Slides by Matthew Will

1. Principles of Corporate Finance Brealey and Myers Sixth Edition • Cash Management Slides by Matthew Will Chapter 31 Irwin/McGraw Hill • The McGraw-Hill Companies, Inc., 2000

2. Topics Covered • Inventories and Cash Balances • Cash Collection and Disbursement Systems • Float • Bank Relations

3. Inventories & Cash Balances Economic Order Quantity - Order size that minimizes total inventory costs.

4. Inventories & Cash Balances Determination of optimal order size Total costs Carrying costs Inventory costs, dollars Total order costs Order size Optimal order size

5. Inventories & Cash Balances • The optimal amount of short term securities sold to raise cash will be higher when annual cash outflows are higher and when the cost per sale of securities is higher. Conversely, the initial cash balance falls when the interest is higher.

6. Inventories & Cash Balances • Money Market - market for short term financial assets. • commercial paper • certificates of deposit • repurchase agreements

7. Inventories & Cash Balances Cash (Everyman’s Bookstore) balance ($000) 25 Average 12.5 inventory Weeks 0 1 2 3 4 5 Value of bills sold = Q = 2 x annual cash disbursement x cost per sale interest rate 2 x 1260 x 20 .08 = = 25

8. Float • Time exists between the moment a check is written and the moment the funds are deposited in the recipient’s account. • This time spread is called Float. Payment Float - Checks written by a company that have not yet cleared. Availability Float - Checks already deposited that have not yet cleared.

9. Float Payment Float illustration - The company issues a $200,000 check that has not yet cleared.

10. Float Payment Float illustration - The company issues a $200,000 check that has not yet cleared. Company’s ledger balance $800,000 Payment float $200,000 +

11. Float Payment Float illustration - The company issues a $200,000 check that has not yet cleared. Company’s ledger balance $800,000 Payment float $200,000 + equals Bank’s ledger balance $1,000,000

12. Float Availability Float illustration - The company deposits a $100,000 check that has not yet cleared.

13. Float Availability Float illustration - The company deposits a $100,000 check that has not yet cleared. Company’s ledger balance $900,000 Payment float $200,000 +

14. Float Availability Float illustration - The company deposits a $100,000 check that has not yet cleared. Company’s ledger balance $900,000 Payment float $200,000 + equals Bank’s ledger balance $1,100,000

15. Float Net Float illustration Net float = payment float - availability float

16. Float Net Float illustration Net float = payment float - availability float Bank’s ledger balance $1,100,000

17. Float Net Float illustration Net float = payment float - availability float Bank’s ledger balance $1,100,000 equals Available balance $1,000,000 Availability float $100,000 +

18. Managing Float • Payers attempt to create delays in the check clearing process. • Recipients attempt to remove delays in the check clearing process. • Sources of delay • Time it takes to mail check • Time for recipient to process check • Time for bank to clear check

19. Managing Float Check mailed

20. Managing Float Check mailed Mail float Check received

21. Managing Float Check mailed Mail float Check received Processing float Check deposited

22. Managing Float Check mailed Mail float Check received Processing float Check deposited Availability float Presentation float Cash available to recipient Check charged to payer’s account

23. Managing Float Concentration Banking - system whereby customers make payments to a regional collection center which transfers the funds to a principal bank. Lock-Box System - System whereby customers send payments to a post office box and a local bank collects and processes checks. Zero-Balance Accounts - Regional bank accounts to which just enough funds are transferred daily to pay each day’s bills.