ch 09 - cash and marketable securities management

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Chapter 9Chapter 9

Cash and Marketable Cash and Marketable Securities Securities

ManagementManagement

Cash and Marketable Cash and Marketable Securities Securities

ManagementManagement© 2001 Prentice-Hall, Inc.

Fundamentals of Financial Management, 11/eCreated by: Gregory A. Kuhlemeyer, Ph.D.

Carroll College, Waukesha, WI

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Cash and Marketable Cash and Marketable Securities ManagementSecurities Management

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

Cash Payouts Electronic Commerce

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Cash and Marketable Cash and Marketable Securities ManagementSecurities Management

Outsourcing Cash Balances to Maintain Investment in Marketable

Securities

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Motives for Holding CashMotives for Holding Cash

Transactions MotiveTransactions Motive -- to meet payments arising in the ordinary course of business

Speculative MotiveSpeculative Motive -- to take advantage of temporary opportunities

Precautionary MotivePrecautionary Motive -- to maintain a cushion or buffer to meet unexpected cash needs

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Cash Management SystemCash Management System

Collections Disbursements

Marketable securitiesinvestment

Control through information reporting

= Funds Flow = Information Flow

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Speeding Up Speeding Up Cash ReceiptsCash Receipts

Expedite preparing and mailing the invoice

Accelerate the mailing of payments from customers

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

Collections

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Collection FloatCollection Float

Collection FloatCollection Float: total time between the mailingof the check by the customer and the availability

of cash to the receiving firm.

ProcessingProcessingFloatFloat

AvailabilityAvailabilityFloatFloat

MailMailFloatFloat

Deposit FloatDeposit Float

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Mail FloatMail Float

Mail FloatMail Float: time the check is in the mail.

Customer Customer mails checkmails check

FirmFirmreceives checkreceives check

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Processing FloatProcessing Float

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

FirmFirmdeposits checkdeposits check

FirmFirmreceives checkreceives check

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Availability FloatAvailability Float

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

FirmFirmdeposits checkdeposits check

Firm’s bankFirm’s bankaccount creditedaccount credited

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Deposit FloatDeposit Float

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

Processing FloatProcessing Float Availability FloatAvailability Float

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Earlier BillingEarlier Billing

Accelerate preparation and mailing of invoices

computerized billing

invoices included with shipment

invoices are faxed

advance payment requests

preauthorized debits

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Preauthorized PaymentsPreauthorized Payments

Preauthorized debit Preauthorized debit

The transfer of funds from a payor’s bank account on a specified date to

the payee’s bank account; the transfer is initiated by the payee

with the payor’s advance authorization.

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Lockbox SystemLockbox System

LockboxLockbox

A post office box maintained by a firm’s bank that is used as a receiving point for customer

remittances.

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Lockbox ProcessLockbox 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.

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Lockbox SystemLockbox System

DisadvantageDisadvantage

Cost of creating and maintaining a lockbox system. Generally, not

advantageous for small remittances.

AdvantageAdvantage

Receive remittances sooner which reduces processing float.

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Concentration BankingConcentration Banking

Compensating BalanceCompensating Balance

Non-interest-bearing demand deposits maintained by a firm to compensate a

bank for services provided, credit lines, or loans.

Cash ConcentrationCash Concentration

The movement of cash from lockbox or field banks into the firm’s central cash pool residing in a concentration bank.

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Concentration BankingConcentration Banking

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.

Moving cash balances to Moving cash balances to a central location:a central location:

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Concentration Services Concentration Services for Transferring Fundsfor Transferring Funds

Definition: A non-negotiable check payable to a single company account at a concentration bank.

Funds are not immediately available Funds are not immediately available upon receipt of the DTC.upon receipt of the DTC.

(1) Depository Transfer Check (DTC)(1) Depository Transfer Check (DTC)

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Definition: An electronic version of the depository transfer check (DTC).

(1) Electronic check image version of Electronic check image version of the DTC.the DTC.

(2) Cost is not significant and is (2) Cost is not significant and is replacing DTC.replacing DTC.

(2) Automated Clearinghouse (2) Automated Clearinghouse (ACH) Electronic Transfer (ACH) Electronic Transfer

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Definition: A generic term for electronic funds transfer using a two-way communications system, like Fedwire.

Funds are available upon receipt of the Funds are available upon receipt of the wire transfer. Much more expensive.wire transfer. Much more expensive.

(3) Wire Transfer(3) Wire Transfer

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

“Playing the Float” Control of Disbursements

Payable through Draft (PTD) Payroll and Dividend

Disbursements Zero Balance Account (ZBA)

Remote and Controlled Disbursing

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““Playing the Float”Playing the Float”

You write a check today, which is subtracted from your calculation of the account balance.

The check has not cleared, which creates float. You can potentially earn interest on money that

you have “spent.”

