502331_Cash and Marketable Securities Management

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

Chapter 9Chapter 9

Cash and Marketable Cash and Marketable Securities Securities

ManagementManagement

Cash and Marketable Cash and Marketable Securities Securities

ManagementManagement


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.

After Studying Chapter 9, After Studying Chapter 9, you should be able to:you should be able to:


• Motives for Holding Cash• Speeding Up Cash Receipts• S-l-o-w-i-n-g D-o-w-n

Cash Payouts• Electronic Commerce

Cash and Marketable Cash and Marketable Securities ManagementSecurities Management


• Outsourcing• Cash Balances to Maintain• Investment in Marketable

Securities

Cash and Marketable Cash and Marketable Securities ManagementSecurities Management


Transactions MotiveTransactions Motive – to meet payments arising in the ordinary course of business

Speculative MotiveSpeculative Motive – to take advantage of temporary opportunities

Precautionary MotivePrecautionary Motive – to maintain a cushion or buffer to meet unexpected cash needs

Motives for Holding CashMotives for Holding Cash


Collections Disbursements

Marketable securitiesinvestment

Control through information reporting

= Funds Flow = Information Flow

Cash Management SystemCash Management System


• 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

Collections

Speeding Up Speeding Up Cash ReceiptsCash Receipts


Collection FloatCollection Float: Total time between the mailingof the check by the customer and the availability

of cash to the receiving firm.

ProcessingProcessingFloatFloat

AvailabilityAvailabilityFloatFloat

MailMailFloatFloat

Deposit FloatDeposit Float

Collection FloatCollection Float


Mail FloatMail Float: Time the check is in the mail.

Customer Customer mails checkmails check

FirmFirmreceives checkreceives check

Mail FloatMail Float


Processing FloatProcessing Float: Time it takes a companyto process the check internally.

FirmFirmdeposits checkdeposits check

FirmFirmreceives checkreceives check

Processing FloatProcessing Float


Availability FloatAvailability Float: Time consumed in clearingthe check through the banking system.

FirmFirmdeposits checkdeposits check

Firm’s bankFirm’s bankaccount creditedaccount credited

Availability FloatAvailability Float


Deposit FloatDeposit Float: Time during which the check received by the firm remains uncollected funds.

Processing FloatProcessing Float Availability FloatAvailability Float

Deposit FloatDeposit Float


Accelerate preparation and mailing of invoices

• computerized billing

• invoices included with shipment

• invoices are faxed

• advance payment requests

• preauthorized debits

Earlier BillingEarlier Billing


Preauthorized debit 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.

Preauthorized PaymentsPreauthorized Payments


Traditional LockboxTraditional LockboxA post office box maintained by a firm’s bank that is used as a receiving point for customer

remittances.

Electronic LockboxElectronic LockboxA 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.

Lockbox SystemsLockbox Systems


• 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

Lockbox Process*Lockbox Process*


DisadvantageDisadvantage

Cost of creating and maintaining a lockbox system. Generally, not

advantageous for small remittances.

AdvantageAdvantage

Receive remittances sooner which reduces processing float.

Lockbox SystemLockbox System


Compensating BalanceCompensating Balance

Demand deposits maintained by a firm to compensate a bank for services

provided, credit lines, or loans.

Cash ConcentrationCash Concentration

The movement of cash from lockbox or field banks into the firm’s central cash pool residing in a concentration bank.

Concentration BankingConcentration Banking


Reduces availability float associated with check clearing.

Accounts Receivable ConversionAccounts 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?So what is the Benefit of ARCs?

Collections ImprovementsCollections Improvements


Check Clearing for the 21Check Clearing for the 21stst Century Act Century Act

“Check 21”: US, Federal law that facilitates electronic check exchange by enabling banks to exchange check image files

electronically and, where necessary, to create legally equivalent paper “substitute checks” from images for presentment to

banks that have not agreed to accept checks electronically.



