ICAI Notes- Unit 2: Management of Working Capital | Financial Management & Strategic Management for CA Intermediate PDF Download

 Page 1


 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.37 
UNIT - II  
TREASURY AND CASH MANAGEMENT 
7. TREASURY MANAGEMENT: MEANING 
In the wake of the competitive business environment resulting from the 
liberalization of the economy, there is a pressure to manage cash scientifically.  The 
demand for funds for expansions coupled with high interest rates, foreign exchange 
volatility and the growing volume of financial transactions have necessitated 
efficient management of money.  
Treasury management encompasses planning, organizing & controlling the funds 
& working capital of an enterprise in order to ensure best use of funds, maintain 
liquidity, reduce overall cost of funds and mitigating operational & financial risk. It 
involves the corporate handling of all financial matters, the generation of external 
and internal funds for business, the management of currencies and cash flows and 
the complex, strategies, policies and procedures of corporate finance. 
The treasury management mainly deals with:- 
? Working capital management; and  
? Financial risk management (It includes forex and interest rate management).  
The key goals of treasury management are:- 
? Maximize the return on the available cash; 
? Minimize interest cost on borrowings; 
? Mobilise as much cash as possible for corporate ventures for maximum 
returns; and   
? Effective dealing in forex, money and commodity markets to reduce risks 
arising because of fluctuating exchange rates, interest rates and prices which 
can in turn affect the profitability of the organization. 
 
 
@The Institute of Chartered Accountants of India
Page 2


 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.37 
UNIT - II  
TREASURY AND CASH MANAGEMENT 
7. TREASURY MANAGEMENT: MEANING 
In the wake of the competitive business environment resulting from the 
liberalization of the economy, there is a pressure to manage cash scientifically.  The 
demand for funds for expansions coupled with high interest rates, foreign exchange 
volatility and the growing volume of financial transactions have necessitated 
efficient management of money.  
Treasury management encompasses planning, organizing & controlling the funds 
& working capital of an enterprise in order to ensure best use of funds, maintain 
liquidity, reduce overall cost of funds and mitigating operational & financial risk. It 
involves the corporate handling of all financial matters, the generation of external 
and internal funds for business, the management of currencies and cash flows and 
the complex, strategies, policies and procedures of corporate finance. 
The treasury management mainly deals with:- 
? Working capital management; and  
? Financial risk management (It includes forex and interest rate management).  
The key goals of treasury management are:- 
? Maximize the return on the available cash; 
? Minimize interest cost on borrowings; 
? Mobilise as much cash as possible for corporate ventures for maximum 
returns; and   
? Effective dealing in forex, money and commodity markets to reduce risks 
arising because of fluctuating exchange rates, interest rates and prices which 
can in turn affect the profitability of the organization. 
 
 
@The Institute of Chartered Accountants of India
 
 
 
FINANCIAL MANAGEMENT 
 
9.38 
8. FUNCTIONS OF TREASURY DEPARTMENT 
The treasury department have evolved in importance over number of years from 
being responsible for only cash handling issues to technical areas revolving around 
hedging forex risks, composition of capital structure etc. The fundamental tasks for 
which treasury department of any enterprise is responsible are :-  
1. Cash Management: It involves efficient cash collection process and managing 
payment of cash both inside the organisation and to third parties.  
 There may be complete centralization within a group treasury or the treasury 
may simply advise subsidiaries and divisions on policy matter viz., 
collection/payment periods, discounts, etc.   
 Treasury will also manage surplus funds in an investment portfolio.  
Investment policy will consider future needs for liquid funds and acceptable 
levels of risk as determined by company policy.  
2. Currency Management: The treasury department manages the foreign 
currency risk exposure of the company. In a large multinational company 
(MNC) the first step will usually be to set off intra-group indebtedness.  The 
use of matching receipts and payments in the same currency will save 
transaction costs and also will save the organization from any unfavorable 
exchange movements.  Accordingly, Treasury might advise on the currency to 
be used when invoicing overseas sales. 
 The treasury will manage any net exchange exposures in accordance with 
company policy.  If risks are to be minimized then forward contracts can be 
used either to buy or sell currency forward. 
3. Fund Management: Treasury department is responsible for planning and 
sourcing the company’s short, medium and long-term cash needs. They also 
facilitate temporary investment of surplus funds by mapping the time gap 
between funds inflow and outflow. Treasury department will also participate 
in the decision on capital structure and forecast future interest and foreign 
currency rates. 
4. Banking: It is important that a company maintains a good relationship with its 
bankers.  Treasury department carry out negotiations with bankers with respect 
to interest rates, foreign exchange rates etc. and act as the initial point of contact 
with them.  Short-term finance can come in the form of bank loans or through 
the sale of commercial paper in the money market. 
@The Institute of Chartered Accountants of India
Page 3


