Answer to Question #196295 in Accounting for jamila

Question

The COO (chief operating officer) of a company emphasized that any surplus amount of cash must be used to pay off previously borrowed money. In contrast, the CMO (chief marketing officer) argued that doing such would not fulfil our minimum cash balance target at the end of each month/quarter. Do you agree with CMO? Why or why not? What will be the optimum solution?

Answer 1

Solution:

A cash surplus refers to the cash that exceeds the cash required for day-to-day operations.

I do not agree with the CMO that utilizing cash surplus would not fulfil the minimum cash balance target at the end of each month or quarter. This is because the cash surplus is over and above the minimum cash balance kept on hand to offset any unplanned cash outflows. Since this is the excess cash over the minimum cash balance target, it can therefore, be utilized to clear some of the pending debt which are eating on the company profits due to the debt interests charged.

The optimum solution is minimizing the sum of fixed cost of transactions and the opportunity cost of holding cash balance so as to have an optimal balance.

Optimal balance means a position where the cash balance is on the most ideal proportion so that the company has the ability to invest the excess cash for a return and at the same have sufficient cash or liquidity for future needs.