Motives Holding Cash Assignment Help | Motives Holding Cash Homework Help


It has been suggested that there are four primary motives for holding cash.
These are as follows:

1)    Transaction motive:

Business firm as well as individuals keep cash because they require it for meeting demand for cash flow arising out of day to day transactions. In order t meet the obligations for cash flows arising in the normal course of business , every firm has to maintain adequate cash balance. A firm may require cash for making for purchase of goods & services.
These cash outflows are met out of cash inflows arising out of cash sales or recovery from the debtors. Further, the cash inflows & outflows are not fully and exactly synchronized, a firm is always required to maintain a minimum cash balance with it. The necessity of keeping a minimum cash balance to meet payment obligations arising out of expected transactions, is known as Transactions motive for holding cash.

2)    Precautionary motive :

The precautionary motive for holding cash is based on the need to maintain sufficient cash to act as a cushion or buffer against unexpected events. A firm should maintain larger cash balance than required for day to day transactions in order to avoid any unforeseen situation arising because of insufficient cash. The necessity of keeping a cash balance to meet any emergency situation or unpredictable obligation, is known as precautionary motive for holding cash.

The amount of cash, a firm must hold for transaction & precautionary depends upon;
a)    Degree of predictability of its cash flows
b)    Its willingness and capacity to take risk of running hot of cash, and
c)    Available immediate borrowing powers.

3)    Speculative motive:

Cash may be held for speculative purpose in order to take advantage of potential profit making situations. A firm may come across an unexpected opportunity to make profit, which is not possible in normal business routine. The motive to keep balance for these purpose is obviously speculative in nature. The firm’s desire to keep some cash balance to capitalize an opportunity of making an unexpected profit is known as speculative motive. The speculative motive provide a firm with sufficient liquidity to take advantage of unexpected profitable opportunity that may suddenly appear ( and just suddenly disappear if not capitalize immediately.)

4)    Compensation motive:

 Commercial banks require that in every current account , there should always be a minimum cash balance. This minimum cash balance is generally not allowed by  the bank to used for transaction purpose and therefore , it becomes a sort of investment by the firm in the bank. In order to avail the convenience of holding a current account , the minimum cash balance must be maintained by the firm and this provides the compensation motive for holding cash.

Out of different motives, the transactions motive is the most obvious one and is found in every firm. Even the precautionary motive is common & a firm maintains cash balance both for the transactions motives & the precautionary motive. However , the speculative motive is a subjective one may differ from one firm to another. Generally, the speculative motive is the least important component for a firm’s preference for liquidity. The transaction & precautionary motives account for most of the reasons why affirm holds cash balance. The compensation motive may be a compulsion and the firm may not have many options. The cash held for transaction motive is necessary, the cash held for precautionary motive provides a margin of safety, but holding a cash does not generate any explicit monetary return, rather it involves a cost. The main cost of holding  cash is the loss of interest which the firm could otherwise earn by investment of cash elsewhere.

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