Brealey−Meyers: Principles of Corporate Finance, 7th Edition - Chapter 31

Brealey−Meyers: Principles of Corporate Finance, Seventh Edition IX. Financial Planning and 31. Cash Management Short−Term Management © The McGraw−Hill Companies, 2003 C H A P T E R T H I R T Y - O N E CASH MANAGEMENT 880 Brealey−Meyers: Principles of Corporate Finance, Seventh Edition IX. Financial Planning and 31. Cash Management Short−Term Management © The McGraw−Hill Companies, 2003 CHAPTER 30 PROVIDED an overall idea of what is involved in short-term financial management. Now it is time to get down to detail. We begin in this chapter by looking at how companies manage their holdings of cash and marketable securities. Then in the next chapter we look at the terms on which firms sell their goods and how they ensure that their customers pay promptly. Out first task is to explain how cash is collected and paid out. In the United States small routine payments are commonly made by check. You want to ensure that when customers pay by check, you can convert these payments into usable cash in the bank quickly and cheaply. The use of checks is on the decline and large payments are almost always made electronically. You therefore need to under-stand how electronic payment systems work. Our second task is to consider how much cash the firm should hold. Companies have a choice be-tween holding cash in the bank and investing it in short-term securities. There is a trade-off here. Cash gives you a store of liquidity, which can be used to pay employees and suppliers. However, cash has the disadvantage that it does not pay interest. As we explain in the second section of this chapter, the trick is to strike a sensible balance. In the last chapter we explained how companies raise short-term loans to tide them over a tem-porary cash shortage. If you are in the opposite position and have surplus cash, you need to know where you can park it to earn interest. So in the final section of this chapter we look at the menu of short-term investments that are available to the financial manager. 31.1 CASH COLLECTION AND DISBURSEMENT The majority of small face-to-face purchases are made with coins or dollar bills. The most popular alternative in the United States for retail purchases is to pay by check. Each year individuals and firms write about 70 billion checks. Notice that the United States is unusual in this heavy use of checks. For exam-ple, Figure 31.1 compares retail payment methods in the United States and Hol- land. You can see that checks are almost unknown in Holland: Most payments there are made by debit cards, direct debit, or credit transfer.1 How Checks Create Float How does the firm’s cash balance change when it writes or deposits a check? Suppose that the United Carbon Company has $1 million on demand deposit with its bank. It now pays one of its suppliers by writing and mailing a check for $200,000. The com-pany’s ledgers are immediately adjusted to show a cash balance of $800,000. But the company’s bank won’t learn anything about this check until it has been received by the supplier, deposited at the supplier’s bank, and finally presented to United Car-bon’s bank for payment.2 During this time United Carbon’s bank continues to show 1Debit cards allow the cardholder to transfer money directly to the receiver’s bank account. With a credit transfer the payer initiates the transaction, for example by giving her bank a standing order to make a regular payment. With a direct debit the transaction is initiated by the payee and is usually processed electronically. 2Checks deposited with a bank are cleared through the Federal Reserve clearing system, through a cor-respondent bank, or through a clearinghouse of local banks. 881 Brealey−Meyers: Principles of Corporate Finance, Seventh Edition IX. Financial Planning and 31. Cash Management Short−Term Management © The McGraw−Hill Companies, 2003 882 PART IX Financial Planning and Short-Term Management USA 19% 2% Check 4% Direct debit 1% Debit card Credit card 74% Credit transfer Holland 3% 27% 52% 0% 18% Check Direct debit Debit card Credit card Credit transfer FIGURE 31.1 Shares of noncash retail payments in the USA and Holland in 1997. Notice the heavy use of checks in the USA. Source: “Retail Payments in Selected Countries: A Comparative Study,” Bank for International Settlements, Basel, 1999. in its ledger that the company has a balance of $1 million. The company obtains the benefit of an extra $200,000 in the bank while the check is clearing. This sum is often called payment, or disbursement float. Company`s ledger balance $800,000 + Payment float $200,000 equals Bank`s ledger balance $1,000,000 Float sounds like a marvelous invention, but unfortunately it can also work in reverse. Suppose that in addition to paying its supplier, United Carbon receives a check for $100,000 from a customer. It deposits the check, and both the company and the bank increase the ledger balance by $100,000: Company`s ledger balance $900,000 + Payment float $200,000 equals Bank`s ledger balance $1,100,000 But this money isn’t available