1. 9.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Chapter 9 Cash and Marketable Securities Management

2. 9.2 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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, you should be able to:

3. 9.3 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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 Securities Management

4. 9.4 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Outsourcing Cash Balances to Maintain Investment in Marketable Securities Cash and Marketable Securities Management

5. 9.5 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Transactions Motive Transactions Motive – to meet payments arising in the ordinary course of business Speculative Motive Speculative Motive – to take advantage of temporary opportunities Precautionary Motive Precautionary Motive – to maintain a cushion or buffer to meet unexpected cash needs Motives for Holding Cash

6. 9.6 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Collections Disbursements Marketable securities investment Control through information reporting = Funds Flow= Information Flow Cash Management System

7. 9.7 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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 Cash Receipts

8. 9.8 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Collection Float Collection Float: Total time between the mailing of the check by the customer and the availability of cash to the receiving firm. ProcessingFloatAvailabilityFloatMailFloat Deposit Float Collection Float

9. 9.9 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Mail Float Mail Float: Time the check is in the mail. Customer mails check Firm receives check Mail Float

10. 9.10 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Processing Float Processing Float: Time it takes a company to process the check internally. Firm deposits check Firm receives check Processing Float

11. 9.11 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Availability Float Availability Float: Time consumed in clearing the check through the banking system. Firm deposits check Firm’s bank account credited Availability Float

12. 9.12 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Deposit Float Deposit Float: Time during which the check received by the firm remains uncollected funds. Processing Float Availability Float Deposit Float

13. 9.13 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Accelerate preparation and mailing of invoices computerized billing invoices included with shipment invoices are faxed advance payment requests preauthorized debits Earlier Billing

14. 9.14 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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 Payments

15. 9.15 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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. Lockbox Systems

16. 9.16 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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*

17. 9.17 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Disadvantage Cost of creating and maintaining a lockbox system. Generally, not advantageous for small remittances. Advantage Receive remittances sooner which reduces processing float. Lockbox System

18. 9.18 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Compensating Balance Demand deposits maintained by a firm to compensate a bank for services provided, credit lines, or loans. Cash Concentration The movement of cash from lockbox or field banks into the firm’s central cash pool residing in a concentration bank. Concentration Banking

19. 9.19 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Reduces availability float associated with check clearing. 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? Collections Improvements

20. 9.20 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Check Clearing for the 21 st 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. Collections Improvements

21. 9.21 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Check 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’ Collections Improvements

22. 9.22 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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 a central location: Concentration Banking

23. 9.23 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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. (1) Depository Transfer Check (DTC) Concentration Services for Transferring Funds

24. 9.24 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Definition: An electronic version of the depository transfer check (DTC). Electronic check image version of the DTC. (1) Electronic check image version of the DTC. (2) Cost is not significant and is replacing DTC. (2) Automated Clearinghouse (ACH) Electronic Transfer Concentration Services for Transferring Funds

25. 9.25 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Definition: A generic term for electronic funds transfer using a two- way communications system, like Fedwire. Funds are available upon receipt of the wire transfer. Much more expensive. (3) Wire Transfer Concentration Services for Transferring Funds

26. 9.26 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. “ 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 Cash Payouts

27. 9.27 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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 Float Net 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”

28. 9.28 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Solution: Centralize payables into a single (smaller number of) account(s). This provides better control of the disbursement process. 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. Control of Disbursements

29. 9.29 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Delays the time to have funds on deposit to cover the draft.Delays the time to have funds on deposit to cover the draft. Some suppliers prefer checks.Some suppliers prefer checks. Banks will impose a higher service charge due to the additional handling involved.Banks will impose a higher service charge due to the additional handling involved. 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 Disbursements

30. 9.30 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Many times a separate account is set up to handle each of these types of disbursements.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]A distribution schedule is projected based on 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 Disbursements The firm attempts to determine when payroll and dividend checks will be presented for collection. Methods of Managing Disbursements

31. 9.31 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. F M T W H F M and after (Payday) Percent of Payroll Collected 100% 75% 50% 25% 0% The firm may plan on payroll checks being presented in a similar pattern every pay period. Percentage of Payroll Checks Collected

32. 9.32 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Eliminates the need to accurately estimate each disbursement account. Eliminates the need to accurately estimate each disbursement account. Only need to forecast overall cash needs. Only need to forecast overall cash needs. 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. Methods of Managing Disbursements

33. 9.33 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Example: 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. Remote Disbursement 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. Remote and Controlled Disbursing

34. 9.34 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Late check presentments are minimal, which allows more accurate predicting of disbursements on a day-to-day basis. Controlled Disbursement 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 dollar amount of checks that will be presented against its account that day. Remote and Controlled Disbursing

