Summary of Previous Lecture

We studied Overview of Working Capital Management and discussed the following topics;

• The two fundamental decision issues in working capital management -- and the trade-offs involved in making these decisions.

• Discuss how to determine the optimal level of current assets.

• Describe the relationship between profitability, liquidity, and risk in the management of working capital.

• Explain how to classify working capital according to its “components” and according to “time

• Describe the hedging (maturity matching) approach to financing and the advantages/disadvantages of short- versus long-term financing.

Chapter 9

Cash and Marketable Securities Management

Learning OutcomesAfter studying Chapter 9, you should be able to:• List and explain the motives for holding cash.• Understand the purpose of efficient cash management. • Describe methods for speeding up the collection of accounts

receivable and methods for controlling cash disbursements. • Differentiate between remote and controlled disbursement, • Discuss how electronic data interchange (EDI) and outsourcing

each relates to a company’s cash collections and disbursements.• Identify the key variables that should be considered before

purchasing any marketable securities. • Define the most common money-market instruments that a

marketable securities portfolio manager would consider for investment.

• Describe the three segments of the marketable securities portfolio and note which securities are most appropriate for each segment and why.

Cash and Marketable Securities Management

• Motives for Holding Cash• Speeding Up Cash Receipts• S-l-o-w-i-n-g D-o-w-n Cash Payouts• Electronic Commerce

Cash and Marketable Securities Management

• Outsourcing• Cash Balances to Maintain• Investment in Marketable

Securities

Motives for Holding CashTransactions Motive - to meet payments arising in the ordinary course of business such as purchases, wages, taxes, and dividends etc.

Speculative Motive - to take advantage of temporary opportunities such as sudden decline in the prices of raw material.

Precautionary Motive - to maintain a cushion or buffer to meet unexpected cash needs, the more predictable the cash flows of a firm, the lesser the cash required for precautionary motive.

Cash Management System

Collections Disbursements

Marketable securitiesinvestment

Control through information reporting

= Funds Flow = Information Flow

Speeding Up Cash Receipts

• Expedite preparing and mailing the invoices

• Accelerate the mailing of payments from customers

• Reduce the time during which payments received by the firm remain uncollected

Collections

Collection Float

Collection Float: total time between the mailing of the check by the customer and the availability of cash to the receiving firm.

ProcessingFloat

AvailabilityFloat

MailFloat

Deposit Float

Mail Float

Mail Float: time the check is in the mail.

Customer mails check

Firmreceives check

Processing Float

Processing Float: time it takes a companyto process the check internally.

Firmdeposits check

Firmreceives check

Availability Float

Availability Float: time consumed in clearingthe check through the banking system.

Firmdeposits check

Firm’s bankaccount credited

Deposit Float

Deposit Float: time during which the check received by the firm remains uncollected funds.

Processing Float Availability Float

Earlier Billing

Accelerate preparation and mailing of invoices as the payment habits of the customers differ, some would pay their bills on discount date and other on the final due date.

– computerized billing– invoices included with shipment– invoices are faxed– advance payment requests– preauthorized debits

Preauthorized Payments

Preauthorized debit Under this arrangement the funds are withdrawn directly from a bank account at predetermined intervals such as monthly. The transfer is initiated by the payee with the payer's advance authorization.The amount withdrawn can be fixed or fluctuate over time depending upon the agreement.

Lockbox Systems

Traditional LockboxA post office box maintained by a firm’s bank that is used as a receiving point for customer remittances. This system can eliminate the processing float.This system can eliminate mail float and availability float by locating the lockboxes closer to customers mailing points.Cost associated with this system is higher as the banks has to collect the checks, clear the checks and inform the firm also.

Electronic LockboxA collection service provided by a firm’s bank that receives electronic payments and accompanying remittance data and communicates this information to the company in a specified format.

Lockbox Process

• Customers are instructed to mail their remittances to the lockbox location.

• Bank picks up remittances several times daily from the lockbox.

• Bank deposits remittances in the customers account and provides a deposit slip with a list of payments.

• Company receives the list and any additional mailed items.

Lockbox System

Advantage

Receive remittances sooner which reduces processing float.

DisadvantageCost of creating and maintaining a lockbox system. Generally, not advantageous for small remittances.

Concentration Banking

Cash Concentration

The movement of cash from lockbox or field banks into the firm’s central cash pool residing in a concentration bank.Compensating BalanceDemand deposits maintained by a firm to compensate a bank for services provided, credit lines, or loans.

Concentration Banking

Moving cash balances to a central location:

• Improves control over inflows and outflows of corporate cash.

• Reduces idle cash balances to a minimum.• Allows for more effective investments by

pooling excess cash balances.

Concentration Services for Transferring FundsThere are three methods to move fund between banks(1) Depository Transfer Check (DTC)

Definition: A non-negotiable check payable to a single company account at a concentration bank.Funds are not immediately available upon receipt of the DTC.

