© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Chapter 23: Liquidity Management Corporate Finance, 3e Graham, Smart, and Megginson

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Cash management: The collection, concentration, and disbursement of funds Cash manager responsible for Cash management Financial relationships with banks Cash flow forecasting Investing and borrowing Development and maintenance of information systems for cash management Float: Funds that have been sent by the payer but are not yet usable by the company Mail float Processing float Availability float Clearing float Time Cash Management 2

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Cash Position Management  Management of short-term investing if the company has a surplus of funds and borrowing arrangements if company has a temporary deficit of funds Cash position management: Tasks related to collection, concentration, and disbursement of funds on a daily basis Smaller companies set a target cash balance for their checking accounts. Bank account analysis statement Bank provides report to its customers to show recent activity in firms’ accounts. Banks cannot pay interest on corporate checking account balances. Firms use earnings credit for balances to offset charges. 3

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Collections Primary objective: Speeding up collection of funds from customers and others A firm’s collection system is primarily determined by the nature of its business. Field banking system Collections made over the counter (as at a retail store) or at a collection office (often used by utilities) Point-of-sale (POS) information systems Mail-based system Mail payments are processed at companies’ collection centers. Electronic systems Becoming increasingly popular for both receivers and payers due to reduced float, lower costs, and better forecasting. 4

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Collections Lockbox system Speeds up collections because it affects all components of float. Customers mail payments to a post office box. Firm’s bank empties the box and processes each payment and deposits the payments in the firm’s account. Lockboxes reduce mail and clearing time. Perform cost-benefit analysis to determine if lockbox system is worth using. Net benefit or cost = (FVR × r a ) – LC FVR = float value reduction in dollars r a = cost of capital LC = annual operating cost of the lockbox system 5

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part.  Cash concentration is the process of bringing the lockbox and other deposits together into one bank, commonly called the concentration bank.  Advantages of cash concentration:  Creates large pool of funds for use in making short- term cash investments  Improves tracking and internal control of cash  Allows firm to implement more effective payment strategies that preserve its invested balances for as long as possible Cash Concentration 6

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Funds Transfer Mechanisms Automated clearinghouse debit transfers Preauthorized electronic withdrawal from the payer’s account Settles accounts among participating banks. Individual accounts are settled by respective bank balance adjustments. Transfers clear in one day. Wire transfers Electronic communication that, via bookkeeping entries, removes funds from the payer’s bank and deposits the funds in the payee’s bank on a same-day basis. Expensive – used only for high-dollar payments Fedwire is the primary wire transfer system in the U.S. 7

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Accounts Payable Management Management of time from purchase of raw materials until payment is placed in the mail Accounts payable functions Examine all incoming invoices and determine the amount to be paid Control function: cash manager verifies that invoice information matches purchase order and receiving information Decide between centralized or decentralized payables and payments systems 8

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. d = percent discount (in decimal form) CP = credit period DP = (cash) discount period Cash Discounts If supplier offers cash discounts, choose the better alternative between paying at the end of credit period and taking the discount. 9

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Disbursements Products and Methods  Zero-balance accounts (ZBAs): Disbursements accounts that always have end-of-day balance of zero  Controlled disbursement: Bank provides early notification of checks presented against a company’s account every day.  Positive pay: Company transmits to the bank a check- issued file to the bank when checks are issued. 10

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Developments in Accounts Payable and Disbursements  Integrated (comprehensive) accounts payable: Outsourcing of accounts payable or disbursements operations  Purchasing/procurement cards: Increased use of credit cards for low-dollar indirect purchases  Imaging services: Both sides of the check, as well as remittance information, are converted into digital images.  Especially useful when incorporated with positive-pay services 11

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Developments in Accounts Payable and Disbursements  Fraud prevention measures in disbursements  Written policies and procedures for creating and disbursing checks  Separating check-issuance duties (approval, signing, reconciliation)  Using safety features on checks (microprinting, watermarks, tamper resistance)  Setting maximum dollar limits and/or requiring multiple signatures  Using positive-pay services  Increasing the use of electronic pay methods 12

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Short-Term Investing  Instead of keeping excess balances in non-interest-bearing accounts, a company will hold some “near-cash” assets in the form of short-term investments, often labeled marketable securities.  Primary concerns are providing liquidity and preserving principal 13

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Short-Term Investing  Marketable securities:  Money market mutual funds  Money market financial instruments  U.S. Treasuries  Federal agency issues  Bank financial instruments (CDs, time deposits, banker’s acceptances)  Corporate obligations (commercial paper, adjustable rate preferred stock) 14

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Yield Calculations for Discount Instruments  Yield for short-term discount investments such as T-bills and commercial paper are typically calculated using algebraic approximations rather than precise present value methods.  In a discount investment, investor pays less than face value at time of purchase, and receives face value at its maturity date.  Generally no interim interest or coupon payments during the course of holding such an investment. 15

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. Short-Term Borrowing  Variable-rate basis  Base rate + spread = all-in-rate  Typical base rates include the prime rate and LIBOR  For lines of credit, banks often require commitment fees and/or compensating balances. 16