2Chapter 10 AgendaUnderstand 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.
3Cash 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.
4Cash ConcentrationLockbox 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).
6Types of Concentration Systems Firms have two, basic concentration system options:Decentralized Transfer InitiationThe 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 InitiationBanks 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.
7Concentration 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.
8Decentralized 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 TransferAn immediate transfer of funds with immediate availability.Wires are expensive with an incoming and outgoing charge.Only collected funds can be transferred.
9Decentralized 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 methodi = Annual opportunity costECR = Earnings Credit Raterrr = Required Reserve RatioTBAL = Balance to be transferred.
10Decentralized 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?
11Decentralized Transfer Example Transfers must be at least this amount to justify using wires versus EDT.Where:DS = # of days saved with faster transfer methodi = Annual opportunity costECR = Earnings Credit Raterrr = Required Reserve RatioTBAL = Balance to be transferred.
13Cash 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.
14Cash 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.
15Cash Concentration Analysis Create a 2-week schedule of deposit/transfer clearing activity.Add funds availability
16Cash 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 DayAdd Daily Transfers and calculate Ledger Balance
17Cash 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 DepositsCalculate Collected BalanceCalculat Collected Balance
18Cash 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’
19Cash Transfer Scheduling Scheduling transfers is complicated by:Fluctuations in daily depositsVarying availabilityDifficulty in matching time delay in deposit instrument with availability schedule.No weekend banking
20Cash Transfer Scheduling Guidelines for cash concentrationDaily Transfer ruleTransfer all available balances every dayManaging about a targetBegin with $0 in accountTransfer when average daily balance reaches target (RCMP?)AnticipationTransfer expected available balance (requires a forecasting system)Weekend timingFriday balances have 3-day opportunity cost