2. Cash and Marketable Securities
• Cash – cash on hand-i.e currency,
coin and demand deposits
account
• Marketable securities – short term
financial assets (i.e T bills) than
can be converted into cash with in
the period of 1 year.
20-2
3. Cash Management vs
Liquidity Management
• Cash management- closely related to
optimizing instrument for collecting
and disbursing cash.
• Liquidity management- concern with
the best possible or optimal quantity
of liquid assets a firm should have on
hand.
20-3
4. 20-4
Reasons/Motives for Holding
Cash
• Speculative motive – hold cash to take
advantage of unexpected opportunities
• Precautionary motive – hold cash in case
of emergencies
• Transaction motive – hold cash to pay the
day-to-day bills
• Trade-off between opportunity cost of
holding cash relative to the transaction
cost of converting marketable securities to
cash for transactions
5. 20-5
Understanding Float
• Float – difference between cash balance
recorded in the cash account and the cash
balance recorded at the bank
• Disbursement float
• Generated when a firm writes checks
• Available balance at bank – book balance > 0
• Collection float
• Checks received increase book balance before
the bank credits the account
• Available balance at bank – book balance < 0
• Net float = disbursement float + collection float
6. Types of Float
• Mail float-caused by the time lapse from the
moment a customer mails are remittance check
until the firm begins to process it.
• Processing float- caused by the time required for
the firm to process the customer’s remittance
checks before they can be deposited in the bank.
• Transit float- caused by the time necessary for a
deposited check from a customer to clear
through the commercial banking system and
become usable funds to the company.
6
7. 20-7
Example: Measuring Float
• Size of float depends on the dollar amount and
the time delay
• Delay = mailing time + processing delay +
availability delay
• Suppose you mail a check for $1000 and it takes
3 days to reach its destination, 1 day to process
and 1 day before the bank makes the cash
available
• What is the average daily float (assuming 30-day
months)?
• Method 1: (3+1+1)(1000)/30 = 166.67
• Method 2: (5/30)(1000) + (25/30)(0) = 166.67
8. 20-8
Example: Cost of Float
• Cost of float – opportunity cost of not being able
to use the money
• Suppose the average daily float is $3 million with
a weighted average delay of 5 days.
• What is the total amount unavailable to earn interest?
• 5*3 million = 15 million
• What is the NPV of a project that could reduce the
delay by 3 days if the cost is $8 million?
• Immediate cash inflow = 3*3 million = 9 million
• NPV = 9 – 8 = $1 million
9. 20-9
Cash Collection/
Managing Cash Inflow
Payment Payment Payment Cash
Mailed Received Deposited Available
Mailing Time Processing Delay Availability Delay
Collection Delay
One of the goals of float management is to try to reduce the
collection delay. There are several techniques that can reduce
various parts of the delay.
10. Lockboxes &
Cash Concentration
• Lockboxes:
- special post office boxes set up to cut off and
speed up accounts receivables payments.
Objectives are:
(1)reduce mail float
(2)reduce processing float
(3)reduce transit float
• Cash concentration-procedure for moving cash
from multiple banks into the firms’ main
accounts.
20-10
11. 20-11
Cash Disbursements/Managing
Cash Outflows
• Slowing down payments can increase disbursement float
– but it may not be ethical or optimal to do this
• Controlling disbursements
• Zero-balance account-firm maintains a zero balance.
Objectives:
(1) achieve better control over cash payments
(2) reduce excess cash balance
(3) possible increase disbursing float
• Controlled disbursement account- firm transfers an
amount that is sufficient to cover demands for
payments.
12. 20-12
Investing Cash
• Money market – financial instruments with
an original maturity of one year or less
• Temporary Cash Surpluses
• Seasonal or cyclical activities – buy
marketable securities with seasonal surpluses,
convert securities back to cash when deficits
occur
• Planned or possible expenditures –
accumulate marketable securities in
anticipation of upcoming expenses
14. 20-14
Characteristics of Short-Term
Securities
• Maturity – firms often limit the maturity of
short-term investments to 90 days to avoid
loss of principal due to changing interest
rates
• Default risk – avoid investing in marketable
securities with significant default risk
• Marketability – ease of converting to cash
• Taxability – consider different tax
characteristics when making a decision
15. Types of Marketable Securities
• Treasury Bills-mature in 3, 6 and 12 months
• Commercial papers-issued by banks and
companies. Maturities range from a few weeks to
270 days.
• Negotiable Instrument of Deposit (NID)-issued by
banks for the deposit of a specific sum of money
for a fixed period of time at a prefixed interest rate.
• Repurchase agreement (Repo)-sales of money
market instruments with an understanding to buy
back the said instruments at an agreed price on a
specific future date.
15
Editor's Notes
The available balance is more important than the book balance. The firm doesn’t want to bounce checks, but they also don’t want to carry excess cash.
Reducing mailing time – lockboxes, Figure 20.3 illustrates how lockboxes can reduce mail delay by having customers mail their payments to PO boxes that are closer to where they live. The processing delay is also reduced because bank employees process the checks instead of the company doing it and then taking the checks to the bank.
Cash concentration – reduce management time by having a systematic process for moving cash received in the lock-boxes to a central account. Allows the company to maintain smaller cash balances overall.
Slowing payments – not ethical to systematically pay bills late; may lose cash discounts by paying late and this can be very expensive
Zero-balance account: maintain a master account, when checks are written on sub-accounts, cash is transferred from the master account to the sub-account to cover the checks; can maintain a smaller overall cash balance by utilizing this technique
Controlled disbursement account – cash is transferred to bank account to cover the day’s anticipated payments
