Short-Term Financial Management: Exam 3

Corporate Cash Management

expedites firm’s cash flow through the CCC through efficient management of working capital accounts (inventory, accounts receivable, accounts payable)

Accounts Receivable

collection of funds

Accounts Payable

disbursement of funds to cover financial obligations

Float

delay in the receipt and conversion of a check to cash

Check

when a firm collects receivable (or pays invoices), it is often in the form of this

Float Either:

• has a cost (A/R), delays receipt of cash

• offers a benefit (A/P), delays disbursement of cash

Payment Systems:

• transfer ownership of claims

• use technology to convert those claims to a preferred form

• settle debts incurred by asset exchanges between the claim issuers

Key Principle of Cash Management

moving funds quickly and efficiently

Firm Liquidity

less efficient payment systems result in a longer time period required to collect on customer accounts

Relationship Management

prompt payment timing helps maintain mutually beneficial relationships with suppliers and vendors

Opportunity Costs of Idle Funds

each day that finds are tie up in a payment system results in either forgone interest earned or additional interest expense

Payment Transactions’ Participants:

• payor

• payor bank

• payee

• payee bank

Providing Payment Instructions

instructing the payor bank to transfer a certain value to the payee through the payee bank

Generating the Payment

entering payment instructions into the payment system

Clearing the Payment

payor and payee banks processing payment information for the transfer of funds between the banks on behalf of the payor and payee

Settlement of Funds

payee’s bank account is credited, and the payor’s bank account is debited

Approximately 5,000 Banks:

• the federal reserve (central bank)

• commercial banks

• savings and loans associations (S&Ls)

• credit unions

• non-bank institutions (insurance firms, mortgage

• companies, fx traders

Primary Payment Methods:

• checks

• electronic

  • ACH, wires, card-based payments, and mobile payments

When Moving Money

transfer usually not effective immediately → results in float

Managing Float is Important

cost, length

Float Goal

expedite collection of A/R, slow down payment A/P

Step 1: Payment Instructions

payor makes the check out to a particular payee for a given dollar amount

Step 2: Payment Generation

the payor sends the check to the payee (payment generation)

Step 3: Clearing and Settlement

payee deposits check at its bank. 2 options

• deposit the physical check

• submit a check image using remote capture (RDC)

Step 4: Presentment

bank receiving the deposits/checks initiates the physical exchange of funds with the bank the funds are drawn on

Federal Reserve System

payee bank sends bundles of checks known as “cash letters” to federal reserve district banks (12) for clearing and value transfer. paying and payee banks are simultaneously debited and credited by the federal reserve. (most popular method for check clearing

Clearinghouse

intermediary which connects several banks. enables settlement of balances between member banks

Direct Presentment

checks are physically delivered via courier to the payor bank

Bill Pay

these transactions are executed as electronic transfers

Provisional Credit

the account is credited when the check is deposited

Ledger Balance

reflects all credits and deposits posted to an account at a certain point in time. includes provisional credit items

Collected Balance

funds that the payee can spend without over drafting the account or borrowing from a credit line

Deposit Float

is the dollar difference between the ledger balance and the collected balance

All Else Equal

deposit float should be minimized to reduce the opportunity cost of uncollected funds

Originator

entity originating an ACH entry is referred to as this

Receiver

entity receiving the ACH entry is this

Originating Depository Financial Institution (ODFI)

bank used by the originator is this

Receiving Depository Financial Institution

bank used by the receiver is this

ACH Transfer Step 1:

originator sends an electronic file to their ODFI

ACH Transfer Step 2:

ODFI submits the file to the ACH operator

ACH Transfer Step 3:

ACH operator then delivers the ACH transaction to the RDFIs according to the specified value-dates

ACH Transfer Step 4:

RDFI then credits or debits the receiver’s account according to the payment information provided by the ACH transaction

Real-Time Gross Settlement (RTGS)

(also known as wires) offer immediate and irrevocable value transfer between payor and payee

Debit Cards

issued by banks. tied to funds held in the card holder’s depository account

Credit Card

cardholder has a line of credit with the financial institution sponsoring the card

Closed-Loop Credit Cards

can only be used for purchases from the card sponsor

Open-Loop Credit Cards

are offered by banks (visa and mastercard) or financial service providers (american express) and are accepted at most locations

Debit Card Transactions

processed electronically

• through network connections to local banks (immediately subtracted from account)

• or off-line through the ACH system (subtracted within two business days)

