In addition to the non synchronization of anticipated cash inflows and outflows in the ordinary course of business, a firm may have to pay cash for purposes which cannot he predicted or anticipated. The unexpected cash needs at short notice may be the result of
• Floods, strikes and failure of important customers
• Bills may be presented for settlement earlier than expected,
• Unexpected slow down in collection of accounts receivable
• Cancellation of some order for goods as the customer is not satisfied and
• Sharp increase in cost of raw materials.
The cash balances held in reserve for such random and unforeseen fluctuations in cash flows are called as precautionary b:&lances. In other words. precautionary motive of holding cash implies the need to hold cash to meet unpredictable obligations. Thus, precautionary cash balance serves to provide a cushion to meet unexpected contingencies. The more unpredictable are the cash flows, the larger is the need for such balances. Another factor which has a bearing on the level of such cash balances is the availability of short-term credit. If a firm can borrow at short notice to pay for unforeseen obligations, it will need to maintain a relatively small balance and vice. Such cash balances are usually held in the form of marketable securities so that they earn a return.