Short-Term Financial Management Chapter 10 – Cash Concentration

Chapter 10 Agenda Understand 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.

Cash 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.

Cash Concentration Lockbox 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).

Cash Concentration Timeline

Types of Concentration Systems Firms have two, basic concentration system options: Decentralized Transfer Initiation The 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 Initiation Banks 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.

Concentration 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.

Decentralized 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 Transfer An immediate transfer of funds with immediate availability. Wires are expensive with an incoming and outgoing charge. Only collected funds can be transferred.

Decentralized 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 method i = Annual opportunity cost ECR = Earnings Credit Rate rrr = Required Reserve Ratio TBAL = Balance to be transferred.

Decentralized 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?

Decentralized Transfer Example Transfers must be at least this amount to justify using wires versus EDT. Where: DS = # of days saved with faster transfer method i = Annual opportunity cost ECR = Earnings Credit Rate rrr = Required Reserve Ratio TBAL = Balance to be transferred.

Centralized Concentration Services

Cash 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.

Cash 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.

Cash Concentration Analysis Create a 2-week schedule of deposit/transfer clearing activity. Add funds availability

Cash 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 Day Add Daily Transfers and calculate Ledger Balance

Cash 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 Deposits Calculate Collected Balance Calculat Collected Balance

Cash 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’

Cash Transfer Scheduling Scheduling transfers is complicated by: Fluctuations in daily deposits Varying availability Difficulty in matching time delay in deposit instrument with availability schedule. No weekend banking

Cash Transfer Scheduling Guidelines for cash concentration Daily Transfer rule Transfer all available balances every day Managing about a target Begin with $0 in account Transfer when average daily balance reaches target (RCMP?) Anticipation Transfer expected available balance (requires a forecasting system) Weekend timing Friday balances have 3-day opportunity cost