“When prosperity comes, do not use all of it.”
~Confucius~
Current Asset Management
by
Charles Lamson
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Collections and Disbursements
Managing the cash inflows and payments is a function of many variables such as a float, the mail system, use of electronic funds transfer mechanisms, lock boxes, international sales, and more. These are presented in detail in the following section. Float Some people are shocked to realize that even the most trusted asset on a corporation's books, cash, may not portray actual dollars at a given time. There are actually two cash balances of importance: the corporation's recorded amount and the amount credited to the corporation by the bank. The difference between the two is called float, and it arises from time delays in mailing, processing, and clearing checks through the banking system. Once a check is received in the mail and a deposit is made, the deposited funds are not available for use until the check has cleared the banking system and has been credited to the corporate bank account. This works both for checks written to pay suppliers as well as checks deposited from customers. This means float can be managed to some extent through a combination of disbursement and collection strategies. We examine the use of float in Table 1 below. Our firm has deposited $1,000,000 in checks received from customers during the week and has written $900,000 in checks to suppliers. If the initial balance were $100,000, the corporate books would show $200,000. But what will the bank records show in the way of the usable funds? Perhaps $800,000 of the checks from customers will have cleared accounts at other banks and been credited to us, while only $400,000 of our checks may have completed a similar cycle. As indicated in Table 1, we have used "float" to provide us with $300,000 extra in available short-term funds. Table 1 The use of float to provide funds  Some companies actually operate with a negative cash balance on the corporate books, knowing float will carry them through at the bank. In a follow-up to the example in Table 1, the firm may write $1.2 million in checks on the assumption that only $800,000 will clear by the end of the week, thus leaving it with surplus funds in the bank account. The results, shown in Table 2, represent the phenomenon known as playing the float. A float of $200,000 turns a negative balance on the corporation's books into a positive temporary balance on the bank's book.   Improving Collections We may expedite the collection and check-clearing process through a number of strategies. A popular method is to utilize a variety of collection centers throughout our marketing area. An insurance company such as Allstate, with headquarters in Chicago, may have 75 collection offices dispersed throughout the country, each performing a billing and collection deposit function. One of the collection offices in San Francisco using a local bank, may be able to clear a check on a San Jose Bank in one day whereas a Chicago bank would require a substantially longer time to remit and clear the check at the California Bank. For those who wish to enjoy the benefits of expeditions check clearance at lower costs, a lockbox system may replace the network of regional collection offices. Under this plan, customers are requested to forward their checks to a post office box in their geographic region and a local bank pick up the checks. The bank can then process the local checks through the local clearinghouse for rapid collection and have the funds available for use in 24 hours or less. Whether the corporation uses a collection system or the less-expensive lockbox system, excess cash balances at the local thanks are remitted to the corporate headquarter bank through a daily wire transfer or automated clearing house that makes the funds immediately available for corporate use. Extending Disbursements Perhaps you have heard of the multimillion-dollar corporation with its headquarters located in the most exclusive office space in downtown Manhattan, but with its primary check disbursement Center in Fargo, North Dakota. Though the firm may engage in aggressive speedup techniques in the processing of incoming checks, a slowdown pattern more aptly describes the payment procedures. While the preceding example represents an extreme case, the slowing of disbursements is not uncommon in cash management. It has even been given the title "extended disbursement float." Many full-service banks offer services to control disbursements, and also reconcile discrepancies between the Federal Reserve's check processing system and the bank's totals. This allows the company to time their payments so that they hold their cash balances as long as possible. While it is not the intent of this analysis to encourage or discourage such practices, they're fairly widespread use is worthy of note.  Cost-Benefit Analysis An efficiently maintained cash management program can be an expensive operation. The use of remote collection and disbursement centers involves additional costs, and banks involved in the process will require that the firm maintain adequate deposit balances or pay sufficient fees to justify the services. Though the use of a lockbox system may reduce total corporate overhead, the costs may still be substantial. These expenses must be compared to the benefits that may accrue through the use of cost-benefit analysis. If a firm has an average daily remittance of $2 million and 1.5 days can be saved in the collection process by establishing a sophisticated collection network, the firm has freed $3 million for investment elsewhere. Also, through stretching the disbursement schedule by one day, perhaps another $2 million will become available for alternate uses. An example of this process is shown in Figure 3. If the firm is able to earn 10 percent on the 5 million dollars that is freed up, as much as $500,000 may be expended on the administrative costs of cash management before the new costs are equal to the generated revenue. Figure 3 Cash management network  Electronic Funds Transfer Some of the techniques of delaying payment and using float are being reduced through the techniques of electronic funds transfer; a system in which funds are moved between computer terminals without the use of a check. Through the use of terminal communication between the store and the bank, your payment to the supermarket is automatically charged against your account at the bank before you walk out the door. Most large corporations have computerized cash management systems. For example, a firm may have 55 branch offices and 56 banks, one bank for each branch office and a lead bank in which the major corporate account is kept. At the end of each day the financial manager can check all the company's bank accounts through an online computer terminal. He or she can then electronically transfer all excess cash balances from each branch or regional bank to the corporate lead bank for overnight investment and money market securities.  