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GRADUATE SCHOOL OF BUSINESS AND MANAGEMENT

Master of Business Administration

FINANCIAL MANAGEMENT

Topic: Cash management

Case Study: Manila Mill Supply, Inc.

Problem 10-A12: “Playing the Float”

Submitted by:

MICHAEL JOHN ROLAND M. ARCAY

Mentored by:

PROF. FAUSTINA C. RANA

CASH MANAGEMENT

Cash management is the process of collecting and managing cash flows. Cash
management can be important for both individuals and companies. In business, it is a key
component of a company's financial stability. For individuals, cash is also essential for financial
stability while also usually considered as part of a total wealth portfolio. Individuals and
businesses have a wide range of offerings available across the financial marketplace to help
with all types of cash management needs. Banks are typically a primary financial service
provider for the custody of cash assets. There are also many different cash management
solutions for individuals and businesses seeking to obtain the best return on cash assets or the
most efficient use of cash comprehensively.

To understand it further, Cash is the primary asset individuals and companies use to pay
their obligations on a regular basis. In business, companies have a multitude of cash inflows
and outflows that must be prudently managed in order to meet payment obligations, plan for
future payments, and maintain adequate business stability. For individuals, maintaining cash
balances while also earning a return on idle cash are usually top concerns. In corporate cash
management, also often known as treasury management, business managers, corporate
treasurers, and chief financial officers are typically the main individuals responsible for overall
cash management strategies, cash related responsibilities, and stability analysis. Many
companies may outsource part or all of their cash management responsibilities to different
service providers. Regardless, there are several key metrics that are monitored and analyzed by
cash management executives on a daily, monthly, quarterly, and annual basis.1

Managing cash has become more sophisticated in the new global and electronic age as
financial managers try to squeeze every dollar of profit out of their cash management strategies.
Despite whatever lifelong teachings you might have learned about the virtues of cash, the
corporate manager actively seeks to keep this nonearning asset to a minimum. Generally, the
less cash you have the better off you are; however, you still do not want to get caught without
cash when you need it. With lower interest rates today and, hence, lower opportunity costs,
firms have opted for higher cash balances. The penalties imposed by short‐term creditors and
bankers when a company runs out of cash may have a lasting impact on relationships. Highly
liquid securities or standby lines of credit available through banking arrangements can meet
cash needs quickly. Liquidity, a desirable characteristic of financial assets, may be defined as
the degree to which a financial asset can be converted into cash quickly and at fair market
value.

Minimizing cash balances as well as having accurate knowledge of when cash moves
into and out of the company can improve overall corporate profitability. Knowledge of the cash
flow cycle can assist in understanding cash management, and the financial forecasting pro
formas are invaluable tools for identifying the cash requirements of the firm. The small business
1
Cash Management by Will Kenton, July 17, 2019 - https://www.investopedia.com/terms/c/cash-
management.asp
often runs into difficulties when these cash requirements are not properly identified and
appropriate arrangements are not made to provide financing as it is needed.

REASONS FOR HOLDING CASH BALANCES

There might be several reasons for holding cash or highly liquid marketable securities:

 Transactions of an immediate (payrolls) or strategic nature (mergers, acquisitions);

Compensating balances for bank services;
 Precautionary balances if bank financing becomes unavailable (cyclical, seasonal, new
product oriented businesses); and
 Avoiding taxes by not repatriating cash.2

Float

Float exists as a result of the time lag between when a payment or receipt is recorded in
the corporation’s ledgers and the eventual acknowledgement that it has altered the corporate
bank account.

Float arises from payments or receipts that are:

 In the mail
 Clearing the banking system
 Being processed
 Slow to be acknowledged by the firm’s (bank’s) information system

With float, the firm’s funds may not be deployed effectively or, conversely, the firm may take
advantage of float opportunities. The efficient Canadian banking system with over $170 billion
cleared daily (2013) provides same‐day clearing (unlike the United States’ next‐day clearing)
and has virtually eliminated its contribution to float. Nevertheless, float still remains, but with
large volumes of payments and receipts, float time can become fairly predictable, and therefore,
can be effectively managed.

