Motives of Holding Cash
Cash Management | Financial Management
BBA | BBA-BI | BBA-TT | BCIS
Each and every firm needs cash for carrying out different activities like: to meet its daily needs(e.g. paying salary,wages ,due loans ,purchase of raw materials,etc),maintains certain level of cash to face the unpredicted fluctuation in cash flows in the future, and holds cash to take advantages of price movement in the markets.
Thus, there are mainly three motives of holding cash which are as follows:
- Transaction Motive
- Precautionary Motive
- Speculative Motive
Transaction motive refers to the need to hold cash to satisfy normal disbursement collection activities associated with a firm’s day to requirement. For e.g.cash for the purchase of goods, payment of salary, wages, rent, interest, tax, insurance, dividend and so on.
A firm also receives cash in terms of sales revenue, interest on loan, return on investments made outside the firm and so on. If these receipts and payments were perfectly synchronized, a firm would not have to hold cash for transaction motive. But in real, cash inflows and outflows cannot be matched exactly. Some times receipts of cash exceeds the disbursement whereas at other time disbursement exceeds the receipt. Because of this reason, if disbursement exceeds the receipt, a firm should hold certain level of cash to meet current payment of cash in excess of its receipt during the period.
Precautionary motive refers to the need to hold cash as a safety margin to act as a financial reserve which may be required for the payment of unpredictable or unanticipated events in the future.For e.g. strikes and lock-up from employees, increase in cost of raw materials, funds and labor, fall in market demand and so on.
These emergencies also bound a firm to hold certain level of cash. But how much cash is held against these emergencies depends on the degree of predictability associated with future cash flows. If there is high degree of predictability, less cash balance is sufficient. Some firms may have strong borrowing capacity at a very short notice, so that they can borrow at the time when emergencies occur. Such a firm may hold very minimum amount of cash for this motive.
Speculative motive refers to the need to hold cash in order to be able to take advantage of additional investment opportunities.For e.g, perhaps the company wants to acquire a competitor or a supplier, and thinks they’ll have the chance soon. Or maybe management sees the opportunity to purchase raw material or repurchase their stock at a significant discount.