1. Copyright  2005 by Thomson Learning, Inc. Chapter 10 Cash Concentration Order Order Sale Payment Sent Cash Placed Received Received Accounts Collection Accounts Collection Time ==> Time ==> Accounts Disbursement Accounts Disbursement Invoice Received Payment Sent Cash Disbursed Invoice Received Payment Sent Cash Disbursed Order Order Sale Payment Sent Cash Placed Received Received Accounts Collection Accounts Collection Time ==> Time ==> Accounts Disbursement Accounts Disbursement Invoice Received Payment Sent Cash Disbursed Invoice Received Payment Sent Cash Disbursed

2. Copyright  2005 by Thomson Learning, Inc. Learning Objectives v Understand the need for a cash concentration system. v Formulate a cash transfer decision model. v Understand the advantages and disadvantages of the different cash transfer tools.

3. Copyright  2005 by Thomson Learning, Inc. Cash Concentration 3 v 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.) v Maintaining idle balances dispersed across many accounts at multiple banks ties up cash (opportunity cost).

4. Copyright  2005 by Thomson Learning, Inc. Cash Concentration Timeline 4

5. Copyright  2005 by Thomson Learning, Inc. Types of Concentration Systems 5 v Firms have two, basic concentration system options: v 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. v 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.

6. Copyright  2005 by Thomson Learning, Inc. Cash Concentration System

7. Copyright  2005 by Thomson Learning, Inc. Basic Structure v Exhibit 10.1 v Cash transfer tools v Initiation of the transfer v System costs v Benefits of the system

8. Copyright  2005 by Thomson Learning, Inc. Cash Transfer Tools v Depository transfer checks : –non negotiable, usually unsigned, check payable to a single bank account at a particular bank. The transfer amount is generally the amount of Deposit v ACH or EDT –The ‘concentration bank’ initiates transfers from the ‘collection’ or ‘gathering’ banks on a next-day basis. v 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.

9. Copyright  2005 by Thomson Learning, Inc. Costs of Concentration System v Transfer cost –Wire transfer costs between $15- $20 –EDT cost roughly $.25 v Administrative Cost v Opportunity cost of idle balances

10. Copyright  2005 by Thomson Learning, Inc. Benefits of the System v Economies of scale v Enhanced visibility and control of balances v Dual balance possibilities

11. Copyright  2005 by Thomson Learning, Inc. Complicating Factors v Minimum transfer balance –Set incremental cost = Days Saved x ((k - ecr(1-rr)) x TBAL –Solve for TBAL –TBAL = Incremental cost/DS x [k - ecr(1-rr)/365] v Fluctuating daily deposits v Deposits with different availabilities v Availability of deposits vs. clearing of transfer instrument v Weekends

12. Copyright  2005 by Thomson Learning, Inc. Minimum Transfer Balance 12  If the firm choose between two alternative,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 DS = Number of days saved with faster transfer method i = Annual opportunity cost i = Annual opportunity cost ECR = Earnings Credit Rate ECR = Earnings Credit Rate rrr = Required Reserve Ratio rrr = Required Reserve Ratio TBAL = Balance to be transferred. TBAL = Balance to be transferred.

13. Copyright  2005 by Thomson Learning, Inc. Minimum Transfer Balance 13  A firm is choosing between wires and EDT.  Wires cost more, but have longer float.  What minimum transfer amount justifies the use of wires?

14. Copyright  2005 by Thomson Learning, Inc. Minimum Transfer Balance 14 Where: DS = # of days saved with faster transfer method DS = # of days saved with faster transfer method i = Annual opportunity cost i = Annual opportunity cost ECR = Earnings Credit Rate ECR = Earnings Credit Rate rrr = Required Reserve Ratio rrr = Required Reserve Ratio TBAL = Balance to be transferred. TBAL = Balance to be transferred. Transfers must be at least this amount to justify using wires versus EDT.

15. Copyright  2005 by Thomson Learning, Inc. Objective: Minimize Transfer Costs v Subject To: adequate bank compensation v TC = Fee + (k x (ACB - RCB)) Where: RCB = (SC - Fee)/ecr(1-rr)

16. Copyright  2005 by Thomson Learning, Inc. Transfer Rules v Daily transfer: transfer the daily deposit v Managing about a target: –one-time transfer out to earn interest –reduces the number of transfers v Anticipation: initiate transfer prior to deposit

17. Copyright  2005 by Thomson Learning, Inc. Summary v A collection system such as a lockbox necessitates the development of a concentration system. v This chapter discussed the structure of a cash concentration system and identified the advantages and disadvantages. v The chapter developed an objective function for the cash transfer scheduling problem. v Three transfer scheduling rules were identified and discussed. v The chapter concluded by comparing cash concentration characteristics.