Check 21Check 21• Driven by September 11, 2001 attacks

• Meant to foster innovation and encourage the move from paper checks to electronic payment processing to create cost and time benefits for financial institutions

• Requires banks to accept substitute checks (a paper copy of an electronic image of both sides of the original check) as the legal equivalent of the original paper check

• Cleared the legal path to allow ‘remote deposit capture’



• 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.

Moving cash balances to Moving cash balances to a central location:a central location:

Concentration BankingConcentration Banking


Definition: A non-negotiable check payable to a single company account at a concentration bank.

Funds are not immediately available Funds are not immediately available upon receipt of the DTC.upon receipt of the DTC.

(1) Depository Transfer Check (DTC)(1) Depository Transfer Check (DTC)

Concentration Services Concentration Services for Transferring Fundsfor Transferring Funds


Definition: An electronic version of the depository transfer check (DTC).

(1) Electronic check image version of Electronic check image version of the DTC.the DTC.

(2) Cost is not significant and is (2) Cost is not significant and is replacing DTC. replacing DTC.

(2) Automated Clearinghouse (2) Automated Clearinghouse (ACH) Electronic Transfer (ACH) Electronic Transfer



Definition: A generic term for electronic funds transfer using a two-way communications system, like Fedwire.

Funds are available upon receipt of the Funds are available upon receipt of the wire transfer. Much more expensive.wire transfer. Much more expensive.

(3) Wire Transfer(3) Wire Transfer



• “Playing the Float”

• Control of Disbursements• Payable through Draft (PTD)• Payroll and Dividend

Disbursements• Zero Balance Account (ZBA)

• Remote and Controlled Disbursing

S-l-o-w-i-n-g D-o-w-n S-l-o-w-i-n-g D-o-w-n Cash PayoutsCash Payouts


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.”

Net FloatNet Float -- The dollar difference between the balance shown in a firm’s (or

individual’s) checkbook balance and the balance on the bank’s books.

““Playing the Float”Playing the Float”


SolutionSolution::

Centralize payables into a single (smaller number of) account(s). This provides better

control of the disbursement process.

Firms should be able toFirms 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.

Control of DisbursementsControl of Disbursements


• Delays the time to have funds on deposit Delays the time to have funds on deposit to cover the draft.to cover the draft.

• Some suppliers prefer checks.Some suppliers prefer checks.• Banks will impose a higher service charge Banks will impose a higher service charge

due to the additional handling involved. due to the additional handling involved.

Payable Through Draft (PTD)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.

Methods of Managing Methods of Managing DisbursementsDisbursements


• Many times a separate account is set up to Many times a separate account is set up to handle each of these types of disbursements.handle each of these types of disbursements.

• A distribution schedule is projected based on A distribution schedule is projected based on past experiences. [See the next slide]past experiences. [See the next slide]

• Funds are deposited based on expected needs.Funds are deposited based on expected needs.• Minimizes excessive cash balances.Minimizes excessive cash balances.

Payroll and Dividend DisbursementsPayroll and Dividend DisbursementsThe firm attempts to determine when payroll and dividend checks will be presented for collection.



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

Per

cen

t o

fP

erce

nt

of

Pay

roll

Co

llec

ted

Pay

roll

Co

llec

ted

100%

75%

50%

25%

0%

The firm may plan onpayroll checks beingpresented in a similar

pattern every pay period.

Percentage of Payroll Percentage of Payroll Checks CollectedChecks Collected


• Eliminates the need to accurately Eliminates the need to accurately estimate each disbursement account.estimate each disbursement account.

• Only need to forecast overall cash needs.Only need to forecast overall cash needs.

Zero Balance Account (ZBA)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.



Example: Example: A Vermont business pays a Maine supplier with a check drawn on a bank in Montana.

This This maymay stress supplier relations, and raises ethical stress supplier relations, and raises ethical issues.issues.

Remote DisbursementRemote 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. This maximizes disbursement float.

