Caracterización general

The two main theories or models that explain the relationship between cash management and growth of businesses are the Baumol-Allouis-Tobin (BAT) model and the Miller Orr Model (Mauchi, et al., 2011:1302).

The BAT model of demand for cash based on the micro-economic theory of an optimal enterprise inventory was formulated by Baumol-Allouis-Tobin in 1952. The BAT model explains the principles of establishing cash balances by the market participants to maintain an undisturbed process of consumption. The BAT model contradicts commonly accepted approaches which stipulate that minimum cash balances should be more or less stable parts of currently consumed incomes (Pollok, 2003:61, Mauchi, et al., 2011:1302).

In addition, Pollok (2003:61) stated that the BAT model is based on assets similar to money in terms of their properties, earning interest as their income and that carry a relatively small risk. In the BAT model, it is acknowledged that keeping cash balances involved certain economic costs, as is the case with any other choice made by the market participants. Hence, it is a natural tendency of all businesses that are guided by rational premises either to bring those costs to a minimum or, alternatively, to maximise total utility derived from the interest earned.

It is further noted in the BAT model that the search is for a cash balance level that would minimise the total cost of its maintenance. Baumol-Allouis-Tobin refers to this as optimisation criterion. Hence the BAT model of the demand for cash is based on the principle of minimising economic costs by the businesses participating in the market.

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Baumol-Allouis-Tobin assumed a priori, to free himself from the prudent and speculative motive of maintaining cash balances by some businesses that all market transactions are perfectly predictable, and all expenditure is uniformly distributed in time, which means that the same volume of expenditure is allocated to the same time unit (Mauchi, et al., 2011:1302).

Apart from the above provisions, the BAT model also assumes uniformity of interest rates in the scale of the whole economy. This means that in a particular market, interest rates for deposits, regardless of their characteristics, are the same as for loans. An additional oversimplified assumption of the BAT model is a static economy. In other words, the BAT model completely neglects the problem of money changing its value over time and the consequences of the impact of the monetary factor represented by changing prices within the economy (Pollok, 2003:62). In addition, the BAT model asserts that businesses should keep the optimal amount of assets that can be liquidated whenever the business requires cash for running its operations. The level of assets held should maximise interest received on marketable securities while minimising the cost of selling marketable securities with the overall effect being the increase in profitability that is one of the major indicators of business growth. Thus the theory assumes that businesses that keep more liquid assets will jeopardise their growth as they will forego interest, while maintaining that businesses should not keep too low a cash balance to risk running out of liquidity (Mauchi, et al. 2011:1303).

Despite the model’s importance, it has been criticised for being unrealistic as it assumes regular cash flows while in actual business operations cash flows tend to be stochastic or irregular which makes its planning and application difficult (Alvarez & Lippi, 2009:363). Another criticism of the BAT model is the unrealistic assumption of a static economy where it assumes that cash held at certain point in time does not lose value due to inflation (Pollok, 2003:62).

The second cash management model is the one propounded by Miller and Orr known as the Miller-Orr model, a stochastic model that aims at determining the amount of marketable assets to be sold or purchased whenever there is need for cash (Mauchi, et

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al., 2011:1303). In addition, Mauchi, et al. (2011:1303) stated that the Miller-Orr model is based on the real life assumption that cash use is random rather than the regularity assumption of the BAT model. Furthermore, Mauchi, et al., (2011:1303) pointed out that the Miller-Orr model suggests that a business sells marketable securities when a specified lower limit of cash is reached. Marketable securities are purchased when the specified upper limit of cash is reached as it becomes necessary to reduce cash. When there is no attempt to manage cash balances clearly, the cash balance is likely to meander upwards or downwards.

The Miller–Orr model imposes limits to this meandering by determining that if the cash balances reach an upper limit, the business buys sufficient assets to return the cash balance to a normal level (called the return point), while if the cash balance reaches a lower limit, the business sells securities to bring the balance back to the return point. Thus, unlike the BAT model, the number of transactions per period is a random variable that varies from period to period depending on the pattern of cash inflows and outflows (Waweru, 2011b:132).

