Disbursement System

Disbursement System include the banks and the delivery mechanism and procedures firms use to transfer of cash from the firm’s centralized cash pool to disbursement banks and then on to supplier and other payees.

Disbursement system are simpler because headquarters control it more directly.

Objective

By slowing down cash disbursement as much as possible and accelerating cash collection, the desired objective of cash disbursement is to increase the availability of cash or retain the cash as long as possible.

Disbursement Policy: 4 Principles Maximize value through payment timing Optimize the accuracy and timeliness of

information Minimize balances in disbursement accounts Prevent fraud

Maximize value through payment timing Payment should be timed to add the

maximum value to the company- First for a cash poor company, it should pay

on terms but not before- A company should take cash discount when it

is available- Within ethical, legal, and practical constraints

a company should take advantage of float offered by strategic location of disbursement bank.

Optimize the accuracy and timeliness of information Accuracy and timeliness of information are

key attributes of disbursement system. Providing accurate information in a timely

manner without incurring excessive cost Accurate fund balance information received

early in the days add value through access to investment with higher interest

Types of Disbursement Decisions Strategic Decisions – Decisions that have

long term effect and cannot be changed immediately.

Tactical Decisions- Day to day operating decisions.

Disbursement Decisions

Centralized VS Decentralized disbursing Disbursement control lies between

completely centralized and completely decentralized decision making.

Strategic decisions made on a centralized basis whereas tactical decisions may be made in the field.

Rarely all decisions are made both at the Headquarter and in the field.

Primarily Decentralized System Field managers make major tactical

decisions. Payment authorization, preparation and

release are performed at the field level Checks are drawn on a local Bank.

Primarily decentralized Systems Advantages- More autonomy to field managers- Relationship with the payee enhanced. Disadvantages- Larger balances need to be kept- Disbursement float is lower- Risk of unauthorized disbursement

Primarily Centralized System

Headquarter selects drawee bank and authorizes payment, prepares and releases payment.

Advantages- Excess balances are eliminated and can be

employed in profitable venture.- Disbursement practices are implemented at the

best interest of the company.- Unauthorized disbursement is reduced

Primarily Centralized System

Disadvantages- Autonomy of the field manager is reduced- Relationship with the payee is strained- Extra processing time may result in missed

discounts.

Cash Disbursements and the Cash Flow Timeline Payment system Ethics and organizational policies Decentralized v.s. centralized disbursements Organizational structure Banking system Treasury information system Cash flow characteristics

Payment system

Payment mechanism available to the company, their current state of development and relative cost, the existing clearing and settlement mechanism, the regulatory framework are important parts of the payment system.

Ethics and organization policy Writing checks in anticipation of adequate

balances by the clearing time Sending checks to the company’s office

instead of lockbox designated by the vendor

Decentralization Vs Centralization disbursement Centralized disbursement allows the corporate HQ

to look after each disbursement and possibly also initiate each disbursement.

Cash manager at Company HQ has a better view of the company cash position and allow him to take better decision related to availing a cash discount and amount of transfer to the disbursement account.

Disbursement float is higher. Elimination of duplicate disbursement account

reduces cost. Young small company operating at single location

are centralized and deals with only one bank.

Decentralized disbursement

Decentralized disbursement allows payments to be made by offices or individual stores.

Companies with operation spread throughout multiple locations tend to be decentralized

Improved relationship with the supplier. Severely hamper the efficiency and control of

disbursement accounts.

Organizational Structure

Functional areas within the organization affect a company’s disbursement system.

By organizational structure we mean firm’s functional areas, their relationship, chains of command, decision making flows and formal and informal groups.

Treasury Information System

Capability of a company’s MIS is limiting factor on the disbursement system.

Companies are more highly automated in payables than in any other areas

Automated system ensures that bills are paid in time achieving substantial cost savings

Cash Flow characteristics

Cash management system create value because cash flows are unsynchronized or uncertain.

A company with predictable cash flow prefers a disbursement system in which surplus are transferred in interest bearing accounts.

Companies with unpredictable cash flows prefer banks that link disbursement to attractive credit facilities.

Value of disbursement float

Payor receives invoice

Payor mails check

Payee receives check

Payor deposits check

Payor’s account debited

DisbursementFloat

Payment float

Cash Flow Timeline

Mail Processing ClearingMail Processing ClearingFloatFloat Float Float Float Float

Availability SlippageAvailability Slippage FloatFloat

Payor puts check in the mailPayor puts check in the mail

Payee receives checkPayee receives check

Payee deposits check at bankPayee deposits check at bank

Payee receives good fundsPayee receives good funds

Bank debitsBank debits payor’s accntpayor’s accnt

Disbursement FloatDisbursement Float

Components of Disbursement float Disbursement float consists of –

Mail float – time between Payor's mailing of the check and the payee’s receipt of itProcessing float – the time required to deposit the check after it has been receivedPresentation/Clearing float – the time required by the banking system to return the check and present it against the Payor's banking account.

An example

XYZ Garments pays suppliers with paper checks. Invoices are net 30 and XYZ usually mails check an average of 30 days from the invoice date. Mail time from XYZ to suppliers averages 4 calendar days. Most checks are received by lockboxes and processed on average .5 day after receipt. Clearing time back to XYZ disbursement bank averages 1.5 days. An average of $ 36500000 is disbursed to suppliers every year. The opportunity cost is 10 % per annum.

The payment float associated with the disbursement system-

Payment initiation time = 30.0 days

Mail time = 4.0 days

Processing time = 0.5 days

Presentation time = 1.5 days

36.0 days

Value of payment float = $ 36500000/365 X .10 X 36 days = $ 360000 per year

An Example (Cont.)

