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Factors Affecting Cash Requirements

A firm must have so much cash balance, that daily requirements and unexpected demands can be met out. The factors affecting cash requirements and their effect on cash management are as follows:

1. Credit Position of Firm
2. Relation With Banks
3. Terms of Purchase and Sale
4. Nature of Demand of Goods
5. Inventory Policy
6. Production Process
7. Collection Period of Receivables
8. Management Policy
9. Matching of Cash Inflows and Outflows

Credit Position of Firm

Firms with good and sound credit standing and goodwill need not maintain separate cash for unforeseen situations, as cash is available to such firms whenever needed. They can get liberal credit facilities to purchase necessary materials. On the contrary, firms with bad credit positions shall have to maintain a high level of cash balance.

Relation With Banks

If a firm has good relations with banks, it can get the facility of cash credit and bank overdrafts resulting in less requirement of maintaining a cash balance.

Terms of Purchase and Sale

Terms of purchase and sale also affect the level of cash balance. If a firm has facilities to buy material on credit terms but sells its products on cash, it can operate its business affairs with a little cash balance.

On the other hand, if the firm makes purchases on a cash basis but sells its products to customers on credit terms, a larger cash balance will have to be maintained.

Nature of Demand of Goods

If there is a steady demand for products in the market i.e. products of day-to-day requirement (necessary items) and the product is sold for cash or for a short credit period, the firm will need a low level of cash. On the contrary, firms engaged in the production of luxury items have to maintain a high level of cash.

Inventory Policy

If a high level of inventory is maintained by the firm, a large amount is required for this, while if a firm follows just in the time inventory system, it does need not to maintain large cash funds.

Production Process

The longer the production process, the higher the requirement for a cash balance but if the production process is short, the need of maintaining a cash balance will be low.

Collection Period of Receivables

If, in a firm, the speed of collection of accounts receivable is quick, the cash will be available at all times, bad debts will be lower and, the firm is not required to carry a large cash balance. However, if the collection period is large, a high balance will have to be maintained.

Management Policy

The cash balance held by a firm also depends upon management policies and attitude towards liquidity preference, risk-bearing capacity, sales and purchases policy, the quantity of investment and inventory, etc. If the owners and managers of the firm want strict plans of cash management, it can work with a lower cash balance otherwise high balance will be required.

Matching of Cash Inflows and Outflows

The extent of non-synchronization between cash inflow and outflow determines the requirement of cash. The higher the degree of variance between cash collection and disbursement, the higher will be the requirement for cash and vice versa.

FAQs About the Factors Affecting Cash Requirements