Principles of Corporate Finance Seventh Edition Richard A. Brealey Stewart C. Myers Chapter 31 Cash Management Slides by Matthew Will McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved

Topics Covered Cash Collection and Disbursement Systems Managing Float How Much Cash Should the Firm Hold? Investing Idle Cash Money Market Investments Floating Rate Preferred Stock

Float Time exists between the moment a check is written and the moment the funds are deposited in the recipient’s account. This time spread is called Float. Payment Float - Checks written by a company that have not yet cleared. Availability Float - Checks already deposited that have not yet cleared. 3

Company’s ledger balance Float Payment Float illustration - The company issues a $200,000 check that has not yet cleared. Company’s ledger balance $800,000 Payment float $200,000 + equals Bank’s ledger balance $1,000,000 6

Company’s ledger balance Float Availability Float illustration - The company deposits a $100,000 check that has not yet cleared. Company’s ledger balance $900,000 + Payment float $200,000 equals Bank’s ledger balance $1,100,000 9

Float Net Float illustration Net float = payment float - availability float Bank’s ledger balance $1,100,000 equals Available balance $1,000,000 + Availability float $100,000 12

Managing Float Payers attempt to create delays in the check clearing process. Recipients attempt to remove delays in the check clearing process. Sources of delay Time it takes to mail check Time for recipient to process check Time for bank to clear check 16

Managing Float Check mailed Check received Mail float Check deposited Processing float Presentation float Cash available to recipient Check charged to payer’s account Availability 20

Managing Float Concentration Banking - system whereby customers make payments to a regional collection center which transfers the funds to a principal bank. Lock-Box System - System whereby customers send payments to a post office box and a local bank collects and processes checks. Zero-Balance Accounts - Regional bank accounts to which just enough funds are transferred daily to pay each day’s bills. 21

Money Markets Money Market - market for short term financial assets. commercial paper certificates of deposit repurchase agreements 26

Inventories & Cash Balances Economic Order Quantity - Order size that minimizes total inventory costs. 23

Inventories & Cash Balances Determination of optimal order size Total costs Carrying costs Inventory costs, dollars Total order costs Order size Optimal order size 24

Inventories & Cash Balances The optimal amount of short term securities sold to raise cash will be higher when annual cash outflows are higher and when the cost per sale of securities is higher. Conversely, the initial cash balance falls when the interest is higher. 25

Inventories & Cash Balances (Everyman’s Bookstore) balance ($000) 25 Average 12.5 inventory 1 2 3 4 5 Weeks Value of bills sold = Q = 2 x annual cash disbursement x cost per sale interest rate 2 x 1260 x 20 .08 = = 25