1. T19.1 Chapter Outline Chapter 19 Cash and Liquidity Management Chapter Organization 19.1Reasons for Holding Cash 19.2Understanding Float 19.3Cash Collection and Concentration 19.4Managing Cash Disbursements 19.5 Investing Idle Cash 19.6Summary and Conclusions Appendix: Determining the Target Cash Balance Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc. 2000 CLICK MOUSE OR HIT SPACEBAR TO ADVANCE

2. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc. 2000 T19.2 Key Issues: Cash and Liquidity Management Key issues:  What is the tradeoff between carrying a large versus a small cash balance?  What is the proper management of the cash balance? Preliminaries: understanding float  Identifying the opportunity cost of float  Decreasing the collection float  Increasing disbursement float

3. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc. 2000 T19.3 Reasons for Holding Cash Speculative Motive - the need to hold cash to take advantage of additional investment opportunities, such as bargain purchases. Precautionary Motive - the need to hold cash as a safety margin to act as a financial reserve. Transaction Motive - the need to hold cash to satisfy normal disbursement and collection activities associated with a firm’s ongoing operations. Compensating Balance Requirements - cash balances kept at commercial banks to compensate for banking services the firm receives.

4. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc. 2000 T19.4 Understanding Float Preliminaries: what is float? The difference between book cash and bank cash, representing the net effect of checks in the process of clearing. Types of Float  Disbursement float The result of checks written; decreases book balance but does not immediately change available balance  Collection float The result of checks received; increases book balance but does not immediately change available balance  Net float The overall difference between the firm’s available balance and its book balance

5. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc. 2000 T19.5 Check Clearing Illustrated Payment through debit Payment through credit Check forwarded Check deposited Canceled check Check presented Payor writes checkPayee receives check Federal Reserve Bank or Correspondent Bank or Local Clearinghouse 36 12 45 Payor’s bankPayee’s bank

6. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc. 2000 T19.6 Overview of Lockbox Processing (Figure 19.3) Envelopes opened; separation of checks and receipts Local bank collects funds from post office boxes Deposit of checks into bank account Bank check- clearing process Firm processes receivables Details of receivables go to firm Post office box 1 Post office box 2 Customer payments

7. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc. 2000 T19.7 Lockboxes and Concentration Banks in a Cash Management System (Figure 19.4) Maintenance of compensating balance at creditor bank Short-term investment of cash Disbursements activity Maintenance of cash reserves Firm cash manager Concentration bank Local bank deposits Post office lockbox receipts Customer payments Firm sales office Customer payments Cash manager analyzes bank balance and deposit information and makes cash allocation revision. Statements are sent by mail to firm for receivables processing Funds are transferred to concentration bank

8. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc. 2000 T19.8 Zero-Balance Accounts (Figure 19.5) With zero-balance accounts, the firm keeps a single safety stock of cash in a master account. Funds are transferred into disbursement accounts as needed. With no zero-balance accounts, separate safety stocks must be maintained, thereby tying up cash unnecessarily. Payroll accountSupplier accountMaster account Safety stocks Cash transfers Payroll accountSupplier account No zero-balance accountsTwo zero-balance accounts Safety stock

9. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc. 2000 T19.9 Money Market Securities Risk Money MarketMarketability InstrumentIssuerMaturityDenomination U.S. Treasury BillsU.S. Governmentat issue: 90, 180,no default risk 270, 360 daysgood secondary market $1,000 minimum Short-term municipalState & local1 week to 1 yearsome default risk securitiesgovernmentsgood secondary market $5,000 and up Commercial paperFinance companiesfew weeks tobacked with credit lines Large companies270 daysno secondary market Banks$100,000 and up Negotiable CDsBanksat issue: 30, 60,no deposit insurance 90, 180, 270, andgood secondary market 360 days$100,000 minimum RepurchaseU.S. securityovernight tosecured Agreements (repos)dealers, banksseveral weeksno secondary market $1 million and up

10. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc. 2000 T19.10 Chapter 19 Quick Quiz 1. What are some reasons for firms holding cash? Classical motives: precautionary, transactions, speculative 2. What is the difference between liquidity management and cash management? Liquidity management concerns the optimal quantity of liquid assets to hold; cash management concerns the optimal collection and disbursement of cash 3. What is a controlled-disbursement account? A controlled disbursement account is an account to which the firm transfers an amount that is sufficient to cover demands for payment.