1. Short-Term Financial Management
Chapter 10 – Cash Concentration

2. Chapter 10 Agenda
Understand the need for a cash concentration system, formulate a cash transfer decision model, and discuss the advantages and disadvantages of the various cash transfer tools.

3. Cash Flow Timeline The firm is a system of cash flows.
These cash flows are unsynchronized and uncertain.
The cash conversion period is the time between when cash is received versus paid.
The shorter the cash conversion period, the more efficient the firm’s working capital.

4. Cash Concentration
Lockbox or not, it is common for large firms to have multiple accounts at multiple banks (collection or gathering banks), based on:
Purpose (operating, payables, payroll, etc.)
Location (division/stores/branches, number of cities, etc.)
Maintaining idle balances dispersed across many accounts at multiple banks ties up cash (opportunity cost).

5. Cash Concentration Timeline

6. Types of Concentration Systems
Firms have two, basic concentration system options:
Decentralized Transfer Initiation
The firm manually transfers funds to a single account periodically.
It is time-consuming, expensive, has larger time intervals between transfers, and the firm does not know which funds are collected and available for transfer.
Centralized Transfer Initiation
Banks provide concentration services to electronically pool funds into a single bank (the concentration bank).
The firm has greater control over funds and gains economies of scale managing big blocks of funds.

7. Concentration System Costs
Regardless of concentration system type, firms want to maximum the concentration of funds while minimizing ‘transfer costs’ and administrative costs.
All balances and analysis charges can be combined for analysis purposes.
Utilization of a ‘national’ bank can minimize concentration issues.

8. Decentralized Concentration
If the firm is initiating the transfer, two options (which vary in cost and performance) include:
EDT (Electronic Depository Transfer; an ACH item)
The ‘concentration bank’ initiates transfers from the ‘collection’ or ‘gathering’ banks on a next-day basis.
Wire Transfer
An immediate transfer of funds with immediate availability.
Wires are expensive with an incoming and outgoing charge.
Only collected funds can be transferred.

9. Decentralized Transfers
If the firm uses decentralized transfers, there is some minimum transfer amount representing the ‘breakeven point’ of the incremental cost and associated benefit between ACH and wires.
Where:
DS = Number of days saved with faster transfer method
i = Annual opportunity cost
ECR = Earnings Credit Rate
rrr = Required Reserve Ratio
TBAL = Balance to be transferred.

10. Decentralized Transfer Example
A firm is choosing between wires and EDT.
Wires cost more, but have longer float.
What minimum transfer amount justifies the use of wires?

11. Decentralized Transfer Example
Transfers must be at least this amount to justify using wires versus EDT.
Where:
DS = # of days saved with faster transfer method
i = Annual opportunity cost
ECR = Earnings Credit Rate
rrr = Required Reserve Ratio
TBAL = Balance to be transferred.

12. Centralized Concentration Services

13. Cash Concentration Analysis
Data was collected for a national department store chain. The chart shows the total, daily remittances, which are deposited into multiple banks. Funds are wire transferred to the company’s main bank once a week, which is expensive, time-consuming, and leaves funds idle. The firm is considering concentration services to its main bank to ‘concentrate’ funds daily.
There is no weekend bank check processing.
50% of deposits are immediately available and 50% clear in 1-Day.
The firm automatically transfers for the deposit amount the same day, which clears on a next- day basis.

14. Cash Concentration Analysis
Create a 2-week schedule of deposit/transfer clearing activity.
Organize the deposit activity beginning with Friday to account for the lack of weekend processing. Cash and checks received over the weekend are combined with Monday’s deposit.

15. Cash Concentration Analysis
Create a 2-week schedule of deposit/transfer clearing activity.
Add funds availability

16. Cash Concentration Analysis
Create a 2-week schedule of deposit/transfer clearing activity.
Ending Ledger Balance = Previous Ledger Balance + Current Day's Deposit - Transfers Clearing Same Day
Add Daily Transfers and calculate Ledger Balance

17. Cash Concentration Analysis
Create a 2-week schedule of deposit/transfer clearing activity.
Collected Balance = Previous Day's Collected Funds + Current Day's Immediately Available Funds + Funds Now Available From Previous Day’s Deposits
Calculate Collected Balance
Calculat Collected Balance

18. Cash Concentration Analysis
Create a 2-week schedule of deposit/transfer clearing activity.
Average Collected Balance is the new collected balances available. This would be compared to the EXISTING collected balances. The difference in costs (or RCMP) is then woven into the analysis to ascertain the benefit.
Calculate Average Collected Balance for ‘steady state’

19. Cash Transfer Scheduling
Scheduling transfers is complicated by:
Fluctuations in daily deposits
Varying availability
Difficulty in matching time delay in deposit instrument with availability schedule.
No weekend banking

20. Cash Transfer Scheduling
Guidelines for cash concentration
Daily Transfer rule
Transfer all available balances every day
Managing about a target
Begin with $0 in account
Transfer when average daily balance reaches target (RCMP?)
Anticipation
Transfer expected available balance (requires a forecasting system)
Weekend timing
Friday balances have 3-day opportunity cost