Financial Mangement Slides Lecture 1
Financial Mangement Slides Lecture 1
Cash
Cash and
and Marketable
Marketable
Securities
Securities
Management
Management
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Created by: Gregory A. Kuhlemeyer, Ph.D.
Carroll College, Waukesha, WI
1
After studying Chapter 9,
you should be able to:
List and explain the motives for holding cash.
Understand the purpose of efficient cash management.
Describe methods for speeding up the collection of accounts receivable
and methods for controlling cash disbursements.
Differentiate between remote and controlled disbursement, and discuss
any ethical concerns raised by either of these two methods.
Discuss how electronic data interchange (EDI) and outsourcing each
relates to a company’s cash collections and disbursements.
Identify the key variables that should be considered before purchasing
any marketable securities.
Define the most common money-market instruments that a marketable
securities portfolio manager would consider for investment.
Describe the three segments of the marketable securities portfolio and
note which securities are most appropriate for each segment and why.
2
Cash and Marketable
Securities Management
Outsourcing
Cash Balances to Maintain
Investment in Marketable
Securities
4
Motives for Holding Cash
Transactions Motive -- to meet
payments arising in the ordinary
course of business
Speculative Motive -- to take
advantage of temporary opportunities
Precautionary Motive -- to maintain a
cushion or buffer to meet unexpected
cash needs
5
Cash Management System
Collections Disbursements
Marketable securities
investment
Deposit Float
Collection Float:
Float total time between the mailing
of the check by the customer and the availability
of cash to the receiving firm.
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Mail Float
Customer Firm
mails check receives check
Mail Float:
Float time the check is in the mail.
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Processing Float
Firm Firm
receives check deposits check
Processing Float:
Float time it takes a company
to process the check internally.
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Availability Float
Availability Float:
Float time consumed in clearing
the check through the banking system.
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Deposit Float
Deposit Float:
Float time during which the check
received by the firm remains uncollected funds.
12
Earlier Billing
Accelerate preparation and
mailing of invoices
computerized billing
invoices included with shipment
invoices are faxed
advance payment requests
preauthorized debits
13
Preauthorized Payments
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.
14
Lockbox Systems
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.
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Lockbox Process*
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
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Lockbox System
Advantage
Receive remittances sooner which
reduces processing float.
Disadvantage
Cost of creating and maintaining a
lockbox system. Generally, not
advantageous for small remittances.
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Concentration Banking
Cash Concentration
The movement of cash from lockbox or
field banks into the firm’s central cash
pool residing in a concentration bank.
Compensating Balance
Demand deposits maintained by a firm
to compensate a bank for services
provided, credit lines, or loans.
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Concentration Banking
Moving cash balances to
a central location:
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.
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Concentration Services
for Transferring Funds
(1) Depository Transfer Check (DTC)
25%
0%
F M T W H F M and after
(Payday)
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Methods of Managing
Disbursements
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.
Eliminates the need to accurately
estimate each disbursement account.
Only need to forecast overall cash needs.
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Remote and
Controlled Disbursing
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.
EDI
Financial EDI (FEDI)
33
Electronic Funds
Transfer (EFT)
Electronic Funds Transfer (EFT) -- the electronic
movements of information between two
depository institutions resulting in a value
(money) transfer.
New Regulation
In January 1999, a new regulation requires
ALL federal government payments be made
electronically.* This will:
• provide more security than paper checks and
• be cheaper to process for the government.
35
Financial EDI (FEDI)
Financial EDI -- The movement of financially
related electronic information between a
company and its bank or between banks.
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Cash Balances to Maintain
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.
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Investment in
Marketable Securities
Marketable Securities are shown
on the balance sheet as:
1. Cash equivalents if maturities are
less than three (3) months at the
time of acquisition.
2. Short-term investments if remaining
maturities are less than one (1)
year.
40
The Marketable
Securities Portfolio
Ready Cash
Segment (R$)
F$
Optimal balance of
R$ marketable securities
held to take care of
C$ probable deficiencies
in the firm’s cash
account.
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The Marketable
Securities Portfolio
Controllable Cash
Segment (C$)
F$
Marketable securities
R$ held for meeting
controllable
C$ (knowable) outflows,
such as taxes and
dividends.
42
The Marketable
Securities Portfolio
Free Cash
Segment (F$)
F$
“Free” marketable
R$ securities (that is,
available for as yet
C$ unassigned
purposes).
43
Variables in Marketable
Securities Selection
Safety
Refers to the likelihood of getting back the
same number of dollars you originally
invested (principal).
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.
44
Variables in Marketable
Securities Selection
Interest Rate (or Yield) Risk
The variability in the market price of a
security caused by changes in
interest rates.
Maturity
Refers to the remaining life of the
security.
45
Common Money
Market Instruments
Money Market Instruments
All government securities and short-term
corporate obligations. (Broadly defined)
Treasury Bills (T-bills): Short-term,
non-interest bearing obligations of the
U.S. Treasury issued at a discount and
redeemed at maturity for full face
value. Minimum $1,000 amount and
$1,000 increments thereafter.
46
T-Bills and Bond Equivalent
Yield (BEY) Method:
BEY = [ (FA – PP) / (PP) ] *[ 365 / DM ]
• FA: face amount of security
• PP: purchase price of security
• DM: days to maturity of security
48
Common Money
Market Instruments
Treasury Notes: Medium-term
(2-10 years’ original maturity)
obligations of the U.S. Treasury.
52
Common Money
Market Instruments
Eurodollars: A U.S. dollar-
denominated deposit -- generally in a
bank located outside the United
States -- not subject to U.S. banking
regulations
Money Market Preferred Stock:
Preferred stock having a dividend
rate that is reset at auction every 49
days.
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Selecting Securities for
the Portfolio Segments
Ready Cash
Segment (R$)
F$
Safety and ability to
R$ convert to cash is
most important.
C$
Select U.S.
Treasuries for this
segment.
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Selecting Securities for
the Portfolio Segments
Controllable Cash
Segment (C$)
F$
Marketability less
R$ important. Possibly
match time needs.
C$
May select CDs,
repos, BAs, euros for
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this segment.
Selecting Securities for
the Portfolio Segments
Free Cash
Segment (F$)
F$
Base choice on yield
R$ subject to risk-return
trade-offs.
C$ Any money market
instrument may be
selected for this
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segment.