Automated Clearing Houses (ACH) are an important element in electronic funds transfers. An ACH transfers information between one financial institution and another and from account to account via computer tape. There are 40 Regional automated clearing houses throughout the United States, claiming total membership of over 25,000 financial institutions (newyorkfed.org). These institutions transmit or receive ACH entries through Central clearing facilities operated by the American Clearing House Association, the Federal Reserve System, the electronic payment Network, and Visa (Block & Hirt, 2005, p. 182). The National Automated Clearing House Association (NACHA), nacha.org, states that 2018 was a milestone year for the ACH Network. Payment volume climbed by almost 1.5 billion payments, the fourth straight year the ACH Network has added more than 1 billion new payments. ACH Network volume reached nearly 23 billion payments in 2018, a year-over-year increase of 6.9 percent and the highest growth rate since 2008. That is nearly 70 payments for every person in the U.S. The value of ACH payments in 2018 was $51.2 trillion, a 9.5 percent increase over 2017. It marked the sixth consecutive year in which ACH payment value has risen by at least one trillion dollars. For perspective, the value of last year's ACH payments was more than two and a half times that of the nation's 2017 gross domestic product. Same-day ACH volume soared in 2018, the first full year with same-day debits as well as credits. There were nearly 178 million same-day ACH payments last year: 98.3 million credits and 79.7 million debits. Overall the same-day ACH volume jumped 137 percent from 2017. Total same-day ACH value in 2018 was 159.9 billion dollars, up 83 percent over the year before. "The results for 2018 make clear that the ACH Network is vibrant and continues to be a vital component of the nation's economic engine," said Chief Operating Officer Jane Larimer. "With more enhancements to Same Day ACH being rolled out this year and next, the experience for businesses and consumers will only get better." Figure 4 diagrams the flow of funds through the ACH Network. The originator can be an individual, corporation, or other entity that initiates entrees into the automated clearinghouse network. The originator forwards the credit or debit transactions data to an originating depository financial institution (ODFI), which then sorts and transmits the file to an automated clearinghouse operator. The ACH then distributes the file to the receiving depository financial institution (RDFI), which then makes the use of funds available to the individual, corporation, or other entity that has authorized the originator to initiate a credit or debit entry to the receiver's account held at the RDFI. Figure 4 ACH network   International electronic funds transfer is mainly carried out through SWIFT. SWIFT is an acronym for the Society for Worldwide Interbank Financial Telecommunications. SWIFT provides around-the-clock international payments between banks---foreign exchange and trade transactions, and cash flows due to international securities transactions. Having disrupted the manual processes that were the norm of the past, SWIFT is now a global financial infrastructure that spans every continent, 200+ countries and territories, and services more than 11,000 institutions around the world (www.swift.com). Rigid security standards are enforced, each message is encrypted (secretly coded), and every money transaction is authenticated by another code. These security measures are important to the members as well as to SWIFT, which assumes the financial liability for the accuracy, completeness, and confidentiality of transaction instructions from and to the point of connection to member institution circuits. International Cash Management Multinational corporations can shift funds around from country to country much as a firm may transfer funds from Regional Banks to the Lead Bank. Just as financial institutions in the United States have become more involved in electronic funds transfer, an international payment system has also developed. International cash management has many differences from domestic-based cash management systems. Payment methods differ from country to country. For example in Poland, Russia, and other Eastern European countries, checks were seldom used in preference to cash, and in other countries, electronic payments are more common than in the United States. International cash management is more complex because liquidity management, involving short-term cash balances and deficits, has to be managed across international boundary and time zones and is subject to the risks of currency fluctuations and interest rate changes in all countries. There are also differences in banking systems and check clearing processes, account balance management, information reporting systems, and cultural, tax, and accounting differences.  A company may prefer to hold cash balances in one currency rather than another or to take advantage of the high interest rates available in a particular country for short-term investments and marketable securities. In periods in which one country's currency is rising in value relative to other currencies, an astute financial manager will try to keep as much cash as possible in the country with the strong currency. In periods in which the dollar is rising relative to other currencies, many balances are held in U.S. bank accounts or in dollar-denominated bank accounts in foreign banks, more commonly known as euro dollar deposits. The international money markets have been growing in scope and size, so these markets have become a much more important aspect of efficient cash management. International and domestic cash managers employ the same techniques and rely on forecasting methods using cash budgets and daily cash reports to predict cash balances. For those companies that are unable to actively manage their cash balances, banks often provide them special accounts to manage their cash flow and earn a return on their excess cash. The sweep account is one such account that allows companies to maintain zero balances with all their access cash swept into an interest-earning account. Most banks have accounts that allow corporate clients to write checks on zero balance accounts with the understanding that when the check is presented for payment, money will be moved from the interest-bearing account to the appropriate account. These examples illustrate the way banks help manage excess cash for their corporate customers. The next post explains how companies manage their own excess cash balances by purchasing marketable securities.  *MAIN SOURCE: BLOCK & HIRT, 2005, FOUNDATIONS OF FINANCIAL MANAGEMENT, 11TH ED., PP. 177-184* end |
