Introduction Cash is the oil that lubricates the wheels of your economic success. Without oil machines normally seizes up and comes to a grinding halt. Without sufficient cash you will not be able to do anything, much like a machine without oil. On the other hand, keeping cash can be a very expensive exercise, since cash is a non income earning asset. The aim of money management is to minimize the amount that you need to keep in order to service your normal amount needed without loosing out on special discounts, ensuring that you will maintain an acceptable credit rating and to meet unexpected needs for immediate money.
The tool mostly used to achieve this is the cash budget. In this article we will investigate this budget tool.
Budgeting You should determine your need for hard currency as part of your personal budgeting process. The budgeting process includes forecasting for acquiring both long and short term assets. Combining the forecasting information about expenses with expected income cash flows is called the cash budget. This budget reveals your expected cash in- and outflows over a given period. It is a good practice to have this budget drafted for monthly intervals for a period looking forward for a year. In addition to this a more detailed daily (or at worst weekly) the budget must also be generated for the coming month. The monthly budget is used for planning purposes and the daily budget for actual cash control.
The Monthly Cash Budget The monthly budget is the forecast of the expected cash in and out flows for every month of the annual forecast. It reflects these figures as accurately as possible to provide you with a tool to plan when any particular purchase should be made using the funds in your current account.
It is important to note that in this type of budget only cash items are reflected. Items such as depreciation should not be included as it does not influence the flow of funds at hand. Every single expected cash item should be included in the budget. For information on step by step instructions on how to compile a cash budget please read my ezine article on this topic.
The Daily Cash Budget The daily cash budget is a reflection of the actual money flows and provides the ideal tool to control your actual available funds on a daily basis. By updating the balance on a daily basis and updating the budget prior to making any payment you can determine if you will stay within your cash balance target. You will also be able to plan for making more funds available by calling up short term investments to be available to make these payments.
Managing Funds at Hand It is true that money in your till does not generate any income and therefore the ideal is to have as little cash at hand as possible while still being in a position to take care of your responsibilities. You should remember that you could make various income generating instruments instead of keeping it readily available. There are basically three motives why people will keep some cash at hand.
The first and most obvious motive to keep money at hand is to be able to continue to do transactions. You may reason that you could do this on credit, however you need to establish what is financially more beneficial, to buy on credit and have no or little negotiating ability or to buy with cash and negotiate discounts and be in a better bargaining position for delivery and other extras. The amount of money you need to keep available to satisfy this motive will depend on your lifestyle, the quantity and size of regular purchases done as well as the type of purchases you intend to make.
The second motivation not to invest all you money in long term instruments is the precautionary motive. Most households will need some cash to prepare for some unforeseen event. The magnitude of this amount will of cause vary depending on the risk appetite, the security of income inflows (such as salaries and wages) and the amount of available funds set aside for this purpose.
The third motivation for keeping currency on hand is to take advantage of potential situations that may occur that would require one to have money to take advantage of opportunities. As it is mostly an issue that you cannot plan for in detail an objective assessment of this is not possible and each individual will consider what the magnitude of the readily available funds will be. This amount will than be kept aside for this purpose. The amount is based on feeling rather than fact.
Conclusion The cost of keeping cash at hand should be compared with the benefits derived from it. The cost of keeping cash can be equated with expected return when it is held in some alternative investment. This implies that you should not keep excessive amounts of cash as there will be a loss of income. This reduced income should be balanced with the risk of not having it when needed.
The optimum amount of readily available money to keep is normally calculated by large companies who utilize complex cash management models. It would be wise for the normal sized household to consider the factors mentioned above when considering the amount of money to keep available for each of the reasons mentioned above.
The amount could be adjusted over time, based on your experience. In the final analysis it should be remembered that CASH is KING and if you have it you can dictate the terms and conditions of most purchases.