Remote and Remote and Controlled DisbursingControlled Disbursing


Late check presentments are minimal, which Late check presentments are minimal, which allows more accurate predicting of allows more accurate predicting of

disbursements on a day-to-day basis.disbursements on a day-to-day basis.

Controlled DisbursementControlled 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 dollar amount of checks that will

be presented against its account that day.

Remote and Remote and Controlled DisbursingControlled Disbursing


Messaging systems can be:1. UnstructuredUnstructured – utilize technologies

such as faxes and e-mails faxes and e-mails

2. 2. StructuredStructured – utilize technologies such such as as electronic data interchange (EDI)electronic data interchange (EDI)..

Electronic Commerce Electronic Commerce – The exchange of business information in an electronic (non-paper) format, including over the Internet.

Electronic CommerceElectronic Commerce


Electronic Data InterchangeElectronic Data Interchange – The movement of business data electronically

in a structured, computer-readable format.

EDIEDIElectronic Funds Transfer (EFT)Electronic Funds Transfer (EFT)

Financial EDI (FEDI)Financial EDI (FEDI)

Electronic Data Electronic Data Interchange (EDI)Interchange (EDI)


Electronic Funds Transfer (EFT)Electronic Funds Transfer (EFT) – the electronic movements of information between two

depository institutions resulting in a value (money) transfer.

EDIEDISubsetSubset

Electronic Funds Transfer (EFT)Electronic Funds Transfer (EFT)

Society of Worldwide Interbank Financial Telecommunications (SWIFT)

Clearinghouse Interbank Payments System (CHIPS)

Electronic Funds Electronic Funds Transfer (EFT)Transfer (EFT)


EFT RegulationEFT Regulation

In January 1999, a regulation that required ALL federal government payments be made electronically.* This:

• provides more security than paper checks and• is cheaper to process for the government.

* Except tax refunds and special waiver situations

Electronic Funds Electronic Funds Transfer (EFT)Transfer (EFT)


Financial EDIFinancial EDI – The movement of financially related electronic information between a

company and its bank or between banks.


Examples includeExamples include:

Lockbox remittance information

Bank balance information

EDIEDISubsetSubset



CostsCosts• Computer hardware and

software expenditures

• Increased training costs to implement and utilize an EDI system

• Additional expenses to convince suppliers and customers to use the electronic system

• Loss of float

BenefitsBenefits• Information and payments

move faster and with greater reliability

• Improved cash forecasting and cash management

• Customers receive faster and more reliable service

• Reduction in mail, paper, and document storage costs

Costs and Benefits of EDICosts and Benefits of EDI


1. Reducing and controlling operating costs

2. Improve company focus (close 2nd)3. Freeing resources for other purposes

* The Outsourcing Institute, 2005

OutsourcingOutsourcing – Subcontracting a certain business operation to an outside firm,

instead of doing it “in-house.”

Why might a firm outsource?* Why might a firm outsource?*

OutsourcingOutsourcing


Business Process Outsourcing (BPO)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

OutsourcingOutsourcing


The optimal level of cash should The optimal level of cash should be the larger of:be the larger of:

(1) The transaction balances required when cash management is efficient.

(2) The compensating balance requirements of commercial banks.

Cash Balances to MaintainCash Balances to Maintain


Note regarding the management Note regarding the management of marketable securities.of marketable securities.

• Marketable Securities are shown on the balance sheet as “Short-term Investments”

Investment in Investment in Marketable SecuritiesMarketable Securities


Ready Cash Ready Cash Segment (R$)Segment (R$)

Optimal balance of Optimal balance of marketable securities marketable securities

held to take care of held to take care of probable deficiencies probable deficiencies

in the firm’s cash in the firm’s cash account.account.

R$F$

C$

The Marketable The Marketable Securities PortfolioSecurities Portfolio


Controllable Cash Controllable Cash Segment (C$)Segment (C$)

Marketable securities Marketable securities held for meeting held for meeting

controllable controllable (knowable) outflows, (knowable) outflows,

such as taxes and such as taxes and dividends.dividends.

