Explain the main models that are used to estimate an optimal cash balance for a company

A firm must maintain enough liquidity by managing minimum money balance. Firm required money to pay suppliers of raw materials, pay salaries and alternative expenses still as paying interest, tax and dividends. enough liquidity suggests that the supply of money to pay the firm obligations in time. Generally, the minimum money balance is adequate to the money required for group action and safety money which will be maintained supported firm’s past expertise. Maintenance of money balance provides enough liquidity however involve cost (loss of interest), whereas less money balance maintenance weakens liquidity and involves profitableness. A firm must maintain optimum money balance. best money balance is that money balance wherever the firm’s value|cost} equals to group action value and therefore the total cost square measure minimum. Then a way to confirm optimum money balance?
Optimum money balance is determined by variety of mathematical models. however here the foremost necessary 2 models square measure mentioned. They are:
1. Baumol Model (Inventory Model)
2. Miller and Orr Model (Statistical Model)
Baumol Model
This model was developed by Baumol. This model is appropriate only if the price flows square measure predictable (under certainty). It considers optimum money balance almost like the economic order amount, since it's supported EOQ thought and conjointly in each the cases there's trade off between value of borrowing (sale of securities cost) and chance the price. the purpose wherever the whole value is minimum. Figure 13.1 shows Baumol model.
Assumptions: Baumol model is predicated on the following:
1. The firm is aware of its money wants with certainty.
2. The money payments (disbursement) of the firm occur uniformly over a amount of your time and is understood with certainty.
3. the chance value of holding money is understood and it remains stable over time.
4. The group action value is understood and remains stable.

Miller and Orr Model
The Miller and Orr model is really a shot to create Baumol model a lot of elastic with regards to the pattern of periodic changes in money balances. Baumol’s model is predicated on the idea that uniform and sure level of money balances. however in follow corporations don't use uniform money balances nor square measure they able to predict daily money inflows and outflows. The Miller Orr Model overcomes the constraints of Baumol model. It’s increased on the Baumol Model and came out of a applied math model. that's helpful for the corporations with unsure money flows. The Miller and Orr model provides 2 management limits—the higher management limit and therefore the lower management limit together with a come back purpose. the subsequent Figure thirteen.2 shows a pair of} management limits and come back purpose.
According to this model, money balance fluctuates between LCL and UCL. Whenever, money balance touches UCL then the firm purchases enough (UCL – RP) marketable securities to require bank money balance to come back purpose. On the opposite hand once the firm touches the lower management limit, it'll sell the marketable securities to the extent of (RP – LCL), take back money balance to come back purpose.
The money balance at the lower management limit (LCL) is ready by the firm as per demand of maintaining minimum money balance. The money balances at higher management limit (UCL) and record points are going to be determined on the idea of the group action value (C), the rate of interest (O) and variance (?) of web money flows.