 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.37 
UNIT - II  
TREASURY AND CASH MANAGEMENT 
7. TREASURY MANAGEMENT: MEANING 
In the wake of the competitive business environment resulting from the 
liberalization of the economy, there is a pressure to manage cash scientifically.  The 
demand for funds for expansions coupled with high interest rates, foreign exchange 
volatility and the growing volume of financial transactions have necessitated 
efficient management of money.  
Treasury management encompasses planning, organizing & controlling the funds 
& working capital of an enterprise in order to ensure best use of funds, maintain 
liquidity, reduce overall cost of funds and mitigating operational & financial risk. It 
involves the corporate handling of all financial matters, the generation of external 
and internal funds for business, the management of currencies and cash flows and 
the complex, strategies, policies and procedures of corporate finance. 
The treasury management mainly deals with:- 
? Working capital management; and  
? Financial risk management (It includes forex and interest rate management).  
The key goals of treasury management are:- 
? Maximize the return on the available cash; 
? Minimize interest cost on borrowings; 
? Mobilise as much cash as possible for corporate ventures for maximum 
returns; and   
? Effective dealing in forex, money and commodity markets to reduce risks 
arising because of fluctuating exchange rates, interest rates and prices which 
can in turn affect the profitability of the organization. 
 
 
@The Institute of Chartered Accountants of India
 
 
 
FINANCIAL MANAGEMENT 
 
9.38 
8. FUNCTIONS OF TREASURY DEPARTMENT 
The treasury department have evolved in importance over number of years from 
being responsible for only cash handling issues to technical areas revolving around 
hedging forex risks, composition of capital structure etc. The fundamental tasks for 
which treasury department of any enterprise is responsible are :-  
1. Cash Management: It involves efficient cash collection process and managing 
payment of cash both inside the organisation and to third parties.  
 There may be complete centralization within a group treasury or the treasury 
may simply advise subsidiaries and divisions on policy matter viz., 
collection/payment periods, discounts, etc.   
 Treasury will also manage surplus funds in an investment portfolio.  
Investment policy will consider future needs for liquid funds and acceptable 
levels of risk as determined by company policy.  
2. Currency Management: The treasury department manages the foreign 
currency risk exposure of the company. In a large multinational company 
(MNC) the first step will usually be to set off intra-group indebtedness.  The 
use of matching receipts and payments in the same currency will save 
transaction costs and also will save the organization from any unfavorable 
exchange movements.  Accordingly, Treasury might advise on the currency to 
be used when invoicing overseas sales. 
 The treasury will manage any net exchange exposures in accordance with 
company policy.  If risks are to be minimized then forward contracts can be 
used either to buy or sell currency forward. 
3. Fund Management: Treasury department is responsible for planning and 
sourcing the company’s short, medium and long-term cash needs. They also 
facilitate temporary investment of surplus funds by mapping the time gap 
between funds inflow and outflow. Treasury department will also participate 
in the decision on capital structure and forecast future interest and foreign 
currency rates. 
4. Banking: It is important that a company maintains a good relationship with its 
bankers.  Treasury department carry out negotiations with bankers with respect 
to interest rates, foreign exchange rates etc. and act as the initial point of contact 
with them.  Short-term finance can come in the form of bank loans or through 
the sale of commercial paper in the money market. 
@The Institute of Chartered Accountants of India
 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.39 
5. Corporate Finance: Treasury department is involved with both acquisition and 
divestment activities within the group.  In addition, it will often have 
responsibility for investor relations.  The latter activity has assumed increased 
importance in markets where share-price performance is regarded as crucial and 
may affect the company’s ability to undertake acquisition activity or, if the price 
falls drastically, render it vulnerable to a hostile bid.  
9. MANAGEMENT OF CASH 
Management of cash is an important function of the finance manager.  It is 
concerned with the managing of: 
(i)  Cash flows into and out of the firm;  
(ii)  Cash flows within the firm; and  
(iii)  Cash balances held by the firm at a point of time by financing deficit or 
investing surplus cash. 
The main objectives of cash management for a business are:- 
? Provide adequate cash to each of its units as per requirements; 
? No funds are blocked in idle cash; and  
? The surplus cash (if any) should be invested in order to maximize returns for 
the business.    
A cash management scheme therefore, is a delicate balance between the twin 
objectives of liquidity and costs.  
9.1 The Need for Cash 
The following are three basic considerations in determining the amount of cash or 
liquidity as have been outlined by Lord Keynes, a British Economist: 
? Transaction need:  Cash facilitates the meeting of the day-to-day expenses and 
other debt payments.  Normally, inflows of cash from operations should be 
sufficient for this purpose.  But sometimes this inflow may be temporarily 
blocked.  In such cases, it is only the reserve cash balance that can enable the 
firm to make its payments in time.  
@The Institute of Chartered Accountants of India
Page 4


