CHAPTER ORGANIZATIONCHAPTER 17WORKING CAPITAL MANAGEMENTCHAPTER 17 QUIZCHAPTER ORGANIZATIONThe basic objective in cash management is to keep the investment in cash as low as possible while still operating the firm's activities efficiently and effectively. This goal usually reduces to the dictum “Collect early and pay late.” Accordingly, we discuss ways of accelerating collections and managing disbursements.In addition, firms must invest temporarily idle cash in short-term marketable securities. These securities can be bought and sold in the financial markets. As a group, they have very little default risk, and most are highly liquid.17.1 Float and Cash Management- Reasons for Holding CashSpeculative motive - The need to hold cash in order to be able to take advantage of, for example, bargain purchase opportunities that might arise, attractive interest rates, and (in the case of international firms) favorableexchange rate fluctuations.Precautionary motive - The need to hold cash as a safety margin to act as a financial reserve. is the need for a safety supply to act as a financial reserve.Transaction motive - The need to have cash on hand to pay bills. Transaction-related needs come from the normal disbursement and collection activities of the firm.The opportunity cost of holding cash is the return that could be earned by investing the cash in other assets. However, there is also a cost to convert between cash and other assets. The optimal cash balance will balance these costs to minimize the overall cost of holding cash.- Understanding Float - The difference between the available balance and the ledger balance is called the float, and it represents the net effect of checks in the process of clearing (moving through the banking system).Book balance – the amount of cash recorded in the accounting records of the firmAvailable balance – the amount of cash the bank says is available to be withdrawn from the account (may not be the same as the amount of checks deposited minus amount of checks paid, because deposits are not normally available immediately)Prepared by Jim Keys1Float = Available balance – book balanceNegative float implies that checks have been deposited that are not yet available. The firm needs to be careful that it does not write checks over the available balance, or the checks may bounce.Positive float implies that checks have been written that have not yet cleared. The company needs to make be sure to adjust the available balance so it does not think that there is more money to spend than there actually is.Disbursement float – generated by checks the firm has written that have not yet cleared the bank; arrangements can be made so that this money is invested in marketable securities until needed.Collection float – generated by checks that have been received by the firm but are not yet included in the available balance at the bankHave you ever written a check a day or two before receiving your paycheck, even though on the day you mailed the check, your checking account had insufficient funds to cover it? This is an example of using disbursement float. We recognize that the time for the check to travel through the mail and then be processed and cleared, should allow enough time for the paycheck to clear our bank. We do need to be careful about this process, however. The check we wrote maygo through the system faster than anticipated and it may take the paycheck longer to become available than anticipated. In this case, our check may bounce or at the very least our credit line will be tapped and we end up paying some unexpected interest charges.Float management involves controlling the collection and disbursement of cash. The objective in cash collection is to speed up collections and reduce the lag between the time customers pay their bills and the time the cash becomes available. The objective in cash disbursement is to control payments and minimize the firm's costs associated with making payments. Managers need to be more concerned with net float and available balances than with the book balance.Total collection or disbursement times can be broken down into three parts: mailing time, processing delay, and availability delay: o Mailing time is the part of the collection and disbursement process during which checks are trapped in the postal system. o Processing delay is the time it takes the receiver of a check to process the payment and deposit it in a bank for collection. o Availability delay refers to the time required to clear a check through the banking system.The Institutional Investor (September 1985) provides a lengthy discussion of legal and ethical questions surrounding cash management. The article, “Cash management: Where do you draw the line,” by Barbara Donnelly, focuses on the E.F. Hutton check kiting scandal. In retrospect, it is clear that the value of lost reputation far exceeded the savings gained via the company’s cash management strategies.The Expedited Funds Availability Act (EFAA) governs the availability of funds deposited by firms. The following rulesapply (based on US Code: Title 12 Section 4002 as of January 23, 2000):- Cash or electronic payment and government checks are available the day after deposit.- Local checks are available two days after deposit.- Non-local checks are available five days after deposit.Prepared by Jim Keys2Note that these rules indicate the maximum time for availability. A bank may make funds available sooner. Also, deposits made at ATMs can have a different schedule due to the processing time required.Electronic Data Interchange and Check 21: The End of Float?17.2 Cash Management: Collection, Disbursement, and Investment- Cash Collection and ConcentrationCollection Time = mailing time + processing delay + availability delayCash collection policies depend on the nature of the business. Firms can choose to have checks mailed toone location, or many locations (reduces mailing time), or allow preauthorized payments. Many firms also accept online payments either with a credit card or with authorization to request the funds directly from your bank.Prepared by Jim Keys3Lockboxes are special post office boxes that allow banks to process the incoming checks and then send the information on account payment to the firm; that reduces processing time and often reduces mail time because several regional lockboxes can be used.Prepared by Jim Keys4Cash concentration is the practice of moving cash from multiple