Table 7–1 provides an example determining the bank records for usable funds. Perhaps
only $800,000 of the deposits (cheques from customers) have been processed and deposited to
the firm’s account, and only $400,000 of the firm’s cheques may have completed a similar cycle.
Float will then provide $300,000 in extra short‐term funds. Some companies actually operate
with a negative cash balance on the corporate books, knowing that float will carry them through
at the bank. Table 7–2 represents the phenomenon known as “playing the float.” The firm may
write $1.2 million in cheques, estimating that only $800,000 will clear by the end of the week,
thus leaving it with surplus funds in its bank account. The negative balance on the corporation’s

2
Cash Management - Foundation of Financial Management, Tenth Canadian Edition, 2015 by
Stanley B. Block
books becomes a positive temporary balance on the bank’s books from the float of $200,000.
Obviously, float can also work against the firm if cheques going out are being processed more
quickly than cheques coming in.

A lockbox system is an alternative to collection at local branch offices (they may not exist) or
when customers are scattered across and outside the country. Under this plan, customers
forward their cheques to a post office box in one of the cities that serve as regional data
processing centres for the chartered banks. This allows the bank to process the cheques
immediately through its computer network and credit the firm’s account on a timelier basis. The
firm is notified of the deposit and can do its accounting after the funds have already been put to
work. The company, thus, retains many of the benefits of regional branch office collections and,
with lower cheque processing costs, reduces corporate overhead.

On the other side of the ledger, it is important that disbursements be made only when due and
not before. This allows a firm to retain the use of these funds for a longer period and to utilize
them to increase returns.

Cash Management Analysis

An efficiently maintained cash management program can be an expensive operation. Using a

cost‐benefit analysis, the expenses of setting up a program must be compared to the benefits
that may accrue. Cost‐benefit analysis provides a framework to identify all the resultant changes
arising from a decision. Some results will be incremental, increasing the firm’s value, and some
will be decremental, decreasing value. Good value‐adding decisions will ensue when the
benefits exceed the costs. Cost‐benefit analysis (as demonstrated under the topic “cash
management analysis”) must consider explicit and implicit costs and benefits. Opportunity costs
(benefits) are forgone alternatives. Employee time and effort resulting from a new procedure
must be considered if it could have been directed elsewhere, if not for the new procedure.
Capital that is tied up as a result of a new project could have been earning a return elsewhere in
the firm. As we examine and analyze techniques for working capital management, consideration
should be given to:

 Employee costs for training, implementation, and monitoring

 New technology required
 Capital tied up (or freed up)
 Rates of return on capital
 Timeliness of information provided (whether better or worse)
 Exposure to risk
 Fees or charges

Careful thought and information gathering must be the inputs into cost‐benefit analysis. We will
use this technique as a foundation to many of the techniques to follow. Several tools can be
used by the financial manager to analyze whether a decision will create shareholder value.
Common methods to measure value include net present value (NPV), break‐even analysis, as
well as sensitivity analysis. A cost-benefit analysis is a process businesses use to analyze
decisions. The business or analyst sums the benefits of a situation or action and then subtracts
the costs associated with taking that action. The outcome of the analysis will determine whether
the project is financially feasible or if the company should pursue another project.

In many models, a cost-benefit analysis will also factor the opportunity cost into the decision-
making process. Opportunity costs are alternative benefits that could have been realized when
choosing one alternative over another. In other words, the opportunity cost is the forgone or
missed opportunity as a result of a choice or decision. Factoring in opportunity costs allows
project managers to weigh the benefits from alternative courses of action and not merely the
current path or choice being considered in the cost-benefit analysis. By considering all options
and the potential missed opportunities, the cost-benefit analysis is more thorough and allows for
better decision-making.

Suppose a firm has average daily collections of $2 million and 1.5 days can be saved in the
collection process by establishing a sophisticated collection network. Also, through stretching
the disbursement schedule by one day, perhaps another $2 million becomes available for
alternative uses. The money that could be earned on this freed‐up capital represents a
significant opportunity benefit to the firm. An example of this process is shown in Figure 7–1. To
complete the example, suppose the bank that sets up the cash management system will charge
monthly fees of $15,000, but will also provide you with more timely information worth $40,000 a
year to your firm. If the firm is able to earn 4 percent on the funds freed up, is the bank’s system
worth it?
Based on the results, the new system is worth it.
Case Study – Manila Mill Supply, Inc.