The implications of the Miller-Orr model in relation to business growth are that business managers must fulfil four conditions namely, to set the lower limit for the cash balance, to estimate the standard deviation of daily cash flows, to determine the interest rates and to estimate the trading costs of buying and selling marketable assets. The model further implies that businesses that allow their cash balances to reach levels in excess of the maximum level hold too much cash and are likely to lose profitability that would otherwise be gained from investment of additional cash balances. However businesses that maintain cash balances below the minimum level, run the risk of not having enough liquidity to sustain their operations (Uwonda, et al., 2013:69).

The other two important theories that link cash management and business growth are the pecking order and agency theories (Palombini & Nakamura, 2012:59). In their elaboration, Palombini and Nakamura (2012:59) stated that the pecking order theory takes into consideration the information asymmetry that suggests that managers know more about the value of their company than potential investors. They argued that this

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information asymmetry affects the choice between internal and external financing in a way that businesses tend to rely more on internal funds, preferring to issue debt to equity when external financing needs arise.

Nakamura, Forte, Martin, Manoel, Da Costa, Castilho and Amaral (2007:76) complemented Palombini and Nakamura (2012:59), by stating that the pecking order theory is based on the assumption that cash resources generated internally do not have transaction costs, and issuing new bonds tends to signal positive information about the business, while issuing new shares, on the contrary, tends to signal negative information. In addition, Palombini and Nakamura (2012:60) and Nakamura, et al. (2007:76) elaborated that businesses do not pursue specific objectives regarding debt level as they use external funds only when internal funds are not sufficient.

It is further argued that external sources of funds are less desirable because this manager-investor information asymmetry implies that external sources of funds are under-priced in relation to the level of asymmetry. Therefore, to avoid both lack of resources and the need for external sources, businesses choose to keep reserves in cash or other forms of highly liquid assets. According to this point of view, external resources are sought when there is a cash shortage and debts are paid when there is an excess of cash. Therefore, the business chooses a more passive cash management policy, waiting to settle existent debts whenever further costs are not involved (Palombini & Nakamura, 2012:60). The implication however, is that this idle cash may slow down the growth of the business as it is not being utilised to generate profit through investment and business expansion (Uwuigbe, Uwalomwa & Egbide, 2012:50).

Finally, the agency theory assumes that a business can be considered the nexus of a set of contract relationships, both visible and invisible, among individuals, by which shareholders (principals) delegate everyday business decisions to managers (agents) who should use their specific knowledge and the resources of the business to maximise returns for the shareholders. In these contracts, or internal "rules of the game", shareholders specify the rights of each agent in the business, the performance criteria on which agents are evaluated, and the payoff functions they face (Palombini &

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Nakamura, 2012:60). In addition, Palombini and Nakamura (2012:60) argued that due to a non-rational, opportunistic behaviour of agents, the interests and decisions of managers are not always aligned to those of the shareholders, which causes agency costs or agency problems. The essence of agency problem is thus the separation of ownership and control (Armour, Hansmann & Kraakman, 2009:2).

It is further argued that due to limited control by business owners, managers with substantial free cash flow tend to feel encouraged to engage the business in unnecessary expenses. Free cash flow is defined as the excess of cash flow beyond the necessary to fund all projects with positive net present values, when discounted at the relevant cost of capital. In a business with a low level of monitoring or discipline over management actions, a high level of free cash flow may encourage managers to follow their own interests and undertake negative net present value capital projects rather than return cash to equity holders, which has a negative impact on the overall growth of the business (Palombini & Nakamura, 2012:60).

While the above models and theories (BAT, Miller-Orr model, Pecking Order Theory and Agency theory) laid a foundation for the relationship between cash management and the growth of businesses, little attention was given to the specific case of the relationship in informal business. In the following section, literature on the specific relationship between cash management components and the growth of informal businesses were therefore discussed.

4.3 RELATIONSHIPS BETWEEN CASH MANAGEMENT COMPONENTS AND THE