to the company immediately. The bank doesn’t ac-tually have the money in hand until it has sent the check to, and received pay-ment from, the customer’s bank. Since the bank has to wait, it makes United Car-bon wait too—usually one or two business days. In the meantime, the bank will show that United Carbon has an available balance of $1 million and an availability float of $100,000: Brealey−Meyers: Principles of Corporate Finance, Seventh Edition IX. Financial Planning and 31. Cash Management Short−Term Management © The McGraw−Hill Companies, 2003 CHAPTER 31 Cash Management 883 Company`s ledger balance $900,000 + Payment float $200,000 equals Bank`s ledger balance $1,100,000 equals Available balance $1,000,000 + Availability float $100,000 Notice that the company gains as a result of the payment float and loses as a re-sult of the availability float. The difference is often termed the net float. In our ex-ample, the net float is $100,000. The company’s available balance is therefore $100,000 greater than the balance shown in its ledger. As financial manager you are concerned with the available balance, not with the company’s ledger balance. If you know that it is going to be a week or two before some of your checks are presented for payment, you may be able to get by on a smaller cash balance. This game is often called playing the float. You can increase your available cash balance by increasing your net float. This means that you want to ensure that checks paid in by customers are cleared rap-idly and those paid to suppliers are cleared slowly. Perhaps this may sound like rather small beer, but think what it can mean to a company like Ford. Ford’s daily sales average about $450 million. Therefore if it can speed up the collection process by one day, it frees $450 million, which is available for investment or payment to Ford’s stockholders. Some financial managers have become overenthusiastic in managing the float. In 1985, the brokerage firm E. F. Hutton pleaded guilty to 2,000 separate counts of mail and wire fraud. Hutton admitted that it had created nearly $1 billion of float by shuffling funds between its branches, and through various accounts at different banks. These activities cost the company a $2 million fine and its agreement to re-pay the banks any losses they may have incurred. Managing Float Float is the child of delay. Actually there are several kinds of delay, and so people in the cash management business refer to several kinds of float. Figure 31.2 summarizes. Of course the delays that help the payer hurt the recipient. Recipients try to speed up collections. Payers try to slow down disbursements. Speeding Up Collections Many companies use concentration banking to speed up collections. In this case customers in a particular area make payment to a local branch office rather than to company headquarters. The local branch office then deposits the checks into a Brealey−Meyers: Principles of Corporate Finance, Seventh Edition IX. Financial Planning and 31. Cash Management Short−Term Management © The McGraw−Hill Companies, 2003 884 PART IX Financial Planning and Short-Term Management FIGURE 31.2 Delays create float. Each heavy arrow represents a source of delay. Recipients try to reduce delay to get available cash sooner. Payers prefer delay because they can use their cash longer. Note: The delays causing avail-ability float and presentation float are equal on average but can differ from case to case. Check mailed Mail float Check received Recipient sees delays as collection float Processing float Check deposited Payer sees same delays as payment float Availability float Cash available to recipient Presentation float Check charged to payer`s account local bank account. Surplus funds are transferred to a concentration account at one of the company’s principal banks. Concentration banking reduces float in two ways. First, because the branch office is nearer to the customer, mailing time is reduced. Second, since the customer’s check is likely to be drawn on a local bank, the time taken to clear the check is also reduced. Concentration banking brings many small balances together in one large, central bal-ance, which can then be invested in interest-paying assets through a single transaction. For example, when Amoco streamlined its U.S. bank accounts in 1995, it was able to reduce its daily bank balances in non-interest-bearing accounts by almost 80 percent.3 Often concentration banking is combined with a lock-box system. In a lock-box system, you pay the local bank to take on the administrative chores. The system works as follows. The company rents a locked post office box in each principal re-gion. All customers within a region are instructed to send their payments to the post office box. The local bank, as agent for the company, empties the box at regu-lar intervals and deposits the checks in the company’s local account. Surplus funds are transferred periodically to one of the company’s principal banks. 3“Amoco Streamlines Treasury Operations,” The Citibank Globe, November/December 1998. ... - tailieumienphi.vn