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Cash and Marketable Securities ManagementCash and Marketable
Securities Management
1. List and explain the motives for holding cash.2. Understand the purpose of efficient cash management. 3. Describe methods for speeding up the collection of accounts receivable and
methods for controlling cash disbursements. 4. Differentiate between remote and controlled disbursement, and discuss any
ethical concerns raised by either of these two methods.5. Discuss how electronic data interchange (EDI) and outsourcing each relates
to a company’s cash collections and disbursements6. Identify the key variables that should be considered before purchasing any
marketable securities. 7. Define the most common money-market instruments that a marketable
securities portfolio manager would consider for investment. 8. Describe the three segments of the marketable securities portfolio and note
which securities are most appropriate for each segment and why.
After Studying Chapter 9, you should be able to:
• Motives for Holding Cash
• Speeding Up Cash Receipts
• S-l-o-w-i-n-g D-o-w-n Cash Payouts
• Electronic Commerce
Cash and Marketable Securities Management
• Outsourcing
• Cash Balances to Maintain
• Investment in Marketable Securities
Cash and Marketable Securities Management
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
Motives for Holding Cash
Collections Disbursements
Marketable securitiesinvestment
Control through information reporting
= Funds Flow = Information Flow
Cash Management System
• 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
Collections
Speeding Up Cash Receipts
Collection Float: Total time between the mailingof the check by the customer and the availability
of cash to the receiving firm.
ProcessingFloat
AvailabilityFloat
MailFloat
Deposit Float
Collection Float
Mail Float: Time the check is in the mail.
Customer mails check
Firmreceives check
Mail Float
Processing Float: Time it takes a companyto process the check internally.
Firmdeposits check
Firmreceives check
Processing Float
Availability Float: Time consumed in clearingthe check through the banking system.
Firmdeposits check
Firm’s bankaccount credited
Availability Float
Deposit Float: Time during which the check received by the firm remains uncollected funds.
Processing Float Availability Float
Deposit Float
Accelerate preparation and mailing of invoices
• computerized billing• invoices included with shipment• invoices are faxed• advance payment requests• preauthorized debits
Earlier Billing
Preauthorized 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.
Preauthorized Payments
Traditional LockboxA post office box maintained by a firm’s bank that
is used as a receiving point for customer remittances.
Electronic LockboxA 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.
Lockbox Systems
• 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
Lockbox Process*
Disadvantage
Cost of creating and maintaining a lockbox system. Generally, not advantageous for small
remittances.
Advantage
Receive remittances sooner which reduces processing float.
Lockbox System
Compensating BalanceDemand deposits maintained by a firm to
compensate a bank for services provided, credit lines, or loans.
Cash Concentration
The movement of cash from lockbox or field banks into the firm’s central cash pool residing in a concentration bank.
Concentration Banking
Reduces availability float associated with check clearing.
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?
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.
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’
Collections Improvements
• 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.
Moving cash balances to a central location:
Concentration Banking
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.
(1) Depository Transfer Check (DTC)
Concentration Services for Transferring Funds
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.
(2) Automated Clearinghouse (ACH) Electronic Transfer
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
Concentration Services for Transferring Funds
• “Playing the Float”
• Control of Disbursements• Payable through Draft (PTD)• Payroll and Dividend
Disbursements• Zero Balance Account (ZBA)
• Remote and Controlled Disbursing
S-l-o-w-i-n-g D-o-w-n Cash Payouts
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.”
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.
“Playing the Float”
Solution:
Centralize payables into a single (smaller number of) account(s). This provides better
control of the disbursement process.
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.
Control of Disbursements
• 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.
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.
Methods of Managing Disbursements
• 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.
Payroll and Dividend DisbursementsThe firm attempts to determine when payroll and dividend checks will be presented for collection.
Methods of Managing Disbursements
F M T W H F M and after(Payday)
Per
cen
t o
fP
ayro
ll C
oll
ecte
d
100%
75%
50%
25%
0%
The firm may plan onpayroll checks beingpresented in a similar
pattern every pay period.
Percentage of Payroll Checks Collected
• Eliminates the need to accurately estimate each disbursement account.
• Only need to forecast overall cash needs.
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.
Methods of Managing Disbursements
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.
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.
Remote and Controlled Disbursing
Late check presentments are minimal, which allows more accurate predicting of disbursements on a day-
to-day basis.
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.
Remote and Controlled Disbursing
Messaging systems can be:
1. Unstructured – utilize technologies such as faxes and e-mails
2. Structured – utilize technologies such as electronic data interchange (EDI).
Electronic Commerce – The exchange of business information in an electronic (non-paper) format, including over the Internet.
Electronic Commerce
Electronic Data Interchange – The movement of business data electronically
in a structured, computer-readable format.
EDIElectronic Funds Transfer (EFT)
Financial EDI (FEDI)
Electronic Data Interchange (EDI)
Electronic Funds Transfer (EFT) – the electronic movements of information between two
depository institutions resulting in a value (money) transfer.
