How to determine the target cash balance?

The target cash balance involves a trade-off between the opportunity costs of holding too much cash and the trading costs of holding too little. If a firm tries to keep its cash holdings too low, it will find itself selling marketable securities (and perhaps later buying marketable securities to replace those sold) more frequently than if the cash balance were higher. Thus, trading costs will tend to fall as the cash balance becomes larger. In contrast, the opportunity costs of holding cash rise as the cash holdings rise.  So the target or optimal cash balance is at the point where the sum of both costs is at a minimum.