I. Viewpoint:

- Mariano Gonzalez, newly-hired finance manager

II. Time Context:

- 1996

III. Definition of the problem:

- Cumbersome collection system resulting to cash float.

IV. Objectives:

Must:

Determine whether direct collection is better than the collection service offered by
Oriental Bank in terms of playing the float.

Want:

Shift to a more effective system, either direct collection or avail the service offered by
Oriental bank, to maximize the float for profitable use.

V. Areas of Consideration:

Strengths Weaknesses Opportunities Threats

• Controlled • Difficulty in • Play with the • The company

collections handling the float might commit
check collections some errors due
• Established from mail leading • Speed up the to adjustment to
collection to discrepancies collection time change in
system in records; collection system
•
• Cumbersome
Collection
System

VI. Alternative Courses of Action (ACA):

ACA 1 – Direct Collection

Advantages:

1. It will speed up collection by four (4) days;

2. Simple; which will reduce the difficulties in handling the checks; and

3. Convenient on the part of the dealers.

Disadvantages:

1. It will entail additional costs;

2. Additional supervision of employees

ACA 2 - Oriental Bank (outsource)

Advantages:

1. It will speed up collection by two (2) days; and

2. Convenient on the part of the dealers.

Disadvantages:

1. It will entail additional costs;

2. Complex; and

3. Collection will not be under the company’s control.

ACA Computations – Cash Management Analysis using Cost Benefit Analysis

Weekly Freed-up Funds = Amount of collections per week – number of weeks

speed up

= 1 week
P800,000/week x (4 days x )
5 banking days

Weekly Freed-up Funds = P640,000.00

 Annual Freed-up Funds = Weekly Freed-up funds x 52 weeks

= P640,000.00 x 52

Annual Freed-up Funds = P33,280,000.00

Annual Opportunity Benefit = Annual Freed-up Funds x ROI

= P33,280,000.00 x 0.18

Annual Opportunity Benefit = P5,990,400.00 (ACA 1)

Weekly Freed-up Funds = 1 week

P800,000/week x (2 days x )
5 banking days

Weekly Freed-up Funds = P320,000.00

Annual Freed-up Funds = P320,000.00 x 52

Annual Freed-up Funds = P16,640,000.00

Annual Opportunity Benefit = P16,640,000.00 x 0.18

Annual Opportunity Benefit = P2,995,200.00 (ACA 2)

 NOTE:

Net Benefit = Annual Opportunity Benefit – Total Additional Cost

VII. Recommendation:

In this case, ACA 1 – Direct Collection using the main office vehicles and collectors is
recommended. Both ACA 1 and ACA 2 provide services that is more convenient than the
present. However, albeit ACA 1 adds more costs than the other, ACA 1 is much superior
with ACA 2 in all other considerations.

In terms of reducing the float, ACA 1 provides services twice as fast as the other which
reduces the float and thus allows the company to utilize the money for a more profitable use.

In terms of complexity of system, ACA 1 is much simpler than the other which will reduce the
difficulties in handling the checks and thus reduces chances of error.
SOLUTION TO PROBLEM 10-A12: “Playing the float”

Given:
Banco de Plata – Deposit
Banco de Guello – Withdrawal
Time for banks to clear checks = 4days (a check made out on Monday was cleared on
Thursday afternoon.
Minimum Average Compensating balance = P200,000
Company’s Cash Balance = P200,000
Issued check average = P200,000 each day
No issuance of check in 5 days.

Required:
a. From hereon in, how much should the company deposit each day with Banco de Guello?
b. How many days of float does the company carry?
c. Recommend a policy which the company can adopt to take advantage of the float? What will
be the financial return on this policy?

Solution:
Corporate books
Initial Amount 200,000
Deposit ?
Checks (200,000)
Balance 200,000

Deposit = 200,000

a. Deposit = P200,000 per day.

b. Four (4) days.

c. Increase the amount of checks to P800,000 to every 3 days before due date.

Corporate books Bank Books

Initial Amount 200,000 Initial Amount 200,000
Deposit 200,000 Deposit 200,000
Checks (800,000) Checks (200,000)
Balance -400,000 Balance 200,000

Float = 200,000 – (-400,000)

Float = 600,000