The Motives for Holding Cash is simple, the cash inflows and outflows are not well synchronized, and i.e. sometimes the cash inflows are more than the cash outflows while at other times the cash outflows could be more. Hence, the cash is held by the firms to meet the certain as well as uncertain situations. The firm’s need to hold cash may be attributed to the three motives. Let us discuss these motives in details:
The transaction motive
The precautionary motive
The speculative motive.
Transaction Motive: The transaction motive requires a firm to hold cash to conduct its business in the ordinary course and pay for operating activities like purchases, wages and salaries, other operating expenses, taxes, dividends, payments for utilities etc. The basic reason for holding cash is non-synchronization between cash inflows and cash outflows. Firms usually do not hold large amounts of cash, instead the cash is invested in market securities whose maturity corresponds with some anticipated payments. Transaction motive mainly refers to holding cash to meet anticipated payments whose timing is not perfectly matched with cash inflows.
Precautionary Motive: The precautionary motive is the need to hold cash to meet uncertainties and emergencies. The quantum of cash held for precautionary objective is influenced by the degree of predictability of cash flows. In case cash flows can be accurately estimated the cash held for precautionary motive would be fairly low. Another factor which influences the quantum of cash to be maintained for this motive is, the firm’s ability to borrow at short notice. Precautionary balances are usually kept in the form of cash and marketable securities. The cash kept for precautionary motive does not earn any return, therefore, the firms should invest this cash in highly liquid and low risk marketable securities in order to earn some returns.
Speculative Motive: The speculative motive refers to holding of cash for investing in profit making opportunities as and when they arise. These kinds of opportunities are usually prevalent in businesses where the prices are volatile and sensitive to changes in the demand and supply conditions.
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