Question

1) Near the top of the page the word "safety" was used. How is that meant to be interpreted?

firm—cash, marketable securities, accounts receivable, and inventory. In managing cash and marketable securities, the primary concern should be for safety and liquidity—with secondary attention placed on maximizing profitability. As we move to accounts receivable and inventory, a stiffer profitability test must be met. The investment level should not be a result of happenstance or historical determination but must meet the same return-on-investment criteria applied to any decision. We may need to choose between a 20 percent increase in inventory and a new plant location or a major research program. We shall examine the decision techniques that are applied to the various forms of current assets.

2)what does this mean? "The second major reason for holding cash results from the practice of holding balances to compensate a bank for services provided rather than paying directly for those services."

There are several reasons for holding cash: for transactions balances, for compensating balances for banks, and for precautionary needs. The transactions motive involves the use of cash to pay for planned corporate expenses such as supplies, payrolls, and taxes, but also can include planned acquisitions of long-term fixed assets. The second major reason for holding cash results from the practice of holding balances to compensate a bank for services provided rather than paying directly for those services.

3) Precautionary cash balances are primarily used for what?

Holding cash for precautionary motives assumes management wants cash for emergency purposes when cash inflows are less than projected. Precautionary cash balances are more likely to be important in seasonal or cyclical industries where cash inflows are more uncertain. Firms with precautionary needs usually rely on untapped lines of bank credit. For most firms, the primary motive for holding cash is the transactions motive.

Answer 1

  The word Safety should be interpreted as if the manager of firm or funds primarily focuses more on the safety of capital involved in the transactions of account receivable etc where in more weight is given on the scrutiny of the person to whom the goods are given in credit and account receivables  are created then to increase in sales by giving more goods on credit and doing this the manager tries to avoid risk of debtors default, moreover in case of marketable securities the investments are made in those assets which are risk free or which have higher returns but have less standard deviation .

A firm generally has to hold cash balances to compensate its banker for the services provided. their are many different services provided by bank to a firm   which involves payment of funds upfront and on the spot which are not scheduled to happen and are contingent in nature e.g. ( you have discounted a bill with a bank now the bill has been dishonored in that case the bank will hold you for payment of bill in that case you need have cash balances inn holding to compensate your banker) thus their are many other services which . thus this becomes second major reason for holding reason for holding cash.

Firms hold cash to meet uncertainties, emergencies, running out of cash and fluctuations in cash balances. The holding of cash on these reasons are on precaution. The future cashflows and the ability to borrow additional funds at short notice are often uncertain. Sometimes, uncertainty can result in prolongation or disruption of operating cycle. This requires to carry additional cash balances as a precautionary motive.