35. 9.35 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Messaging systems can be: Unstructured faxes and e-mails 1. Unstructured – utilize technologies such as faxes and e-mails 2. Structured such as electronic data interchange (EDI). 2. Structured – utilize technologies such as electronic data interchange (EDI). Electronic Commerce Electronic Commerce – The exchange of business information in an electronic (non- paper) format, including over the Internet. Electronic Commerce

36. 9.36 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Electronic Data Interchange Electronic Data Interchange – The movement of business data electronically in a structured, computer-readable format. EDI Electronic Funds Transfer (EFT) Financial EDI (FEDI) Electronic Data Interchange (EDI)

37. 9.37 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. EDISubset Electronic Funds Transfer (EFT) Society of Worldwide Interbank Financial Telecommunications (SWIFT) Clearinghouse Interbank Payments System (CHIPS) Electronic Funds Transfer (EFT)

38. 9.38 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. EFT 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 Transfer (EFT)

39. 9.39 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Financial EDI Financial EDI – The movement of financially related electronic information between a company and its bank or between banks. Financial EDI (FEDI) Examples include Examples include: Lockbox remittance information Bank balance information EDISubset Financial EDI (FEDI)

40. 9.40 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Costs 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 floatBenefits 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 EDI

41. 9.41 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 1. Reducing and controlling operating costs 2. Improve company focus (close 2 nd ) 3. Freeing resources for other purposes * The Outsourcing Institute, 2005 Outsourcing Outsourcing – Subcontracting a certain business operation to an outside firm, instead of doing it “in-house.” Why might a firm outsource?* Outsourcing

42. 9.42 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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 Outsourcing

43. 9.43 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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. Cash Balances to Maintain

44. 9.44 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Note regarding the management of marketable securities. Marketable Securities are shown on the balance sheet as “Short-term Investments” Investment in Marketable Securities

45. 9.45 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Ready Cash Segment (R$) Optimal balance of marketable securities held to take care of probable deficiencies in the firm’s cash account. R$ F$ C$ The Marketable Securities Portfolio

46. 9.46 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Controllable Cash Segment (C$) Marketable securities held for meeting controllable (knowable) outflows, such as taxes and dividends. R$ F$ C$ The Marketable Securities Portfolio

47. 9.47 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Free Cash Segment (F$) “Free” marketable securities (that is, available for as yet unassigned purposes). R$ F$ C$ The Marketable Securities Portfolio

48. 9.48 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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. Safety Refers to the likelihood of getting back the same number of dollars you originally invested (principal). Variables in Marketable Securities Selection

49. 9.49 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Maturity Refers to the remaining life of the security. Interest Rate (or Yield) Risk The variability in the market price of a security caused by changes in interest rates. Variables in Marketable Securities Selection

50. 9.50 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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 Instruments All government securities and short-term corporate obligations. (Broadly defined) Common Money Market Instruments

51. 9.51 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. BEY = [ (1000 – 990) / (990) ] *[ 365 / 91 ] BEY = 4.05% 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?

52. 9.52 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. EAY = (1 + [.0405/(365 / 91)]) 365/91 - 1 EAY = 4.11% 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?

53. 9.53 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Treasury Bonds:Treasury Bonds: Long-term (more than 10 years’ original maturity) obligations of the US Treasury. Treasury Notes:Treasury Notes: Medium-term (2- 10 years’ original maturity) obligations of the US Treasury. Common Money Market Instruments

54. 9.54 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. 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. Common Money Market Instruments

55. 9.55 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. European Commercial Paper:European Commercial Paper: See above, except maturities extend to one year and more active secondary market. Commercial Paper:Commercial 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. Common Money Market Instruments

56. 9.56 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Federal Agency Securities:Federal Agency Securities: Debt securities issued by federal agencies and government- sponsored enterprises (GSEs). Examples: FFCB, FNMA, and FHLMC. Negotiable Certificate of Deposit:Negotiable 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. Common Money Market Instruments

57. 9.57 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Money Market Preferred Stock:Money Market Preferred Stock: Preferred stock having a dividend rate that is reset at auction every 49 days. Eurodollars:Eurodollars: A US dollar-denominated deposit – generally in a bank located outside the United States – not subject to US banking regulations Common Money Market Instruments

58. 9.58 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Ready Cash Segment (R$) Safety and ability to convert to cash is most important. Select US Treasuries for this segment. R$ F$ C$ Selecting Securities for the Portfolio Segments

59. 9.59 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Controllable Cash Segment (C$) Marketability less important. Possibly match time needs. May select CDs, repos, BAs, euros for this segment. R$ F$ C$ Selecting Securities for the Portfolio Segments

60. 9.60 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer. Free Cash Segment (F$) Base choice on yield subject to risk-return trade-offs. Any money market instrument may be selected for this segment. R$ F$ C$ Selecting Securities for the Portfolio Segments