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TOPIC 3 Cash Management

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MOH. NIEZAM ABDULMUNAP
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509 views25 pages

TOPIC 3 Cash Management

Uploaded by

MOH. NIEZAM ABDULMUNAP
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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FINMAN2: WORKING

CAPITAL MANAGEMENT

PART 2: CASH AND


SECURITIES
MANAGEMENT
CASH AND SECURITIES MANAGEMENT

CASH AND SECURITIES MANAGEMENT


This involves the maintenance of the appropriate
level of cash and investment in marketable
securities to meet the firm’s cash requirements
and maximize income on idle funds. Our
objective should be to invest in cash for a return
while retaining sufficient liquidity to satisfy
future needs.
CASH AND SECURITIES MANAGEMENT

CASH AND SECURITIES MANAGEMENT


As much as possible, the company should not have idle cash on
hand. The following are reasons why the company would need to
hold cash:
1. Transaction purposes
2. Compensating balance requirements
3. Precautionary reserves
4. Potential investment opportunities
5. Speculation
CASH AND SECURITIES MANAGEMENT

FLOAT
The difference between the bank’s balance for a firm’s
account and the balance that the firm shows on its books.
(bank statement vs. book balance)
TWO ASPECTS OF FLOAT
1. The time it takes a company to process its checks internally
2. The time consumed in clearing the check through the
banking system
CASH AND SECURITIES MANAGEMENT

TYPES OF FLOAT
1. Positive float (disbursement float) – occurs when the bank
balance exceeds the book balance, such as when checks issued by
the firm are already delivered to the supplier but the same have
not yet been cleared by the bank. This type of float should be
increased.
2. Negative float (receipt float) – occurs when the book balance
exceeds the bank balance. It shows that there is more cash tied up
in the collection cycle. This type of float should be decreased, or if
possible, eliminated.
CASH AND SECURITIES MANAGEMENT

TYPES OF NEGATIVE FLOAT


1. Mail float - occurs when the payment has already been mailed by
a customer but not yet received by the company
2. Processing float – occurs when the customer’s payments have
been received but not yet deposited
3. Clearing float – occurs when the customer’s checks have been
deposited but not yet cleared
CASH AND SECURITIES MANAGEMENT

PROBLEM 1: FLOATS
Assume that each day a company writes and receives
checks totaling P100,000. If it takes 5 days for the checks to
clear and be deducted from the company’s account, and
only 4 days for the deposits to clear, what is the float?
CASH AND SECURITIES MANAGEMENT

PROBLEM 1: FLOATS

Float Amount
Positive float (disbursement 100,000 x 5 500,000
float) days
Negative float (receipt 100,000 x 4 (400,000)
float) days
Net float (positive) 100,000
CASH AND SECURITIES MANAGEMENT

PROBLEM 2: PLAYING THE FLOAT


ABC Corporation requires all sales agents to mail checks to its head office in Makati. An
average of 6 days is required for mailed checks to be received, 2 days for ABC
Corporation to process them, and 5 days to clear the checks through its banks.
The company’s treasurer proposed a change in the system where the checks will no
longer be mailed to the Makati Office. He suggests that the checks be collected and
deposited on-line in any branch of the company’s depository bank, and the deposit
slips, as well as other pertinent documents will be sent by email to the Makati Office on
the same day. This new system will eliminate the mailing float and the processing time.
The average monthly collection amounted to P900,000. If the new system is
implemented, what will be the increase in the average cash balance of ABC
Corporation?
CASH AND SECURITIES MANAGEMENT

PROBLEM 2: PLAYING THE FLOAT

Float Amount
Average daily collection 900,000 / 30 30,000
Multiply: days reduced in 6 (mailing 8
collection period float) + 2
(processing
float)
Increase in average cash 240,000
balance
CASH AND SECURITIES MANAGEMENT

CASH MANAGEMENT STRATEGIES


Accelerate cash collections
 Bill customers promptly
 Offer cash discounts for prompt payment
 Use of lockbox system
 Local collection offices
 Direct payments to depository bank
 Automatic or electronic fund transfer
CASH AND SECURITIES MANAGEMENT

PROBLEM 3: COLLECTION AGENCY


ABC Company has an average monthly cash receipt in the amount of
P3,300,000. It has an average collection period of 20 days. A
collection agency has offered to be the company’s collector and
shorten collection period by 5 days for a monthly fee of P3,500. The
company can invest its excess funds in money market placement at a
rate of 10%. Determine the annual net benefit if the collection
agent’s offer is accepted.
CASH AND SECURITIES MANAGEMENT

