12 Cash management models. The treasurer of a local government department is reviewing her cash management procedures. She plans to introduce the use of cash management models and has asked you to investigate their applicability to the department. The following information is available.

• The department has agreed with its bank that it will maintain a minimum daily cash balance of £15,000. Severe financial penalties will apply if this balance is not maintained.

• A forecast of daily cash movements for the next twelve months shows a standard deviation of daily cash flows of £3,000.

• The daily interest rate is at present 0.0236 per cent and this is not expected to change for the foreseeable future.

• The transaction cost for each sale or purchase is £25.

Assume you are a newly recruited accountant in the department.

Required:

Write a report to the treasurer which discusses:

(i) the advantages and disadvantages of cash management models over more traditional methods of cash forecasting, making specific reference to their applicability to a public sector organisation such as a local authority;

(ii) how one such model, the Miller—Orr, would operate in practice, using the information given above. Your report should include calculations of the upper and lower limits for cash balances and the return point. Assume a spread of

£26,820.

You do not need to calculate the spread as this is given above, but you should explain the terms used in the Miller-Orr model.