Professional Documents
Culture Documents
Sixth Edition
28
Prepared by Gady Jacoby University of Manitoba and Sebouh Aintablian American University of Beirut
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2003 McGrawHill Ryerson Limited
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Executive Summary
Cash management is not as complex and conceptually challenging as other topics, such as capital budgeting and asset pricing. Financial managers in many companies, especially in the retail and services industries, spend a significant portion of their time on cash management. Most large Canadian corporations hold some of their assets in cash and marketable securities.
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Chapter Outline
28.1 Reasons for Holding Cash 28.2 Determining the Target Cash Balance 28.3 Managing the Collection and Disbursement of Cash 28.4 Investing Idle Cash 28.5 Summary & Conclusions
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Trading costs increase when the firm must sell securities to meet cash needs.
Total cost of holding cash
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1
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Time
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Time
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C Opportunity Costs K 2
Trading costs T F
C* Size of cash balance The optimal cash balance is found where the opportunity costs equal the trading costs 2T * C F 2003 McGrawHill Ryerson Limited McGraw-Hill Ryerson K
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C T K F 2 C
Multiply both sides by C
C2 K T F 2
2TF C K
*
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T F C 2 K
2
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H
When the cash balance reaches the lower control limit, L, investments are sold Z to raise cash to get us up to the target cash balance. L
Time
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3F Z L 4K
2 * 3
H 3Z 2L
* *
where s2 is the variance of net daily cash flows. The average cash balance in the Miller-Orr model is
4Z * L Average cash balance 3
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
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The best return point, Z, is positively related to trading costs, F, and negatively related to the interest rate K. Z and the average cash balance are positively related to the variability of cash flows.
McGraw-Hill Ryerson
2003 McGrawHill Ryerson Limited
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Relative costs
For large firms, the trading costs of buying and selling securities are very small when compared to the opportunity costs of holding cash.
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Disbursement of Cash
The difference between bank cash and book cash is called float. Float management involves controlling the collection and disbursement of cash. The objective in cash collection is to reduce the lag between the time customers pay their bills and the time the cheques are collected. The objective in cash disbursement is to slow down payments, thereby increasing the time between when cheques are written and when cheques are presented.
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Accelerating Collections
Customer mails payment Company receives payment Company deposits payment Cash received
time
Mail delay Processing delay Clearing delay
Mail float
Processing float
Clearing float
Collection float
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Local Bank Collects funds from PO Boxes Envelopes opened; separation of cheques and receipts
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Controlling Disbursements
Firms use zero-balance accounts to avoid carrying extra balances in each disbursement account. With a zero-balance account, the firm, in cooperation with its bank, transfers in just enough funds to cover cheques presented that day. The firm maintains two disbursement accounts: one for suppliers and one for payroll.
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Long-term financing
J
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Default risk
DBRS compiles and publishes ratings of various corporate and public securities.
Marketability
No price-pressure effect Time.
Taxability
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Examples are:
T-bills Commercial paper Bankers acceptances Dollar swaps
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The financial managers must always work with collected company cash balances and not with the companys book balance.
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