does not. So, adequate cash balances are reserved to stabilize the imbalance between the inflow and the outflow. The vacuum that is created by the increased outflows over the inflows is filled by the cash reserves that are maintained by the management.

8) Cost of Cash Balance:

Keeping a cash balance does not contribute to the increase in wealth. It is considered to be totally unproductive. So, while estimating the cash requirements, one must keep an eye on the cost associated with the cash. Keeping excess cash will have its own opportunity cost and the deficiency will come with its own cost. Both these factors should be taken into account while determining the cash balances. Ideally, an optimum level should be fixed and the surplus should be invested elsewhere with a high-profit margin area.

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