Net FloatNet Float -- The dollar difference between the balance shown in a firm’s (or

individual’s) checkbook balance and the balance on the bank’s books.

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Control of DisbursementsControl of Disbursements

Solution:Solution:

Centralize payables into a single (smaller number of) account(s). This provides better

control of the disbursement process.

Firms should be able to:Firms should be able to:

1. shift funds quickly to banks from which disbursements are made.

2. generate daily detailed information on balances, receipts, and disbursements.

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Methods of Managing Methods of Managing DisbursementsDisbursements

Delays the time to have funds on deposit Delays the time to have funds on deposit to cover the draft.to cover the draft.

Some suppliers prefer checks.Some suppliers prefer checks. Banks will impose a higher service charge Banks will impose a higher service charge

due to the additional handling involved. due to the additional handling involved.

Payable Through Draft (PTD):Payable Through Draft (PTD):A check-like instrument that is drawn against the payor and not against a bank as is a check. After

a PTD is presented to a bank, the payor gets to decide whether to honor or refuse payment.

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

A distribution scheduled is projected based on A distribution scheduled is projected based on past experiences. [See slide 9-27]past experiences. [See slide 9-27]

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

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

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Percentage of Payroll Percentage of Payroll Checks CollectedChecks Collected

F M T W H F M and after(Payday)(Payday)

Per

cen

t o

fP

erce

nt

of

Pay

roll

Co

llec

ted

Pay

roll

Co

llec

ted

100%

75%

50%

25%

0%

The firm may plan onpayroll checks beingpresented in a similar

pattern every pay period.

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Eliminates the need to accurately Eliminates the need to accurately estimate each disbursement account.estimate each disbursement account.

Only need to forecast Only need to forecast overalloverall cash needs. cash needs.

Zero Balance Account (ZBA):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.

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Remote and Remote and Controlled DisbursingControlled Disbursing

Example: Example: A Vermont business pays a Maine supplier with a check drawn on a bank in Montana.

This This maymay stress supplier relations, and raises ethical stress supplier relations, and raises ethical issues.issues.

Remote DisbursementRemote 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. This maximizes disbursement float.

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Remote and Remote and Controlled DisbursingControlled Disbursing

Late check presentments are minimal, which Late check presentments are minimal, which allows more accurate predicting of allows more accurate predicting of

disbursements on a day-to-day basis.disbursements on a day-to-day basis.

Controlled DisbursementControlled 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.

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Electronic CommerceElectronic Commerce

Messaging systems can be:1. UnstructuredUnstructured -- utilize technologies

such as faxes and e-mails faxes and e-mails

2. 2. StructuredStructured -- utilize technologies such such as as electronic data interchange (EDI)electronic data interchange (EDI)..

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

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Electronic Data Electronic Data Interchange (EDI)Interchange (EDI)

Electronic Data InterchangeElectronic Data Interchange -- The movement of business data electronically

in a structured, computer-readable format.

EDIEDIElectronic Funds Transfer (EFT)Electronic Funds Transfer (EFT)

Financial EDI (FEDI)Financial EDI (FEDI)

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Electronic Funds Electronic Funds Transfer (EFT)Transfer (EFT)

Electronic Funds Transfer (EFT)Electronic Funds Transfer (EFT) -- the electronic movements of information between two

depository institutions resulting in a value (money) transfer.

EDIEDISubsetSubset

Electronic Funds Transfer (EFT)Electronic Funds Transfer (EFT)

Society of Worldwide Interbank Financial Telecommunications (SWIFT)

Clearinghouse Interbank Payments System (CHIPS)

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Electronic Funds Electronic Funds Transfer (EFT)Transfer (EFT)

New RegulationNew Regulation

In January 1999, a new regulation requires ALL federal government payments 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

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Financial EDIFinancial EDI -- The movement of financially related electronic information

between a company and its bank or between banks.


Examples includeExamples include:

Lockbox remittance information

Bank balance information

EDIEDISubsetSubset

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Costs and Benefits of EDICosts and Benefits of EDI

CostsCosts 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

BenefitsBenefits 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

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OutsourcingOutsourcing

Reducing and controlling operating costs

Improving company focus Access to world-class capabilities

* The Outsourcing Institute, 1998

OutsourcingOutsourcing -- Subcontracting a certain business operation to an outside firm,

instead of doing it “in-house.”

Why might a firm outsourceWhy might a firm outsource?* ?*

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Cash Balances to MaintainCash Balances to Maintain

The optimal level of cash should The optimal level of cash should be the larger of:be the larger of:

(1) the transaction balances required when cash management is efficient.

(2) the compensating balance requirements of commercial banks.