If XYZ change its disbursement policies by increasing the payment initiation time to 34 days and its presentation float to 3.5 days

Then payment float associated with the disbursement system-

Payment initiation time = 34.0 days

Mail time = 4.0 days

Processing time = 0.5 days

Presentation time = 3.5 days

42.0 days

Value of payment float = $ 36500000/365 X .10 X 42 days

= $ 420000 per year

Can we say now that XYZ is $ 60000 better off ?

Mail Float issue

If the postmark date is used by the payee to determine whether an invoice has been paid on time then mail float is considered a part of the disbursement float.

If the receipt date is considered the valid payment date, lengthening the mail time will accompany a corresponding decrease in payment initiation time.

Missed discount

Discount are allowed to encourage early payment.

Disbursement system must consider the possible cost of missed discount if payment cannot be made in time.

PV concepts are useful in computing missed discounts.

Another example

XYZ Garments pays suppliers with paper checks. Invoices are 2/10, net 30 and XYZ usually mails check an average of 30 days from the invoice date. Mail time from XYZ to suppliers averages 4 calendar days. Most checks are received by lockboxes and processed on average .5 day after receipt. Clearing time back to XYZ disbursement bank averages 1.5 days. An average of $ 36500000 is disbursed to suppliers every year. The opportunity cost is 10 % per annum.

The payment float associated with the disbursement system-Payment initiation time = 30.0 daysMail time = 4.0 days

Processing time = 0.5 daysPresentation time = 1.5 days

36.0 days

Another example (Continuation)PV of payment float = $ 36500000 {1 + (36 X .10)/365}

= $ 36140000 with no discount

PV of payment float = $ 36500000 (1-.02) {1 + (16 X .10)/365}

= $ 35610000 with availing discount

The difference is $ 530000 per year. This means if XYZ misses all the discounts and pays on the net day, it loses that amount each year.

Excess Balances in the disbursement banks Available balance above the level necessary

to compensate disbursing banks for its services.

Transfers of funds may not be synchronized with the amount presented against the account.

Timing problem can also create excess balance.

Elimination of excess balance created by timing problem Controlled disbursing – Disbursement bank let the

firm know in advance the amount of check presented so that the firm can have enough time to transfer fund to cover the check presentment.

Zero balance account – Transfer cash at the end of the day from another account at the same bank.

The bank can arrange to sweep any balances left at the end of the day into an interest earning account.

Transaction costs

Costs of transferring value from the concentration account to the disbursing account and to the cost of transferring values to the payee.

Bank charges, third party vendor information charges, in house expenses associated with payment, cost of over-drafting the disbursing accounts.

Disbursement tools

Zero Balance Accounts- Designed to remove excess balance while retaining the

advantages of separate accounts- A zero balance account has a balance of zero at the start of the

day- Its balance at the end of the day will be zero again- Money is usually moved from a master account in the same

Bank- Through the zero balance account the firm can keep less

amount of money than the summation of buffer in each individual disbursement account.

Zero Balance Account

Funding to Zero Balance Account can also be made from another bank.

When the master account is in the same bank then debiting the firm’s account enable transfer of fund.

If the master account is in another Bank then fund is transferred through wire.

Pseudo-zero balance account- In this the firm is notified in advance of the amount

of checks presented against the disbursement account. So the cash management can transfer the fund.

Advantages of Zero Balance Account Excess balance is reduced. Presentation time is increased. Facilitates decentralization by proving local

check writing authority. Maintain funding control from the

headquarter.

Reconciliation serviceAssembling a list of checks presented against the disbursement account and comparing the list to the checks written.

Stop Payment ServicesIssued to the disbursement bank by the firm to recall a check issued earlier.

Sweep Account- Automatic investment service for disbursement account- After clearing the excess balance above some desired level is

automatically invested in overnight investments. - It reduce excess balance and lower administrative costs. Payable through drafts (PTD)- Appear as checks but are drawn on the issuing form instead of

disbursement bank.- The firm will have one day time to verify the authorized amount

and ensure that other conditions have been met.

Controlled Disbursing Account The account receives only one daily

presentment early in the morning. The bank processes the item and notifies the

Company by the mid or late morning. This allows the treasurer to invest the rest in

securities. It thus reduces idle balance. Why early morning is cut off point?

Key Issues in choosing a controlled disbursement bank Float – Used primarily for information. Availability of

clearing information early in the day. Checks presented in the later part of the day allow additional time.

Cost – Bank charges, internal costs of maintaining information system, charges of bank reconciliation and balance reporting.

Time of notification – When did the Bank last receive its last presentment. It is possible to use a second presentment if it is in the late morning.

Key Issues in choosing a controlled disbursement bank Funding alternative- When notified the

concentration Bank can wire transfer the fund to the disbursement bank. But it is expensive

Treasurers prefer to use ACH. ACH has one day delay.

Remote Disbursing

Variation of controlled disbursing Selection of disbursing bank will depend on how

much it extends clearing time of checks. Objective is not only reduce excess balance but

also to extend disbursement float. Extending the disbursement float may benefit the

firm in PV sense, delay in availability may have adverse consequences in future price negotiation.

Dual balances

Arises when the disbursement account is funded by DTCs that available on disbursement account in one days but does not clear the concentration account until a later time.

For the tie of overlap available balances exist in both banks at the same time.

Payee relationship

Relationship with the payee is primary concern in managing a disbursement system.

Effort by the Payor to intentionally delay payments may be considered unfavorable.

Measuring the costs of payee relationship is difficult.

Strained business dealings, higher prices, delivery holdup, damaged image, law suit, adverse credit ratings.