PROBLEM 3: COLLECTION AGENCY


Float Amount
Advantage (benefit) Daily cash collections = 3,300,000 / 30 55,000
days = P110,000

Increase in average cash balance =


P110,000 x 5 days = P550,000

Benefit = P550,000 * 10% = P55,000


Disadvantage (cost) Annual fee = P3,500 * 12 months = (42,000)
P42,000
Net annual 13,000
benefit/advantage
CASH AND SECURITIES MANAGEMENT

PROBLEM 4: LOCKBOX SYSTEM


ABC Company has a number of customers in the province who usually pay
on time but because of the mailing time, processing time, and clearing time,
cash cannot be obtained as payment is made.
A bank has offered to provide the company with a lockbox system at a fixed
fee of P800 per month and a variable fee of P3 for each payment processed
by the bank. The company believes it would benefit from this system since it
receives an average of 80 payments a day, each averaging P5,000. With the
lockbox system, the company’s collection float will decrease by 8 days.
Money market securities earn 6% per year. Determine the net annual
benefit if the lockbox system is used.
CASH AND SECURITIES MANAGEMENT

PROBLEM 4: LOCKBOX SYSTEM


Float Amount
Advantage (benefit) Daily cash collections = 80 * 5,000 = P192,000
400,000

Increase in average cash balance =


400,000 * 8 days = P3,200,000

Benefit = P3,200,000 * 6% =
P192,000
Disadvantage (cost) Fixed fee: P800 * 12 months = P9,600 (96,000)

Variable fee: P3 * 80 * 360 = P86,400


Net annual P96,000
benefit/advantage
CASH AND SECURITIES MANAGEMENT

CASH MANAGEMENT STRATEGIES


Control or slow down disbursements
 Stretch payables
 Maintain zero-balance accounts
 Play the float
 Less frequent payroll and schedule issuance of checks to suppliers
CASH AND SECURITIES MANAGEMENT

CASH MANAGEMENT STRATEGIES


Reduce the need for precautionary cash balance
 More accurate cash budgeting
 Have ready lines of credit
 Invest idle cash in highly liquid, short-term investments instead of
holding idle precautionary cash balances
CASH AND SECURITIES MANAGEMENT

CASH FLOW MANAGEMENT


Cash break-even chart
Baumol cash management model
CASH AND SECURITIES MANAGEMENT

BAUMOL CASH MANAGEMENT MODEL


 An EOQ-type model which can be used to determine
optimal cash balance where the costs of maintaining and
obtaining cash are at a minimum
 There are two types of costs relating to holding cash
 Cost of securities transactions or cost of obtaining a loan
 Opportunity cost of holding cash which includes the return
foregone by not investing in marketable securities or the cost of
borrowing cash.
CASH AND SECURITIES MANAGEMENT

BAUMOL CASH MANAGEMENT MODEL


The equation for the model is as follows:

Where:
C = optimal cash balance
T = transaction costs which is a fixed amount per transaction. It includes the
cost of securities transactions or cost of obtaining a loan
i = interest rate on marketable securities or the cost of borrowing cash
D = total demand for cash over a period of time
CASH AND SECURITIES MANAGEMENT

PROBLEM 5: OPTIMAL CASH BALANCE


ABC Company expects a cash disbursement for the coming year of
P900,000. The interest rate on marketable securities is 8% per year.
The fixed cost of selling marketable securities is P10 per transaction.
1. Determine the optimal cash balance using the Baumol cash
management model
2. Based on the previous answer, what is the average cash balance?
3. What is the total cost for securities transactions and cost of
borrowing cash?
CASH AND SECURITIES MANAGEMENT

MARKETABLE SECURITIES MANAGEMENT


Marketable securities are those short-term money market
instruments that can be easily converted into cash. The
company may hold marketable securities because
1. It would serve as a substitute for cash balances
2. It would serve as temporary investment that yields
return while funds are idle
3. It is needed to meet known financial obligations
CASH AND SECURITIES MANAGEMENT

MARKETABLE SECURITIES MANAGEMENT


The return on marketable securities is the
opportunity cost of idle cash. This return is the
denominator of the optimal balance formula
provided in the Baumol cash management model.
CASH AND SECURITIES MANAGEMENT

MARKETABLE SECURITIES MANAGEMENT


Risks involved:
1. Default risk
2. Interest rate risk
3. Inflation risk
CASH AND SECURITIES MANAGEMENT

MARKETABLE SECURITIES MANAGEMENT


Marketability means how quickly security can be
sold before maturity without a significant price
concession.

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