 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.37 
UNIT - II  
TREASURY AND CASH MANAGEMENT 
7. TREASURY MANAGEMENT: MEANING 
In the wake of the competitive business environment resulting from the 
liberalization of the economy, there is a pressure to manage cash scientifically.  The 
demand for funds for expansions coupled with high interest rates, foreign exchange 
volatility and the growing volume of financial transactions have necessitated 
efficient management of money.  
Treasury management encompasses planning, organizing & controlling the funds 
& working capital of an enterprise in order to ensure best use of funds, maintain 
liquidity, reduce overall cost of funds and mitigating operational & financial risk. It 
involves the corporate handling of all financial matters, the generation of external 
and internal funds for business, the management of currencies and cash flows and 
the complex, strategies, policies and procedures of corporate finance. 
The treasury management mainly deals with:- 
? Working capital management; and  
? Financial risk management (It includes forex and interest rate management).  
The key goals of treasury management are:- 
? Maximize the return on the available cash; 
? Minimize interest cost on borrowings; 
? Mobilise as much cash as possible for corporate ventures for maximum 
returns; and   
? Effective dealing in forex, money and commodity markets to reduce risks 
arising because of fluctuating exchange rates, interest rates and prices which 
can in turn affect the profitability of the organization. 
 
 
@The Institute of Chartered Accountants of India
 
 
 
