Cash is known as most liquid and less productive assets of a firm. If cash remains idle, earns nothing but involves cost in terms of interest payable to finance it. Although cash is least productive current assets, firm should hold certain amount of cash for marketable securities. Mainly, there are three motives for holding cash.
Transaction motive refers to the need to hold cash to satisfy normal disbursement collection activities associated with a firm's ongoing operation. Transaction means the act of giving and taking of cash or kinds in the ordinary course of business. A firm frequently involves in purchase and sales of goods or services. A firm should make payment in terms of 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.
1. Transaction Motive Of Holding Cash
Transaction motive refers to the need to hold cash to satisfy normal disbursement collection activities associated with a firm's ongoing operation. Transaction means the act of giving and taking of cash or kinds in the ordinary course of business. A firm frequently involves in purchase and sales of goods or services. A firm should make payment in terms of 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.
2. Precautionary Motive Of Holding Cash
Precautionary motive refers to hold cash as a safety margin to act as a financial reserve. A firm should hold some cash for the payment of unpredictable or unanticipated events. A firm may have to face emergencies such as 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.
3. Speculative Motive Of Holding Cash
The speculative motive refers to the need to hold cash in order to be able to take advantage of bargain purchases that might arise, attractive interest rates and favorable exchange rate fluctuations. Some firms hold cash in excess than transaction and precautionary needs to involve in speculation. Speculative needs for holding cash require that a firm possibly may have some profitable opportunities to exploit, which are out of the normal course of business. These opportunities arise in conditions, when price of raw material is expected to fall, when interest rate on borrowed funds are expected to decline and purchase of inventory occurs at reduced price on immediate cash payment.