Chapter 9

1. Chapter 9 Cash and Marketable Securities Management

2. After 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, and discuss any ethical concerns raised by either of these two methods. • 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.

3. 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

4. Cash and Marketable Securities Management • Outsourcing • Cash Balances to Maintain • Investment in Marketable Securities

5. Motives for Holding Cash Transactions Motive– to meet payments arising in the ordinary course of business Speculative Motive– to take advantage of temporary opportunities Precautionary Motive– to maintain a cushion or buffer to meet unexpected cash needs

6. Cash Management System Disbursements Collections Marketable securities investment Control through information reporting = Funds Flow = Information Flow

7. Speeding Up Cash Receipts Collections • 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

8. Management Of Receipts & Disbursements • Float: • Funds that have been sent by the payer but are not yet usable funds to the payee. • Effective float management will seek to lengthen the firm’s average payment period, whilst shortening the average collection period. • Three components: • Mail Float • Processing Float • Clearing Float

9. Management Of Receipts & Disbursements • Speeding Up Collections: • Techniques include: • EFTPOS & Bpay • Direct Deposits • Automated Periodic Payment Authorisations • Slowing Down Payments: • Techniques include: • Controlled Disbursing

10. Management Of Receipts & Disbursements • Other Important Float Management Tools: • Overdrafts • Zero Balance Accounts • Automatic Periodic Payment Authorisations

11. Collection Float Mail Float Processing Float Availability Float Deposit Float Collection Float: Total time between the mailing of the check by the customer and the availability of cash to the receiving firm.

12. Mail Float Customer mails check Firm receives check Mail Float: Time the check is in the mail.

13. Processing Float Firm receives check Firm deposits check Processing Float: Time it takes a company to process the check internally.

14. Availability Float Firm deposits check Firm’s bank account credited Availability Float: Time consumed in clearing the check through the banking system.

15. Deposit Float Processing Float Availability Float Deposit Float: Time during which the check received by the firm remains uncollected funds.

16. Earlier Billing Accelerate preparation and mailing of invoices • computerized billing • invoices included with shipment • invoices are faxed • advance payment requests • preauthorized debits

17. Preauthorized Payments Preauthorized debit Direct 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.

18. Lockbox Systems Traditional Lockbox A post office box maintained by a firm’s bank that is used as a receiving point for customer remittances. Electronic Lockbox A 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.

19. 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. * Based on the traditional lockbox system

20. Lockbox System Advantage Receive remittances sooner which reduces processing float. Disadvantage Cost of creating and maintaining a lockbox system. Generally, not advantageous for small remittances.

21. 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 Balance Demand deposits maintained by a firm to compensate a bank for services provided, credit lines, or loans.

22. Collections Improvements Accounts Receivable Conversion A process by which paper checks are converted into ACH debits at lockboxes or other collection sites. • So what is the Benefit of ARCs? Reduces availability float associated with check clearing.

23. Collections Improvements Check Clearing for the 21st Century Act “Check 21”: US, Federal law that facilitates electronic check exchange by enabling banks to exchange check image files electronically and, where necessary, to create legally equivalent paper “substitute checks” from images for presentment to banks that have not agreed to accept checks electronically.

24. Collections Improvements Check 21 • Driven by September 11, 2001 attacks • Meant to foster innovation and encourage the move from paper checks to electronic payment processing to create cost and time benefits for financial institutions • Requires banks to accept substitute checks (a paper copy of an electronic image of both sides of the original check) as the legal equivalent of the original paper check • Cleared the legal path to allow ‘remote deposit capture’

25. 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.

26. Concentration Services for Transferring Funds • (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.

27. Concentration Services for Transferring Funds • (2) Automated Clearinghouse (ACH) Electronic Transfer Definition: An electronic version of the depository transfer check (DTC). (1) Electronic check image version of the DTC. (2) Cost is not significant and is replacing DTC.

28. Concentration Services for Transferring Funds Definition: A generic term for electronic funds transfer using a two-way communications system, like Fedwire. Funds are available upon receipt of the wire transfer. Much more expensive. • (3) Wire Transfer

29. 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

30. “Playing the Float” Net 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. 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.”

31. Control of Disbursements 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. Solution: Centralize payables into a single (smaller number of) account(s). This provides better control of the disbursement process.

32. Methods of Managing Disbursements 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. • 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.

33. Methods of Managing Disbursements Payroll and Dividend Disbursements The 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 schedule is projected based on past experiences. [See the next slide] • Funds are deposited based on expected needs. • Minimizes excessive cash balances.

34. Percentage of Payroll Checks Collected 100% The firm may plan on payroll checks being presented in a similar pattern every pay period. 75% Percent of Payroll Collected 50% 25% 0% F M T W H F M and after (Payday)

35. 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.

36. 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. Example: A Vermont business pays a Maine supplier with a check drawn on a bank in Montana. This may stress supplier relations, and raises ethical issues.

37. 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. Late check presentments are minimal, which allows more accurate predicting of disbursements on a day-to-day basis.

38. 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).

39. Electronic Data Interchange (EDI) Electronic Data Interchange– The movement of business data electronically in a structured, computer-readable format. Electronic Funds Transfer (EFT) EDI Financial EDI (FEDI)

40. Electronic Funds Transfer (EFT) Electronic Funds Transfer (EFT) – the electronic movements of information between two depository institutions resulting in a value (money) transfer. Electronic Funds Transfer (EFT) EDI Subset Society of Worldwide Interbank Financial Telecommunications (SWIFT) Clearinghouse Interbank Payments System (CHIPS)

41. Electronic Funds Transfer (EFT) EFT Regulation • In January 1999, a regulation that required ALL federal government payments be made electronically.* This: • provides more security than paper checks and • is cheaper to process for the government. • * Except tax refunds and special waiver situations

42. Financial EDI (FEDI) Financial EDI – The movement of financially related electronic information between a company and its bank or between banks. Financial EDI (FEDI) EDI Subset Examples include: Lockbox remittance information Bank balance information

43. 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 Costs and Benefits of EDI

44. Outsourcing Outsourcing – Subcontracting a certain business operation to an outside firm, instead of doing it “in-house.” Why might a firm outsource?* • Reducing and controlling operating costs • Improve company focus (close 2nd) • Freeing resources for other purposes * The Outsourcing Institute, 2005

45. Factoring Accounts Receivable • Involves the outright sale of accounts receivable at a discount to a bank or other financial institution (factor) in exchange for funds. • The factor provides the accounting function for the management of the debt. • Similar to borrowing with accounts receivable as capital. • Commonly used by small to medium sized businesses.

46. Factoring Accounts Receivable Advantages • Allows the firm to turn accounts receivable immediately into cash. • Ensures a known pattern of cash flows. • Allows the firm to take advantage of early settlement discounts, or use cash to improve liquidity. • May lead to the elimination credit and collection departments.

47. Outsourcing • Business Process Outsourcing (BPO) • A form of outsourcing in which the entire business process is handed over to a third-party service provider • Entire function such as accounting might be handed over to the BPO • Typically found in low labor cost countries • Many are owned by large multinationals

48. Cash Balances to Maintain The optimal level of cash should be the larger of: (1) The transaction balances required when cash management is efficient. (2) The compensating balance requirements of commercial banks.

49. Investment in Marketable Securities Note regarding the management of marketable securities. • Marketable Securities are shown on the balance sheet as “Short-term Investments”

50. Investment in Marketable Securities • Marketable Securities are short term, interest earning, money market instruments that can easily be converted into cash. • Used to earn a return on temporarily idle funds. • Two types: • Government Issues • Non Government Issues