FINANCIAL MANAGEMENT 
 
9.38 
8. FUNCTIONS OF TREASURY DEPARTMENT 
The treasury department have evolved in importance over number of years from 
being responsible for only cash handling issues to technical areas revolving around 
hedging forex risks, composition of capital structure etc. The fundamental tasks for 
which treasury department of any enterprise is responsible are :-  
1. Cash Management: It involves efficient cash collection process and managing 
payment of cash both inside the organisation and to third parties.  
 There may be complete centralization within a group treasury or the treasury 
may simply advise subsidiaries and divisions on policy matter viz., 
collection/payment periods, discounts, etc.   
 Treasury will also manage surplus funds in an investment portfolio.  
Investment policy will consider future needs for liquid funds and acceptable 
levels of risk as determined by company policy.  
2. Currency Management: The treasury department manages the foreign 
currency risk exposure of the company. In a large multinational company 
(MNC) the first step will usually be to set off intra-group indebtedness.  The 
use of matching receipts and payments in the same currency will save 
transaction costs and also will save the organization from any unfavorable 
exchange movements.  Accordingly, Treasury might advise on the currency to 
be used when invoicing overseas sales. 
 The treasury will manage any net exchange exposures in accordance with 
company policy.  If risks are to be minimized then forward contracts can be 
used either to buy or sell currency forward. 
3. Fund Management: Treasury department is responsible for planning and 
sourcing the company’s short, medium and long-term cash needs. They also 
facilitate temporary investment of surplus funds by mapping the time gap 
between funds inflow and outflow. Treasury department will also participate 
in the decision on capital structure and forecast future interest and foreign 
currency rates. 
4. Banking: It is important that a company maintains a good relationship with its 
bankers.  Treasury department carry out negotiations with bankers with respect 
to interest rates, foreign exchange rates etc. and act as the initial point of contact 
with them.  Short-term finance can come in the form of bank loans or through 
the sale of commercial paper in the money market. 
@The Institute of Chartered Accountants of India
 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.39 
5. Corporate Finance: Treasury department is involved with both acquisition and 
divestment activities within the group.  In addition, it will often have 
responsibility for investor relations.  The latter activity has assumed increased 
importance in markets where share-price performance is regarded as crucial and 
may affect the company’s ability to undertake acquisition activity or, if the price 
falls drastically, render it vulnerable to a hostile bid.  
9. MANAGEMENT OF CASH 
Management of cash is an important function of the finance manager.  It is 
concerned with the managing of: 
(i)  Cash flows into and out of the firm;  
(ii)  Cash flows within the firm; and  
(iii)  Cash balances held by the firm at a point of time by financing deficit or 
investing surplus cash. 
The main objectives of cash management for a business are:- 
? Provide adequate cash to each of its units as per requirements; 
? No funds are blocked in idle cash; and  
? The surplus cash (if any) should be invested in order to maximize returns for 
the business.    
A cash management scheme therefore, is a delicate balance between the twin 
objectives of liquidity and costs.  
9.1 The Need for Cash 
The following are three basic considerations in determining the amount of cash or 
liquidity as have been outlined by Lord Keynes, a British Economist: 
? Transaction need:  Cash facilitates the meeting of the day-to-day expenses and 
other debt payments.  Normally, inflows of cash from operations should be 
sufficient for this purpose.  But sometimes this inflow may be temporarily 
blocked.  In such cases, it is only the reserve cash balance that can enable the 
firm to make its payments in time.  
@The Institute of Chartered Accountants of India
 
 
 
FINANCIAL MANAGEMENT 
 
9.40 
? Speculative needs: Cash may be held in order to take advantage of profitable 
opportunities that may present themselves and which may be lost for want of 
ready cash/settlement. 
? Precautionary needs:  Cash may be held to act as for providing safety against 
unexpected events.  Safety as is explained by the saying that a man has only 
three friends an old wife, an old dog and money at bank. 
9.2 Cash Planning 
Cash Planning is a technique to plan and control the use of cash.  This protects the 
financial conditions of the firm by developing a projected cash statement from a 
forecast of expected cash inflows and outflows for a given period.  This may be 
done periodically either on daily, weekly or monthly basis.  The period and 
frequency of cash planning generally depends upon the size of the firm and 
philosophy of the management.  As firms grows and business operations become 
complex, cash planning becomes inevitable for continuing success. 
The very first step in this direction is to estimate the requirement of cash.  For this 
purpose, cash flow statements and cash budget are required to be prepared.  The 
technique of preparing cash flow and funds flow statements have been discussed 
in Accounting paper at Intermediate level of CA course.  The preparation of cash 
budget has however, been demonstrated here. 
9.3 Cash Budget 
Cash Budget is the most significant device to plan for and control cash receipts and 
payments.  This represents cash requirements of business during the budget period.   
The various purposes of cash budgets are:- 
? Coordinate the timings of cash needs. It identifies the period(s) when there 
might either be a shortage of cash or an abnormally large cash requirement; 
? It also helps to pinpoint period(s) when there is likely to be excess cash; 
? It enables firm which has sufficient cash to take advantage like cash discounts 
on its accounts payable; and 
? Lastly it helps to plan/arrange adequately needed funds (avoiding 
excess/shortage of cash) on favorable terms.  
@The Institute of Chartered Accountants of India
Page 5


