Chapter 27

Cash Management
 Understand the importance of float and how it affects
the cash balance
 Understand how to accelerate collections and manage
disbursements
 Understand the advantages and disadvantages of
holding cash and some of the ways to invest idle cash

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27-1
27.1 Reasons for Holding Cash
27.2 Understanding Float
27.3 Cash Collection and Concentration
27.4 Managing Cash Disbursements
27.5 Investing Idle Cash

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 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

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 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

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 You have $3,000 in your checking account. You just
deposited $2,000 and wrote a check for $2,500.
◦ What is the disbursement float?
◦ What is the collection float?
◦ What is the net float?
◦ What is your book balance?
◦ What is your available balance?

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 Size of float depends on the dollar amount and the
time delay
 Delay = mailing time + processing delay +
availability delay
 Suppose you mail a check each month for $1,000 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)(1,000)/30 = 166.67
◦ Method 2: (5/30)(1,000) + (25/30)(0) = 166.67

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 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

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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.

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 Your company does business nationally, and currently, all
checks are sent to the headquarters in Tampa, FL. You are
considering a lock-box system that will have checks processed
in Phoenix, St. Louis and Philadelphia. The Tampa office will
continue to process the checks it receives in house.
◦ Collection time will be reduced by 2 days on average
◦ Daily interest rate on T-bills = .01%
◦ Average number of daily payments to each lockbox is 5,000
◦ Average size of payment is $500
◦ The processing fee is $.10 per check plus $10 to wire funds
to a centralized bank at the end of each day.

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 Benefits
◦ Average daily collections = 3(5,000)(500) = 7,500,000
◦ Increased bank balance = 2(7,500,000) = 15,000,000
 Costs
◦ Daily cost = .1(15,000) + 3*10 = 1,530
◦ Present value of daily cost = 1,530/.0001 = 15,300,000
 NPV = 15,000,000 – 15,300,000 = -300,000
 The company should not accept this lock-box
proposal

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 Slowing down payments can increase disbursement
float – but it may not be ethical or optimal to do this
 Controlling disbursements
◦ Zero-balance account
◦ Controlled disbursement account

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 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

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 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

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 What are the major reasons for holding cash?
 What is the difference between disbursement float
and collection float?
 How does a lockbox system work?
 What are the major characteristics of short-term
securities?

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