Other Factors Influencing the Target Cash Balance

Before moving on, we briefly discuss two additional considerations that affect the target cash balance.

First, in our discussion of cash management, we assume that cash is invested in marketable securities such as Treasury bills. The firm obtains cash by selling these securities. Another alternative is to borrow cash. Borrowing introduces additional considerations to cash management:

1. Borrowing is likely to be more expensive than selling marketable securities because the interest rate is likely to be higher. 1. The need to borrow will depend on management's desire to hold low cash balances. A firm is more likely to have to borrow to cover an unexpected cash outflow the greater its cash flow variability and the lower its investment in marketable securities.

Second, for large firms, the trading costs of buying and selling securities are very small when compared to the opportunity costs of holding cash. For example, suppose a firm has $1 million in cash that won't be needed for 14 hours. Should the firm invest the money or leave it sitting?

Suppose the firm can invest the money at an annualized rate of 7.57 percent per year. The daily rate in this case is about two basis points (.01 percent or .0002).3 The daily return earned on $1 million is thus .0001 X $1 million = $100. In many cases, the order cost will be much less than this; so a large firm will buy and sell securities very often before it will leave substantial amounts of cash idle.

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