Concentration Services for Transferring Funds(2) Automated Clearinghouse (ACH) Electronic

Transfer

Definition: An electronic version of the depository transfer check (an image of DTC).1. Electronic check image version of the DTC.2. Cost is not significant and is replacing DTC.3. Funds are usually available a day later.

Concentration Services for Transferring Funds

(3) Wire Transfer

Definition: A generic term for electronic funds transfer using a two-way communications system, like Fedwire.A wire transfer is simply a phone like communication, which via bookkeeping entries remove funds from a payer bank account to a payee bank account.Funds are available upon receipt of the wire transfer. This arrangement is much more expensive than the Depository transfer check.

S-l-o-w-i-n-g D-o-w-n Cash Payouts

• Playing the Float• Control of Disbursements– Payable through Draft (PTD)– Payroll and Dividend Disbursements– Zero Balance Account (ZBA)

• Remote and Controlled Disbursing

“Playing the Float”

Net Float -- The dollar difference between the balance shown in a firm’s books and the balance on the bank’s books.

The firm writes a check today, which is subtracted from the firm’s calculation of the account balance. While the check has not been cleared, creates float. The firm can potentially earn interest on money that has been spent.

Control of Disbursements

Firms should be able to:1. Shift funds quickly to from different banks to the

banks from which disbursements are made.2. Generate daily detailed information on balances,

receipts, and disbursements.

Centralize the payables into a single account. This provides better control of the disbursement process.

Methods of Managing Disbursements

Payable Through Draft (PTD):A check-like instrument that is drawn against the payer and not against a bank as is a check. After a PTD is presented to a bank, the payer gets to decide whether to honor or refuse payment.• Delays the time to have funds on deposit to cover

the draft.• Some suppliers prefer checks.• Banks will impose a higher service charge due to the

additional handling involved.

Methods of Managing Disbursements

Payroll and Dividend DisbursementsThe firm attempts to determine when payroll and dividend checks will be presented for collection.

• Many times a separate account is set up to handle each of these types of disbursements.

• A distribution scheduled is projected based on past experiences.

• Funds are deposited based on expected needs.• Minimizes excessive cash balances.

Percentage of Payroll Checks Collected

F M T W T F M and after

(Payday)

Perc

ent o

fPa

yrol

l Col

lect

ed

100%

75%

50%

25%

0%

The firm may plan onpayroll checks being

presented in a similarpattern every pay period.

Methods of Managing Disbursements

Zero Balance Account (ZBA):A corporate checking account in which a zero balance is maintained. The account requires a master (parent) account from which funds are drawn to cover negative balances or to which excess balances are sent.

• Eliminates the need to accurately estimate each disbursement account.

• Only need to forecast overall cash needs.

Remote and Controlled Disbursing

Remote Disbursement : A system in which the firm directs checks to be drawn on a bank that is geographically remote from its customer so as to maximize check-clearing time. This maximizes disbursement float.

Remote and Controlled Disbursing

Controlled Disbursement -- A system in which the firm directs checks to be drawn on a bank (or branch bank) that is able to give early or mid-morning notification of the total dollar amount of checks that will be presented against its account that day.

Electronic Commerce

Electronic Commerce -- The exchange of business information in an electronic (non-paper) format, including over the Internet.

Messaging systems can be:1. Unstructured - utilize technologies such as faxes and

e-mails 2. Structured - utilize technologies such as electronic

data interchange (EDI).

Electronic Data Interchange (EDI)

Electronic Data Interchange -- The movement of business data electronically in a structured, computer-readable format.

EDI1. Electronic Funds Transfer (EFT)

2. Financial EDI (FEDI)

Electronic Funds Transfer (EFT)

Electronic Funds Transfer (EFT) -- the electronic movements of information between two depository institutions resulting in a money transfer.

EDI1. Electronic Funds Transfer (EFT)

Society of Worldwide Interbank Financial Telecommunications (SWIFT)

Clearinghouse Interbank Payments System (CHIPS)

Electronic Funds Transfer (EFT)

In America a new regulation issued in January 1999, which requires ALL federal government payments to be made electronically. This will:

provide more security than paper checks and be cheaper to process for the government.

Except tax refunds and special waiver situations

Financial EDI (FEDI)

Financial EDI -- The movement of financially related electronic information between a company and its bank or between banks.

2. Financial EDI (FEDI)

Examples include:Lockbox remittance informationBank balance information

EDI

Costs and Benefits of EDI

Costs• Computer hardware and

software expenditures• Increased training costs to

implement and utilize an EDI system

• Additional expenses to convince suppliers and customers to use the electronic system

• Loss of float

Benefits• Information and payments

move faster and with greater reliability

• Improved cash forecasting and cash management

• Customers receive faster and more reliable service

• Reduction in mail, paper, and document storage costs

Summary• Purpose of efficient cash management. • Methods for speeding up the collection of accounts

receivable and methods for controlling cash disbursements. • Remote and controlled disbursement, • How electronic data interchange (EDI) and

outsourcing each relates to a company’s cash collections and disbursements.