Week 9

Cash
Cash and
and Marketable
Marketable
Securities
Securities Management
Management

9.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 After Studying this module, you
should be able to:
1. List and explain the motives for holding cash.
2. Understand the purpose of efficient cash management.
3. Describe methods for speeding up the collection of accounts receivable and methods
for controlling cash disbursements.
4. Differentiate between remote and controlled disbursement, and discuss any ethical
concerns raised by either of these two methods.
5. Discuss how electronic data interchange (EDI) and outsourcing each relates to a
company’s cash collections and disbursements
6. Identify the key variables that should be considered before purchasing any
marketable securities.
7. Define the most common money-market instruments that a marketable securities
portfolio manager would consider for investment.
8. Describe the three segments of the marketable securities portfolio and note which
securities are most appropriate for each segment and why.
9.2 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Cash and Marketable
Securities Management

• Motives for Holding Cash

• Speeding Up Cash Receipts
• S-l-o-w-i-n-g D-o-w-n Cash Payouts
• Electronic Commerce

9.3 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Cash and Marketable
Securities Management

• Outsourcing
• Cash Balances to Maintain
• Investment in Marketable
Securities

9.4 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Motives for Holding Cash
Transactions Motive – to meet payments arising in
the ordinary course of business
Speculative Motive – to take advantage of
temporary opportunities
Precautionary Motive – to maintain a cushion or
buffer to meet unexpected cash needs

9.5 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Cash Management System
Collections Disbursements

Marketable securities
investment

Control through information reporting

= Funds Flow = Information Flow

9.6 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Speeding Up
Cash Receipts
Collections
• Expedite preparing and mailing the invoice
• Accelerate the mailing of payments from
customers
• Reduce the time during which payments received
by the firm remain uncollected

9.7 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Collection Float

Mail Processing Availability

Float Float Float

Deposit Float

Collection Float: Total time between the mailing

of the check by the customer and the availability
of cash to the receiving firm.

9.8 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Mail Float

Customer Firm
mails check receives check

Mail Float: Time the check is in the mail.

9.9 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Processing Float

Firm Firm
receives check deposits check

Processing Float: Time it takes a company

to process the check internally.

9.10 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Availability Float

Firm Firm’s bank

deposits check account credited

Availability Float: Time consumed in clearing

the check through the banking system.

9.11 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Deposit Float

Processing Float Availability Float

Deposit Float: Time during which the check

received by the firm remains uncollected funds.

9.12 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Earlier Billing
Accelerate preparation and mailing of invoices
• computerized billing
• invoices included with shipment
• invoices are faxed
• advance payment requests
• preauthorized debits

9.13 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Preauthorized Payments
Preauthorized debit
The transfer of funds from a payor’s bank account on a
specified date to the payee’s bank account; the
transfer is initiated by the payee with the payor’s
advance authorization.

9.14 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Lockbox Systems
Traditional Lockbox
A post office box maintained by a firm’s bank that is
used as a receiving point for customer remittances.
Electronic Lockbox
A collection service provided by a firm’s bank that
receives electronic payments and accompanying
remittance data and communicates this information to
the company in a specified format.

9.15 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Lockbox Process*
• Customers are instructed to mail their remittances to
the lockbox location.
• Bank picks up remittances several times daily from
the lockbox.
• Bank deposits remittances in the customers account
and provides a deposit slip with a list of payments.
• Company receives the list and any additional mailed
items.

* Based on the traditional lockbox system

9.16 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Lockbox System
Advantage
Receive remittances sooner which reduces
processing float.

Disadvantage
Cost of creating and maintaining a lockbox
system. Generally, not advantageous for small
remittances.

9.17 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Concentration Banking
Cash Concentration
The movement of cash from lockbox or field
banks into the firm’s central cash pool residing
in a concentration bank.
Compensating Balance
Demand deposits maintained by a firm to
compensate a bank for services provided, credit
lines, or loans.

9.18 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Collections Improvements
Accounts Receivable Conversion
A process by which paper checks are converted
into ACH debits at lockboxes or other
collection sites.
So what is the Benefit of ARCs?
Reduces availability float associated with check
clearing.

9.19 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Concentration Banking
Moving cash balances to
a central location:
• Improves control over inflows and outflows
of corporate cash.
• Reduces idle cash balances to a minimum.
• Allows for more effective investments by
pooling excess cash balances.