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Investment in Investment in Marketable SecuritiesMarketable Securities

Marketable Securities are shown Marketable Securities are shown on the balance sheet as:on the balance sheet as:

1.1. Cash equivalents if maturities are Cash equivalents if maturities are less than three (3) months at the less than three (3) months at the time of acquisition.time of acquisition.

2.2. Short-term investments if remaining Short-term investments if remaining maturities are less than one (1) maturities are less than one (1) year.year.

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The Marketable The Marketable Securities PortfolioSecurities Portfolio

Ready Cash Ready Cash Segment (R$)Segment (R$)

Optimal balance of Optimal balance of marketable securities marketable securities

held to take care of held to take care of probable deficiencies probable deficiencies

in the firm’s cash in the firm’s cash account.account.

R$F$

C$

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Controllable Cash Controllable Cash Segment (C$)Segment (C$)

Marketable securities Marketable securities held for meeting held for meeting

controllable controllable (knowable) outflows, (knowable) outflows,

such as taxes and such as taxes and dividends.dividends.


R$F$

C$

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Free Cash Free Cash Segment (F$)Segment (F$)

““Free” marketable Free” marketable securities (that is, securities (that is, available for as yet available for as yet

unassigned unassigned purposes).purposes).


R$F$

C$

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Variables in Marketable Variables in Marketable Securities SelectionSecurities Selection

Marketability (or Liquidity)Marketability (or Liquidity)The ability to sell a significant volume of securities in a short period of time in the

secondary market without significant price concession.

SafetySafetyRefers to the likelihood of getting back the

same number of dollars you originally invested (principal).

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Variables in Marketable Variables in Marketable Securities SelectionSecurities Selection

MaturityMaturity

Refers to the remaining life of the security.

Interest Rate (or Yield) RiskInterest Rate (or Yield) Risk

The variability in the market price of a security caused by changes in

interest rates.

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Common Money Common Money Market InstrumentsMarket Instruments

Treasury Bills (T-bills)Treasury Bills (T-bills): : Short-term, non-interest bearing obligations of the U.S. Treasury issued at a discount and redeemed at maturity for full face value. Minimum $1,000 amount and $1,000 increments thereafter.

Money Market InstrumentsMoney Market InstrumentsAll government securities and short-term corporate obligations. (Broadly defined)

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Treasury BondsTreasury Bonds: : Long-term (more than 10 years’ original maturity) obligations of the U.S. Treasury.

Treasury NotesTreasury Notes: : Medium-term (2-10 years’ original maturity) obligations of the U.S. Treasury.

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Bankers’ Acceptances (BAs)Bankers’ Acceptances (BAs): : Short-term promissory trade notes for which a bank (by having “accepted” them) promises to pay the holder the face amount at maturity.

Repurchase Agreements (RPs; Repurchase Agreements (RPs; repos)repos): : Agreements to buy securities (usually Treasury bills) and resell them at a higher price at a later date.

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Federal Agency SecuritiesFederal Agency Securities: : Debt securities issued by federal agencies and government-sponsored enterprises (GSEs). Examples: FFCB, FNMA, and FHLMC.

Commercial PaperCommercial Paper:: Short-term, unsecured promissory notes, generally issued by large corporations (unsecured IOUs). The largest dollar-volume instrument.

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Negotiable Certificate of DepositNegotiable Certificate of Deposit: : A large-denomination investment in a negotiable time deposit at a commercial bank or savings institution paying a fixed or variable rate of interest for a specified period of time.

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Money Market Preferred StockMoney Market Preferred Stock: : Preferred stock having a dividend rate that is reset at auction every 49 days.

EurodollarsEurodollars: : A U.S. dollar-denominated deposit -- generally in a bank located outside the United States -- not subject to U.S. banking regulations

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Selecting Securities for Selecting Securities for the Portfolio Segmentsthe Portfolio Segments

Ready Cash Ready Cash Segment (R$)Segment (R$)

Safety and ability to Safety and ability to convert to cash is convert to cash is most important.most important.

Select Select U.S. U.S. TreasuriesTreasuries for this for this

segment.segment.

R$F$

C$

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Controllable Cash Controllable Cash Segment (C$)Segment (C$)

Marketability less Marketability less important. Possibly important. Possibly match time needs.match time needs.

May select May select CDs, CDs, repos,repos, BAs,BAs, euroseuros for for

this segment.this segment.

R$F$

C$


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Free Cash Free Cash Segment (F$)Segment (F$)

Base choice on yield Base choice on yield subject to risk-return subject to risk-return

trade-offs.trade-offs.

Any money market Any money market instrumentinstrument may be may be

selected for this selected for this segment.segment.

R$F$

C$


ch 09 - cash and marketable securities management

Economy & Finance

cash receiptss

availabilityof cash

idle cash balances

excess cash balances

clearingthe check

lockbox location

whichreduces processing

total time