© 2007 Thomson South-Western

Chapter 23Liquidity

Professor XXXCourse Name/Number

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Cash Management

Float – funds sent by payer but not yet available to payeeMail FloatProcessing FloatAvailability FloatClearing Float

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Cash Management

Cash management: the collection, concentration, and disbursement of funds

Cash manager

responsible for

• Cash management• Financial relationships with banks• Cash flow forecasting• Investing and borrowing• Development and maintenance of

information systems for cash management

Float: funds that have been sent by the payer but not yet usable funds to the company

Mail float Processing float

Availability float

Clearing float

Time

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Cash Position ManagementCash position management: collection,

concentration, and disbursement of funds on a daily basis

Smaller companies set target cash balance for their checking accounts.

Bank account analysis

statement

• Bank provides report to its customers to show recent activity in firms’ accounts.

• Banks cannot pay interest on corporate checking account balances.

• Firms use earnings credit for balances to offset charges.

Management of short-term investing if the company has a surplus of funds and borrowing arrangements if company has a temporary deficit of funds

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Collections

Primary objective: speeding up collections

Collection systems: function of the nature of the business

Field-banking system

• Collections are made over the counter (retail) or at a collection office (utilities).

Mail-based system

• Mail payments are processed at companies’ collection centers.

Electronic system

• Becoming increasingly popular because they offer advantages to both parties.

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Collections

Lockbox system

• Speeds up collections because it affects all components of float.

• Customers mail payments to a post office box.

• Firm’s bank empties the box and processes each payment and deposits the payments in the firm’s account.

• Lockboxes reduce mail and clearing time.

Perform cost-benefit analysis to determine if lockbox system worth using

where,cos ) - LC r (FVR t) t (Net benefi a• FVR = float value reduction in dollars

• ra = cost of capital

• LC = annual operating cost of the lockbox system

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Funds Transfer Mechanisms

Depository transfer checks

• Unsigned check drawn on one of the firm’s bank accounts and deposited in another of the firm’s bank accounts

Automated clearinghous

e debit transfers

• Preauthorized electronic withdrawal from the payer’s account

• Settle accounts among participating banks. Individual accounts are settled by respective bank balance adjustments.

• Transfers clear in one day.

Wire transfers

• Electronic communication that, via bookkeeping entries, removes funds from the payer’s bank and deposits the funds in the payee’s bank.

• Expensive: used only for high-dollar payments

• Fedwire: primary wire transfer system in US

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Accounts Payable Management

Management of time from purchase of raw materials until payment is placed in the mail

Accounts payable

functions

• Examine all incoming invoices and determine the amount to be paid.

• Control function: cash manager verifies that invoice information matches purchase order and receiving information.

Decide between centralized or decentralized payables and payments systems

If supplier offers cash discounts, analyze the best alternative between paying at the end of credit

period and taking the discount.

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Disbursements Products and Methods

Zero-balance accounts (ZBAs): disbursements accounts that always have end-of-day balance of zero Allows the firm to maximize the use of float on each check,

without altering the float time of its suppliers Keeps all cash in interest-bearing accounts

Controlled disbursement: Bank provides early notification of checks presented against a company’s account every day. Federal Reserve Bank makes two presentments of checks to

be cleared each day for most large cash management banks. Positive pay: Company transmits to the bank a

check-issued file to the bank when checks are issued. Check-issued file includes check number and amount of each

item. Used for fraud prevention

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Developments in Accounts Payable and Disbursements Integrated (comprehensive) accounts payable:

outsourcing of accounts payable or disbursements operations

Purchasing/procurement cards: increased use of credit cards for low-dollar indirect purchases

Imaging services: Both sides of the check, as well as remittance information, is converted into digital images. Useful when incorporated with positive pay services

Fraud prevention in disbursements: fraud prevention measures: Written policies and procedures for creating and

disbursing checks; separating duties (approval, signing, reconciliation)

Using safety features on checks; setting maximum dollar limits and/or requiring multiple signatures

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Short-Term Investing

Essentially a substitute for cash, primary concerns should beProviding liquidity Preserving principalNot intended to generate profits

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Short-Term Investing

Marketable securities:Money market mutual fundsMoney market financial instruments

U.S. TreasuriesFederal agency issuesBank financial instrumentsCorporate obligationsOthers (MMF, asset-backed securities,

international money market, repos

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Yield Calculations for Discount Instruments

Yield for short-term discount investments such as T-bills and commercial paper typically calculated using algebraic approximations rather than precise present value methods

In a discount investment, investor pays less than face value at time of purchase, and receives face value at its maturity date.

Generally no interim interest or coupon payments during the course of holdings uch an investment.

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Yield Calculations for Discount Instruments – Example

Yield on a 91-day, $1 million T-bill selling at a discount of 3.75 percent, using 360 days

Step 1: Calculate the dollar discount and purchase price.

Dollar discount = (face value x discount rate) x (days to maturity/360)

($1,000,000 x 0.0375) x (91/360) = $9,479.17

Purchase price = face value − dollar discount ($1,000 − $9,479.17) = $990,520.83

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Yield Calculations for Discount Instruments – Example (cont.)

Step 2: Calculate MMY and BEY.

Money market yield (MMY) = (dollar discount/purchase price) x (360/days to maturity)

($9,479.17/$990,520.83) x (360/91) = 3.786%

Bond equivalent yield (BEY) = money market yield x (365/360)

3.786% x (365/360) = 3.839%

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Short-Term Borrowing

Variable-rate basisBase rate + spread = all-in-ratePrime rate LIBOREffective borrowing rate

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Effective Borrowing Rate