Credit Card Transactions

result in a loan from the credit card issuer

• payment requested at a later point

• interest is charged if payment not remitted in full

Cash Management Services

banks play important role in day-to-day cash management. most of them offer this

Account Analysis

banks services are paid for through a combination of balances and fees

Depository Account Services

deposit accounts provide a safe store of value that is easily accessed to meet daily liquidity needs

Demand Deposit Account (DDA)

checking account that allows the account holder to deposit collected funds as well as to make disbursements via checks or other payment instruments. FDIC insured

Time Deposit Accounts

accounts in which the deposits are maintained for a stipulated time period

• Ex:

  • money market deposit accounts

  • certificates of deposit (CDs)

Money Market Deposit Accounts

provide a liquid store of value that earn a competitive interest rate (ST investment)

Credit Services

commercial lending

Term Loan

borrowing a specific dollar amount to be repaid on specific dates over a specific period of time

Revolving Line of Credit

borrower has access to funds when needed. funds paid back throughout the agreement period

Transaction Processing

facilitates collections on sales using various payment instruments (checks, cards, and electronic transfers)

Information Reporting

bank provides information pertaining to payments collected from customers, payments disbursed to suppliers, and bank account information

Foreign Exchange Services

for firms engaged in international business-to-business transaction. include:

• payments denominated in foreign currency

• foreign currency accounts

Financial Risk Management Services

bank acts as counter party in financial derivatives (forwards, futures, swaps, and options) to help reduce the adverse effects of changes in financial market conditions

International Trade Services

services that facilitate the payment and collection for the international delivery of goods or services

Book (Ledger)

reflects all posted account activity at the firm level; this balance may not be spendable

Deposit Float

amount of funds that have been deposited but not yet collected

Collected:

• actual funds collected/disbursed

• collected balance = book (ledger) balance - deposit float

Reserve Requirement Ratio (RRR)

• portion of deposits that banks have to hold for liquidity purposes

• dictated by the federal reserve

• currently 10%

Banks Prefer Balances:

• it increases deposits available for investment or loans

• it provides a cushion if the firm is also a loan client and defaults

Firms Generally Prefer Fees:

• the ecr is almost always less than the annual opportunity cost (k)

• fees are tax-deductible

Types of Check Float:

• mail float

• processing float

• clearing (availability) float

Mail float

(one day to several days)

• the time between when the check is written until it is physically received by the payee

Processing Float

(hours, to one or more days)

• the time it takes payee to process and deposit the check

Clearing (Availability) Float

(as much as 5 days)

• the time needed by the bank to clear the check

Opportunity Cost of Collection Float

lost interest income or the excess interest expense incurred from idle funds in the process of being collected

Opportunity Cost of Collection Floats:

• fixed costs

• variable costs

Fixed Costs

• real estate rent

• utilities

• supplies

• admin costs

• account maintenance fees

• fixed bank fees

Variable Costs:

• employee wages

• bank charges for processing

• encoding

• depositing, etc.

• stated on a per-check basis

Decentralized System

has lower cost and should be maintained

Lockbox Collection System

a corporate banking product that uses state-of-the-art equipment and a highly trained staff to minimize each component of collection float

A/R Remittance Address

PO box, controlled by bank. unique, pre-sorted zip code (reducing mail float). mail delivered 24 hrs a day, collected by bank employees every hour during the day (+ specific times at night)

Eliminating Processing Float

mail is digitized and transmitted to firm for processing

Reducing Clearing Float

checks deposited in customer’s account throughout the day

Primary Types of Lockboxes:

• retail lockbox

• wholesale lockbox

Retail Lockbox

systems handle a large volume of checks with low average dollar face value, using standardized remittance information

• primarily used by firms with individual consumers as customers

Wholesale Lockbox

systems are used for low check volume with high average dollar face value

• primarily used for B2B check payments

Most Lockboxes Have…

a fixed cost (fee payable monthly), plus variable costs (per item)

Collection or Gathering Banks

common for large firms to have multiple accounts at multiple banks

Opportunity Cost

may end up with idle cash balances dispersed across many accounts at multiple banks

Concentration Bank

cash concentration systems move funds from dispersed accounts to this

Concentration Services

electronically pool funds from multiple banks into a single bank

Typical Check Options:

• paper checks

• ACH (automated clearing house)

Paper Checks

• longer float

• more expensive than electronic options

ACH (Automated Clearing House)

• shorter float

• only collected funds that can be transferred

• cheaper than checks

NPV and Float Neutrality Concept

models quantify the financial impact of changes to disbursement policies

NPV

helps evaluate a change from check to ACH

Float Neutrality Concept

to evaluate whether a firm should pay with check or ACH

Float Neutrality

determines if discount offered will offset the value of the float offered by check