Question

Explain/Discuss the following concepts:

- Three specific motives to hold money instead of non-monetary financial assets

Answer 1

Motives For Holding Money

Cash is known as most liquid and less productive assets of a firm. If cash remains idle, earns nothing but involves cost in terms of interest payable to finance it. Although cash is least productive current assets, firm should hold certain amount of cash for marketable securities. Mainly, there are three motives for holding cash.

1) Transaction Motive Of Holding Cash

Transaction motive refers to the need to hold cash to satisfy normal disbursement collection activities associated with a firm's ongoing operation. Transaction means the act of giving and taking of cash or kinds in the ordinary course of business. A firm frequently involves in purchase and sales of goods or services. A firm should make payment in terms of cash for the purchase of goods, payment of salary, wages, rent, interest, tax, insurance, dividend and so on. A firm also receives cash in terms of sales revenue, interest on loan, return on investments made outside the firm and so on. If these receipts and payments were perfectly synchronized, a firm would not have to hold cash for transaction motive.

2) Precautionary Motive Of Holding Cash

Precautionary motive refers to hold cash as a safety margin to act as a financial reserve. A firm should hold some cash for the payment of unpredictable or unanticipated events. A firm may have to face emergencies such as strikes and lock-up from employees, increase in cost of raw materials, funds and labor, fall in market demand and so on. These emergencies also bound a firm to hold certain level of cash.

3) Speculative Motive Of Holding Cash

The speculative motive refers to the need to hold cash in order to be able to take advantage of bargain purchases that might arise, attractive interest rates and favorable exchange rate fluctuations. Some firms hold cash in excess than transaction and precautionary needs to involve in speculation. Speculative needs for holding cash require that a firm possibly may have some profitable opportunities to exploit, which are out of the normal course of business.