Working Capital Management

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Spring 2008

• Chapter 21 - III
• Working Capital Management

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CASH MANAGEMENT TECHNIQUES FLOAT

• The difference between the balance shown in your
  checkbook and the balance on the banks records
  is called float.

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• The difference between your balance and the
  banks balance caused by delay in when your check
  payments clear is called disbursement
  float.
• Example You pay 5,000 in checks daily with a
  6-day delay. Your disbursement float is 30,000.
  That is, this delay will cause your banks
  balance will be 30,000 higher than your balance.

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• The difference between your balance and the
  banks balance caused by delay in when your
  received checks clear is called collections
  float.
• Example You receive 6,000 in checks daily that
  take 4 days to clear. Your collections float is
  24,000. That is, this delay will cause your
  banks balance will be 24,000 lower than your
  balance.

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• Disbursement float less collections float is
  called net float, which is a source of
  funds.

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• In the example, net float is 6,000.
• That is, the net effect of clearing delays on
  checks paid and clearing delays on checks
  deposited at the bank leaves a balance at the
  bank that is 6,000 higher than the balance on
  your checkbook.
• In this case, it is a source of funds because net
  float is positive.

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In-Class Exercise

• Your company receives and deposits 13,000 daily
  into checking with a 3-day delay in clearing. It
  also makes payments with checks amounting to
  15,000 daily with a 2-day delay in clearing.
• What is your net float?
• What does the sign of your answer indicate?

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Synchronizing Cash Flows

• Example Assume a firm
• - disburses 28 mil weekly to regional offices
• - offices use cash for transactions evenly
  throughout each 7-day week
• - distributing cash daily would cost another
  200,000 in admin. fees
• - i-rate on short-term loans is 10
• Should it switch to daily disbursements?

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Values are in millions
28
avg. idle cash 14
4
avg. idle cash 2
7 days 14 days
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Lockboxes

• Suppose a firm has west coast customers
• - 18.25 million annual sales
• (terms net 30)
• - 6-day delay (mailing/check-clearing)
• - LockBox system will cut delay to 2 days,
• but cost 12,000/year
• - i-rate on short-term loans 12
• Should they switch to using lockboxes?

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• Example The WhyNot Corporation has the
  following estimates
• - credit sales 1,460 million
• - terms net 45
• - mailing clearing delay 5 days
• - i-rate (short-term loans) 15
• Lock-box system
• - cost 12,000 per month
• - reduce collection delay by 4 days
• Should they switch to the lock-box system?

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Lockbox Practices

• Lock-boxes are one of the most widely-used
  collection systems in US, primarily because of
  the widespread use of checks (as of 2002, 95 of
  all B2B transactions were paid by check)
• Collections are enhanced with frequent mail
  pickups from the postal facility by a bank
  officer, instead of waiting for checks to be
  delivered via normal mail.

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• Lock-box systems are generally easy to scale up
  or down as business volume changes, which is
  especially an advantage for seasonal
  businesses.

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• Additional services that may be offered by
  lox-box systems include
• Transmitting images of checks and making them
  available online. This is especially useful to
  financial and utility companies that must
  research a high volume of customer service
  inquiries.

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• Matching a processed payment against the
  companys open invoices, applying the payment,
  and updating the accounts receivable record.
  This service is called receivables matching.
• Processing incoming ACH and wire payments. This
  service is referred to as an electronic lockbox.

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Bank Concentration Accounts

• Transfer of funds from outlying depository
  locations to a central bank account, called the
  concentration account.
• Most frequently-used concentration services are
  automated clearing houses (ACH) and wire
  transfers.
• Wire transfers are used for same-day transfers
  and much more expensive than ACH services.

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Disbursement Methods

• Controlled disbursement is a bank service that
  provides same-day notice to a company of the
  dollar amount of checks that will clear the
  account.
• Company then provides adequate funds to cover the
  account.
• This allows the company to calculate its daily
  net cash position early enough to take advantage
  of better market rates for borrowing/investing.

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• A zero balance account (ZBA) is an account on
  which the company writes and deposits checks, and
  initiates ACH debits or wire transfers at the end
  of the day to maintain a zero balance.
• Needed funds are transferred from a master
  account within same bank.

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• Multi-tiered ZBAs permit companies with multiple
  divisions or subsidiaries to write checks on
  separate accounts (e.g., payroll, accounts
  payable, etc.), but maintain overall control by
  the cash manager.

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• A check drawn for which the payor has one day to
  honor or refuse payment is called a payable
  through draft (PTD).
• This is frequently used for insurance claims that
  have multiple signers and require headquarters
  approval.
• This allows time for the insurance company to
  ensure that all terms have been met, and it
  creates float.
• PDTs may also be in electronic form.

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• Positive pay is a service used to combat check
  fraud. Also called match pay.
• Bank matches check serial numbers and amounts vs
  check records earlier transmitted to the bank by
  the company.

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• Another service is called reverse positive pay.
  The bank transmits to the company a file of
  checks presented for payment and requests
  verification.
• Neither service protects against forged checks.

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• Another service called payable-if-desired (PID)
  permits checks to be presented for payment at a
  bank other than the drawee bank. Both bank names
  appear on the check.
• Used in states that require employees to be paid
  by checks payable locally.
• Alternate bank requires indemnity from paying
  company for potential losses relating to the
  checks (e.g., fraud).

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• Another name for a petty cash account is an
  imprest account.
• The account is maintained at a prescribed level
  for a particular purpose or activity.
• For example, a field office may have an account
  for local disbursements with a balance sufficient
  to cover a month of expenses.

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Electronic Disbursement

• Transfers made from company account to accounts
  of employees, vendors, shareholders, and trading
  partners using ACH credit transfers is a service
  called direct deposit.
• The most common form of direct deposit is for
  payroll.
• Primary advantages are the low cost of the
  transactions and certainty of timing

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• Purchasing or procurement cards
  (P-Cards) are used for small dollar purchases of
  supplies and service contracts.
• The recent trend is to use these for larger
  purchases such as inventory and equipment.
• Unlike credit cards, P-cards are issued for
  pre-specified types of purchases.

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• Their primary advantage is to save costs by
  eliminating the processing of high volume, low
  dollar purchases.
• Another advantage is they allow companies to
  negotiate better pricing or terms with preferred
  suppliers.

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• The primary method used to collect and account
  for employee tax withholdings, and for corporate
  business and excise taxes is the Electronic
  Federal Tax Payment System (EFTPS).

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• Some states require tax payments above a certain
  amount to be remitted via an Automated Clearing
  House (ACH).

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Specialty Services

• Third party specialists who pay all of a
  shippers freight, audit bills for overcharge or
  duplicate payments, and provide reports for
  optimal routes and carriers are called freight
  payment specialists.
• Manufacturers and wholesale distributors
  typically use this service.

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• Vendors who handle checks and direct deposit file
  issuance, payroll tax filings and payments, and
  administration of 401k accounts, as well as
  providing employees with required withholding
  forms, are called payroll services.
• These are most cost-efficient for
  small-to-mid-sized companies.