 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.37 
UNIT - II  
TREASURY AND CASH MANAGEMENT 
7. TREASURY MANAGEMENT: MEANING 
In the wake of the competitive business environment resulting from the 
liberalization of the economy, there is a pressure to manage cash scientifically.  The 
demand for funds for expansions coupled with high interest rates, foreign exchange 
volatility and the growing volume of financial transactions have necessitated 
efficient management of money.  
Treasury management encompasses planning, organizing & controlling the funds 
& working capital of an enterprise in order to ensure best use of funds, maintain 
liquidity, reduce overall cost of funds and mitigating operational & financial risk. It 
involves the corporate handling of all financial matters, the generation of external 
and internal funds for business, the management of currencies and cash flows and 
the complex, strategies, policies and procedures of corporate finance. 
The treasury management mainly deals with:- 
? Working capital management; and  
? Financial risk management (It includes forex and interest rate management).  
The key goals of treasury management are:- 
? Maximize the return on the available cash; 
? Minimize interest cost on borrowings; 
? Mobilise as much cash as possible for corporate ventures for maximum 
returns; and   
? Effective dealing in forex, money and commodity markets to reduce risks 
arising because of fluctuating exchange rates, interest rates and prices which 
can in turn affect the profitability of the organization. 
 
 
@The Institute of Chartered Accountants of India
 
 
 
FINANCIAL MANAGEMENT 
 
9.38 
8. FUNCTIONS OF TREASURY DEPARTMENT 
The treasury department have evolved in importance over number of years from 
being responsible for only cash handling issues to technical areas revolving around 
hedging forex risks, composition of capital structure etc. The fundamental tasks for 
which treasury department of any enterprise is responsible are :-  
1. Cash Management: It involves efficient cash collection process and managing 
payment of cash both inside the organisation and to third parties.  
 There may be complete centralization within a group treasury or the treasury 
may simply advise subsidiaries and divisions on policy matter viz., 
collection/payment periods, discounts, etc.   
 Treasury will also manage surplus funds in an investment portfolio.  
Investment policy will consider future needs for liquid funds and acceptable 
levels of risk as determined by company policy.  
2. Currency Management: The treasury department manages the foreign 
currency risk exposure of the company. In a large multinational company 
(MNC) the first step will usually be to set off intra-group indebtedness.  The 
use of matching receipts and payments in the same currency will save 
transaction costs and also will save the organization from any unfavorable 
exchange movements.  Accordingly, Treasury might advise on the currency to 
be used when invoicing overseas sales. 
 The treasury will manage any net exchange exposures in accordance with 
company policy.  If risks are to be minimized then forward contracts can be 
used either to buy or sell currency forward. 
3. Fund Management: Treasury department is responsible for planning and 
sourcing the company’s short, medium and long-term cash needs. They also 
facilitate temporary investment of surplus funds by mapping the time gap 
between funds inflow and outflow. Treasury department will also participate 
in the decision on capital structure and forecast future interest and foreign 
currency rates. 
4. Banking: It is important that a company maintains a good relationship with its 
bankers.  Treasury department carry out negotiations with bankers with respect 
to interest rates, foreign exchange rates etc. and act as the initial point of contact 
with them.  Short-term finance can come in the form of bank loans or through 
the sale of commercial paper in the money market. 
@The Institute of Chartered Accountants of India
 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.39 
5. Corporate Finance: Treasury department is involved with both acquisition and 
divestment activities within the group.  In addition, it will often have 
responsibility for investor relations.  The latter activity has assumed increased 
importance in markets where share-price performance is regarded as crucial and 
may affect the company’s ability to undertake acquisition activity or, if the price 
falls drastically, render it vulnerable to a hostile bid.  
9. MANAGEMENT OF CASH 
Management of cash is an important function of the finance manager.  It is 
concerned with the managing of: 
(i)  Cash flows into and out of the firm;  
(ii)  Cash flows within the firm; and  
(iii)  Cash balances held by the firm at a point of time by financing deficit or 
investing surplus cash. 
The main objectives of cash management for a business are:- 
? Provide adequate cash to each of its units as per requirements; 
? No funds are blocked in idle cash; and  
? The surplus cash (if any) should be invested in order to maximize returns for 
the business.    
A cash management scheme therefore, is a delicate balance between the twin 
objectives of liquidity and costs.  
9.1 The Need for Cash 
The following are three basic considerations in determining the amount of cash or 
liquidity as have been outlined by Lord Keynes, a British Economist: 
? Transaction need:  Cash facilitates the meeting of the day-to-day expenses and 
other debt payments.  Normally, inflows of cash from operations should be 
sufficient for this purpose.  But sometimes this inflow may be temporarily 
blocked.  In such cases, it is only the reserve cash balance that can enable the 
firm to make its payments in time.  
@The Institute of Chartered Accountants of India
 