EDISubset
Electronic Funds Transfer (EFT)
Society of Worldwide Interbank Financial Telecommunications (SWIFT)
Clearinghouse Interbank Payments System (CHIPS)
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
Electronic Funds Transfer (EFT)
Financial EDI – The movement of financially related electronic information between a
company and its bank or between banks.
Financial EDI (FEDI)
Examples include:
Lockbox remittance information
Bank balance information
EDISubset
Financial EDI (FEDI)
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
1. Reducing and controlling operating costs 2. Improve company focus (close 2nd)3. Freeing resources for other purposes
* The Outsourcing Institute, 2005
Outsourcing – Subcontracting a certain business operation to an outside firm,
instead of doing it “in-house.”
Why might a firm outsource?*
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
Outsourcing
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.
Cash Balances to Maintain
Note regarding the management of marketable securities.
• Marketable Securities are shown on the balance sheet as “Short-term Investments”
Investment in Marketable Securities
Ready Cash Segment (R$)
Optimal balance of marketable securities held to take care of
probable deficiencies in the firm’s cash
account.
R$F$
C$
The Marketable Securities Portfolio
Controllable Cash Segment (C$)
Marketable securities held for meeting
controllable (knowable) outflows, such as taxes
and dividends.
R$F$
C$
The Marketable Securities Portfolio
Free Cash Segment (F$)
“Free” marketable securities (that is, available for as yet
unassigned purposes).
R$F$
C$
The Marketable Securities Portfolio
Marketability (or Liquidity)The ability to sell a significant volume of securities
in a short period of time in the secondary market without significant price concession.
SafetyRefers to the likelihood of getting back the
same number of dollars you originally invested (principal).
Variables in MarketableSecurities Selection
MaturityRefers to the remaining life of the security.
Interest Rate (or Yield) Risk
The variability in the market price of a security caused by changes in
interest rates.
Variables in Marketable Securities Selection
• Treasury Bills (T-bills): Short-term, non-interest bearing obligations of the US Treasury issued at a discount and redeemed at maturity for full face value. Minimum $100 amount and $100 increments thereafter.
Money Market InstrumentsAll government securities and short-term corporate obligations. (Broadly defined)
Common Money Market Instruments
BEY = [ (1000 – 990) / (990) ] *[ 365 / 91 ]
BEY = 4.05%
T-Bills and Bond Equivalent Yield (BEY) Method:
BEY = [ (FA – PP) / (PP) ] *[ 365 / DM ]• FA: face amount of security• PP: purchase price of security• DM: days to maturity of security
A $1,000, 13-week T-bill is purchased for $990 – what is its BEY?
EAY = (1 + [.0405/(365 / 91)])365/91 - 1
EAY = 4.11%
T-Bills and Equivalent Annual Yield (EAY) Method:
EAY = (1 + [ BEY / (365 / DM) ] )365/DM - 1• BEY: bond equivalent yield from the previous slide• DM: days to maturity of security
Calculate the EAY of the $1,000, 13-week T-bill purchased for $990 described on the previous slide?
• Treasury Bonds: Long-term (more than 10 years’ original maturity) obligations of the US Treasury.
• Treasury Notes: Medium-term (2-10 years’ original maturity) obligations of the US Treasury.
Common Money Market Instruments
• Bankers’ Acceptances (BAs): Short-term promissory trade notes for which a bank (by having “accepted” them) promises to pay the holder the face amount at maturity.
• Repurchase Agreements (RPs; repos): Agreements to buy securities (usually Treasury bills) and resell them at a higher price at a later date.
Common Money Market Instruments
• European Commercial Paper: See above, except maturities extend to one year and more active secondary market.
• Commercial Paper: Short-term, unsecured promissory notes, generally issued by large corporations (unsecured IOUs). The largest dollar-volume instrument in US. Maturities don’t exceed 270 days to preclude SEC registration.
Common Money Market Instruments
• Federal Agency Securities: Debt securities issued by federal agencies and government-sponsored enterprises (GSEs). Examples: FFCB, FNMA, and FHLMC.
• Negotiable Certificate of Deposit: A large-denomination investment in a negotiable time deposit at a commercial bank or savings institution paying a fixed or variable rate of interest for a specified period of time.
Common Money Market Instruments
• Money Market Preferred Stock: Preferred stock having a dividend rate that is reset at auction every 49 days.
• Eurodollars: A US dollar-denominated deposit – generally in a bank located outside the United States – not subject to US banking regulations
Common Money Market Instruments
Ready Cash Segment (R$)
Safety and ability to convert to cash is most
important.
Select USTreasuries for this
segment.
R$F$
C$
Selecting Securities for the Portfolio Segments
Controllable Cash Segment (C$)
Marketability less important. Possibly match time needs.
May select CDs, repos, BAs, euros for this
segment.
R$F$
C$
Selecting Securities for the Portfolio Segments
Free Cash Segment (F$)
Base choice on yield subject to risk-return
trade-offs.
Any money market instrument may be
selected for this segment.
R$F$
C$
Selecting Securities for the Portfolio Segments