 Cash Management Principles of Corporate Finance Brealey and Myers Sixth Edition Slides by Matthew Will Chapter 31 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Topics Covered  Inventories and Cash Balances  Cash Collection and Disbursement Systems  Float  Bank Relations

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Inventories & Cash Balances Economic Order Quantity - Order size that minimizes total inventory costs.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Inventories & Cash Balances Determination of optimal order size Inventory costs, dollars Order size Total costs Carrying costs Total order costs Optimal order size

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Inventories & Cash Balances  The optimal amount of short term securities sold to raise cash will be higher when annual cash outflows are higher and when the cost per sale of securities is higher. Conversely, the initial cash balance falls when the interest is higher.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Inventories & Cash Balances  Money Market - market for short term financial assets.  commercial paper  certificates of deposit  repurchase agreements

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Inventories & Cash Balances Value of bills sold = Q = 2 x annual cash disbursement x cost per sale interest rate 2 x 1260 x Weeks balance ($000) Cash Average inventory = = (Everyman’s Bookstore)

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Float  Time exists between the moment a check is written and the moment the funds are deposited in the recipient’s account.  This time spread is called Float. Payment Float - Checks written by a company that have not yet cleared. Availability Float - Checks already deposited that have not yet cleared.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Float Payment Float illustration - The company issues a $200,000 check that has not yet cleared.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Float Payment Float illustration - The company issues a $200,000 check that has not yet cleared. Company’s ledger balance $800,000 + Payment float $200,000

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Float Payment Float illustration - The company issues a $200,000 check that has not yet cleared. Company’s ledger balance $800,000 + Payment float $200,000 equals Bank’s ledger balance $1,000,000

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Float Availability Float illustration - The company deposits a $100,000 check that has not yet cleared.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Float Availability Float illustration - The company deposits a $100,000 check that has not yet cleared. Company’s ledger balance $900,000 + Payment float $200,000

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Float Availability Float illustration - The company deposits a $100,000 check that has not yet cleared. Company’s ledger balance $900,000 + Payment float $200,000 equals Bank’s ledger balance $1,100,000

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Float Net Float illustration Net float = payment float - availability float

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Float Net Float illustration Net float = payment float - availability float Bank’s ledger balance $1,100,000

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Float Net Float illustration Net float = payment float - availability float Available balance $1,000,000 + Availability float $100,000 equals Bank’s ledger balance $1,100,000

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Managing Float  Payers attempt to create delays in the check clearing process.  Recipients attempt to remove delays in the check clearing process.  Sources of delay  Time it takes to mail check  Time for recipient to process check  Time for bank to clear check

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Managing Float Check mailed

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Managing Float Check mailed Check received Mail float

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Managing Float Check mailed Check received Check deposited Mail float Processing float

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Managing Float Check mailed Check received Check deposited Cash available to recipient Check charged to payer’s account Mail float Processing float Presentation float Availability float

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Managing Float Concentration Banking - system whereby customers make payments to a regional collection center which transfers the funds to a principal bank. Lock-Box System - System whereby customers send payments to a post office box and a local bank collects and processes checks. Zero-Balance Accounts - Regional bank accounts to which just enough funds are transferred daily to pay each day’s bills.