R$F$

C$



Free Cash Free Cash Segment (F$)Segment (F$)

““Free” marketable Free” marketable securities (that is, securities (that is, available for as yet available for as yet

unassigned unassigned purposes).purposes).

R$F$

C$



Marketability (or Liquidity)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.

SafetySafetyRefers to the likelihood of getting back the

same number of dollars you originally invested (principal).

Variables in MarketableVariables in MarketableSecurities SelectionSecurities Selection


MaturityMaturity

Refers to the remaining life of the security.

Interest Rate (or Yield) RiskInterest Rate (or Yield) Risk

The variability in the market price of a security caused by changes in

interest rates.

Variables in Marketable Variables in Marketable Securities SelectionSecurities Selection


• Treasury Bills (T-bills)Treasury Bills (T-bills): : Short-term, non-interest bearing obligations of the US Treasury issued at a discount and redeemed at maturity for full face value. Minimum $100 amount and $100 increments thereafter.

Money Market InstrumentsMoney Market InstrumentsAll government securities and short-term corporate obligations. (Broadly defined)

Common Money Common Money Market InstrumentsMarket Instruments


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

BEY = 4.05%

T-Bills and Bond Equivalent T-Bills and Bond Equivalent Yield (BEY) Method: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?


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

EAY = 4.11%

T-Bills and Equivalent T-Bills and Equivalent Annual Yield (EAY) Method: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?


• Treasury BondsTreasury Bonds: : Long-term (more than 10 years’ original maturity) obligations of the US Treasury.

• Treasury NotesTreasury Notes: : Medium-term (2-10 years’ original maturity) obligations of the US Treasury.



• Bankers’ Acceptances (BAs)Bankers’ Acceptances (BAs): : Short-term promissory trade notes for which a bank (by having “accepted” them) promises to pay the holder the face amount at maturity.

• Repurchase Agreements (RPs; repos)Repurchase Agreements (RPs; repos): : Agreements to buy securities (usually Treasury bills) and resell them at a higher price at a later date.



• European Commercial PaperEuropean Commercial Paper: : See above, except maturities extend to one year and more active secondary market.

• Commercial PaperCommercial Paper: : Short-term, unsecured promissory notes, generally issued by large corporations (unsecured IOUs). The largest dollar-volume instrument in US. Maturities don’t exceed 270 days to preclude SEC registration.



• Federal Agency SecuritiesFederal Agency Securities: : Debt securities issued by federal agencies and government-sponsored enterprises (GSEs). Examples: FFCB, FNMA, and FHLMC.

• Negotiable Certificate of DepositNegotiable Certificate of Deposit: : A large-denomination investment in a negotiable time deposit at a commercial bank or savings institution paying a fixed or variable rate of interest for a specified period of time.



• Money Market Preferred StockMoney Market Preferred Stock: : Preferred stock having a dividend rate that is reset at auction every 49 days.

• EurodollarsEurodollars: : A US dollar-denominated deposit – generally in a bank located outside the United States – not subject to US banking regulations



Ready Cash Ready Cash Segment (R$)Segment (R$)

Safety and ability to Safety and ability to convert to cash is convert to cash is most important.most important.

Select Select USUSTreasuries Treasuries for this for this

segment.segment.

R$F$

C$

Selecting Securities for Selecting Securities for the Portfolio Segmentsthe Portfolio Segments


Controllable Cash Controllable Cash Segment (C$)Segment (C$)

Marketability less Marketability less important. Possibly important. Possibly match time needs.match time needs.

May select May select CDs, CDs, repos, BAs, eurosrepos, BAs, euros for for

this segment.this segment.

R$F$

C$



Free Cash Free Cash Segment (F$)Segment (F$)

Base choice on yield Base choice on yield subject to risk-return subject to risk-return

trade-offs.trade-offs.

Any money market Any money market instrumentinstrument may be may be

selected for this selected for this segment.segment.

R$F$

C$


502331_Cash and Marketable Securities Management

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