9.20 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Concentration Services for
Transferring Funds
(1) Depository Transfer Check (DTC)
Definition: A non-negotiable check payable to a
single company account at a
concentration bank.
Funds are not immediately available upon
receipt of the DTC.

9.21 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Concentration Services for
Transferring Funds
(2) Automated Clearinghouse
(ACH) Electronic Transfer
Definition: An electronic version of the
depository transfer check (DTC).
(1) Electronic check image version of the DTC.
(2) Cost is not significant and is replacing DTC.

9.22 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Concentration Services for
Transferring Funds
(3) Wire Transfer
Definition: A generic term for electronic funds
transfer using a two-way
communications system, like
InstaPay.
Funds are available upon receipt of the wire
transfer. Much more expensive.

9.23 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 S-l-o-w-i-n-g D-o-w-n
Cash Payouts
• “Playing the Float”
• Control of Disbursements
• Payable through Draft (PTD)
• Payroll and Dividend
Disbursements
• Zero Balance Account (ZBA)
• Remote and Controlled Disbursing

9.24 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 “Playing the Float”
Net Float -- The peso difference between the
balance shown in a firm’s (or individual’s)
checkbook balance and the balance on the bank’s
books.
You write a check today, which is subtracted from your
calculation of the account balance. The check has not cleared,
which creates float. You can potentially earn interest on
money that you have “spent.”

9.25 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Control of Disbursements
Firms should be able to:
1. shift funds quickly to banks from which
disbursements are made.
2. generate daily detailed information on
balances, receipts, and disbursements.
Solution:
Centralize payables into a single (smaller number of)
account(s). This provides better control of the
disbursement process.
9.26 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Methods of Managing
Disbursements
Payable Through Draft (PTD):
A check-like instrument that is drawn against the payor
and not against a bank as is a check. After a PTD is
presented to a bank, the payor gets to decide whether to
honor or refuse payment.
• Delays the time to have funds on deposit to cover
the draft.
• Some suppliers prefer checks.
• Banks will impose a higher service charge due to
the additional handling involved.
9.27 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Methods of Managing
Disbursements
Payroll and Dividend Disbursements
The firm attempts to determine when payroll and
dividend checks will be presented for collection.
• Many times a separate account is set up to handle each
of these types of disbursements.
• A distribution schedule is projected based on past
experiences. [See the next slide]
• Funds are deposited based on expected needs.
• Minimizes excessive cash balances.
9.28 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Percentage of Payroll Checks
Collected
100%
The firm may plan on
payroll checks being
75% presented in a similar
Payroll Collected

pattern every pay period.

Percent of

50%

25%

0%

F M T W H F M and after
(Payday)

9.29 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Methods of Managing
Disbursements
Zero Balance Account (ZBA):
A corporate checking account in which a zero balance is
maintained. The account requires a master (parent)
account from which funds are drawn to cover negative
balances or to which excess balances are sent.

• Eliminates the need to accurately estimate

each disbursement account.
• Only need to forecast overall cash needs.
9.30 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Remote and Controlled
Disbursing
Remote Disbursement – A system in which the firm
directs checks to be drawn on a bank that is
geographically remote from its customer so as to
maximize check-clearing time.
This maximizes disbursement float.

Example: A Vermont business pays a Maine supplier with a

check drawn on a bank in Montana.
This may stress supplier relations, and raises ethical issues.

9.31 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Remote and Controlled
Disbursing
Controlled Disbursement – A system in which the
firm directs checks to be drawn on a bank (or
branch bank) that is able to give early or mid-
morning notification of the total peso amount of
checks that will be presented against its account
that day.
Late check presentments are minimal, which allows more
accurate predicting of disbursements on a day-to-day
basis.
9.32 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Electronic Commerce
Electronic Commerce – The exchange of business
information in an electronic (non-paper) format,
including over the Internet.
Messaging systems can be:
1. Unstructured – utilize technologies such as
faxes and e-mails
2. Structured – utilize technologies such as
electronic data interchange (EDI).
9.33 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Electronic Data
Interchange (EDI)
Electronic Data Interchange – The movement of
business data electronically in a structured,
computer-readable format.