 
 
FINANCIAL MANAGEMENT 
 
9.40 
? Speculative needs: Cash may be held in order to take advantage of profitable 
opportunities that may present themselves and which may be lost for want of 
ready cash/settlement. 
? Precautionary needs:  Cash may be held to act as for providing safety against 
unexpected events.  Safety as is explained by the saying that a man has only 
three friends an old wife, an old dog and money at bank. 
9.2 Cash Planning 
Cash Planning is a technique to plan and control the use of cash.  This protects the 
financial conditions of the firm by developing a projected cash statement from a 
forecast of expected cash inflows and outflows for a given period.  This may be 
done periodically either on daily, weekly or monthly basis.  The period and 
frequency of cash planning generally depends upon the size of the firm and 
philosophy of the management.  As firms grows and business operations become 
complex, cash planning becomes inevitable for continuing success. 
The very first step in this direction is to estimate the requirement of cash.  For this 
purpose, cash flow statements and cash budget are required to be prepared.  The 
technique of preparing cash flow and funds flow statements have been discussed 
in Accounting paper at Intermediate level of CA course.  The preparation of cash 
budget has however, been demonstrated here. 
9.3 Cash Budget 
Cash Budget is the most significant device to plan for and control cash receipts and 
payments.  This represents cash requirements of business during the budget period.   
The various purposes of cash budgets are:- 
? Coordinate the timings of cash needs. It identifies the period(s) when there 
might either be a shortage of cash or an abnormally large cash requirement; 
? It also helps to pinpoint period(s) when there is likely to be excess cash; 
? It enables firm which has sufficient cash to take advantage like cash discounts 
on its accounts payable; and 
? Lastly it helps to plan/arrange adequately needed funds (avoiding 
excess/shortage of cash) on favorable terms.  
@The Institute of Chartered Accountants of India
 
 
MANAGEMENT OF WORKING CAPITAL 
 
    
 9.41 
On the basis of cash budget, the firm can decide to invest surplus cash in 
marketable securities and earn profits. On the contrary, any shortages can also be 
managed by making overdraft or credit arrangements with banks. 
Main Components of Cash Budget 
Preparation of cash budget involves the following steps:- 
(a) Selection of the period of time to be covered by the budget. It also defines 
the planning horizon. 
(b) Selection of factors that have a bearing on cash flows. The factors that 
generate cash flows are generally divided into following two categories:- 
(i) Operating (cash flows generated by operations of the firm); and 
(ii) Financial (cash flows generated by financial activities of the firm).  
The following figure highlights the cash surplus and cash shortage position over 
the period of cash budget for preplanning to take corrective and necessary steps. 
 
10. METHODS OF CASH FLOW BUDGETING 
A cash budget can be prepared in the following ways: 
1. Receipts and Payments Method: In this method all the expected receipts 
and payments for budget period are considered.  All the cash inflow and 
outflow of all functional budgets including capital expenditure budgets are 
considered.  Accruals and adjustments in accounts will not affect the cash 
@The Institute of Chartered Accountants of India