Electronic Funds Transfer (EFT)

EDI
Financial EDI (FEDI)

9.34 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Electronic Funds
Transfer (EFT)
Electronic Funds Transfer (EFT) – the electronic
movements of information between two depository
institutions resulting in a value (money) transfer.

Electronic Funds Transfer (EFT)

EDI Society of Worldwide Interbank Financial Telecommunications
(SWIFT)
Subset Clearinghouse Interbank Payments System (CHIPS)

9.35 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Financial EDI (FEDI)
Financial EDI – The movement of financially related
electronic information between a company and its bank or
between banks.

Financial EDI (FEDI)

EDI Examples include:
Subset Lockbox remittance information
Bank balance information
9.36 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Costs and Benefits of EDI
Costs Benefits
• Computer hardware and • Information and payments
software expenditures move faster and with greater
• Increased training costs to reliability
implement and utilize an EDI • Improved cash forecasting and
system cash management
• Additional expenses to • Customers receive faster and
convince suppliers and more reliable service
customers to use the
electronic system • Reduction in mail, paper, and
• Loss of float document storage costs

9.37 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Outsourcing
Outsourcing – Subcontracting a certain business
operation to an outside firm, instead of doing it
“in-house.”
Why might a firm outsource?*
1. Reducing and controlling operating costs
2. Improve company focus (close 2nd)
3. Freeing resources for other purposes
* The Outsourcing Institute, 2005

9.38 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Outsourcing
Business Process Outsourcing (BPO)
A form of outsourcing in which the entire
business process is handed over to a third-
party service provider
• Entire function such as accounting might be
handed over to the BPO
• Typically found in low labor cost countries
• Many are owned by large multinationals

9.39 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Cash Balances to Maintain
The optimal level of cash should be the
larger of:
(1) The transaction balances required when
cash management is efficient.
(2) The compensating balance requirements
of commercial banks.

9.40 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Investment in Marketable
Securities
Note regarding the management of marketable
securities.
• Marketable Securities are shown on the
balance sheet as “Short-term Investments”

9.41 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 The Marketable Securities
Portfolio
Ready Cash
Segment (R₱)
F₱
R₱ Optimal balance of
marketable securities
C₱ held to take care of
probable deficiencies in
the firm’s cash account.
9.42 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 The Marketable Securities
Portfolio
Controllable Cash Segment
(C₱)

F₱
R₱ Marketable securities
held for meeting
C₱ controllable (knowable)
outflows, such as taxes
and dividends.

9.43 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 The Marketable Securities
Portfolio
Free Cash Segment (F₱)

F₱ “Free” marketable
R₱ securities (that is,
available for as yet
C₱ unassigned purposes).

9.44 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Variables in Marketable
Securities Selection
Safety
Refers to the likelihood of getting back the same
number of pesos you originally invested (principal).

Marketability (or Liquidity)

The ability to sell a significant volume of securities
in a short period of time in the secondary market
without significant price concession.

9.45 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Variables in Marketable
Securities Selection
Interest Rate (or Yield) Risk
The variability in the market price of a
security caused by changes in interest rates.

Maturity
Refers to the remaining life of the security.

9.46 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Common Money Market
Instruments
Money Market Instruments
All government securities and short-term corporate
obligations. (Broadly defined)
• Treasury Bills (T-bills): Short-term, non-
interest bearing obligations of the Philippine
Bureau of Treasury issued at a discount and
redeemed at maturity for full face value.
Minimum ₱100 amount and ₱100
increments thereafter.
9.47 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 T-Bills and Bond Equivalent Yield
(BEY) Method:
BEY = [ (FA – PP) / (PP) ] *[ 365 / DM ]
• FA: face amount of security
• PP: purchase price of security
• DM: days to maturity of security

A ₱1,000, 13-week T-bill is purchased for ₱990 – what is its BEY?

BEY = [ (1000 – 990) / (990) ] *[ 365 / 91 ]

BEY = 4.05%
9.48 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 T-Bills and Equivalent Annual
Yield (EAY) Method:
EAY = (1 + [ BEY / (365 / DM) ] )365/DM - 1
• BEY: bond equivalent yield from the previous slide
• DM: days to maturity of security

Calculate the EAY of the ₱1,000, 13-week T-bill purchased for ₱990 described on the
previous slide?

EAY = (1 + [.0405/(365 / 91)])365/91 - 1

EAY = 4.11%

9.49 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.